El inicio de Trump (y lo que se avecina)

David Lafferty, Natixis Global AM - Jueves, 26 de Enero

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The electoral votes have been counted. Congress has certified. Cabinet members have been nominated and are being confirmed. The inaugural parade made its way to the White House. The Trump Train has arrived. Change is what happens over time, and it’s also what makes investing interesting and challenging. This month we take a big picture look at President Trump and the change that he will bring. No charts, graphs or tables. Just a step back to try to get some perspective. Unlike polarized party politics, the economic implications are much more nuanced. In our view, Trumponomics holds within it the potential for big surprises, to both the upside and downside.

Inauguration Day

The electoral votes have been counted. Congress has certified. Cabinet members have been nominated and are being confirmed. The inaugural parade made its way to the White House. The Trump Train has arrived.

Change is what happens over time, and it’s also what makes investing interesting and challenging. This month we take a big picture look at President Trump and the change that he will bring. No charts, graphs or tables. Just a step back to try to get some perspective. Unlike polarized party politics, the economic implications are much more nuanced. In our view, Trumponomics holds within it the potential for big surprises, to both the upside and downside.

A Modest Boost to Growth

Much has been written and said about the incoming president’s platform and agenda. To quickly review, the shorthand of Trumponomics includes 1) a significant increase in government spending focused on infrastructure, 2) major tax cuts for both individuals and corporations, 3) rolling back existing (and limiting future) regulation, and 4) on-shoring jobs with the threat of tariffs for unfair trade practices. On the surface, there is much to like here. Post-financial crisis, the U.S. – and much of the globe – have fallen into a growth funk. The recovery and expansion since 2009 is renowned for being the weakest in modern economic history. More spending, lower taxes, more domestic production, and less regulation will be a supply-side cure to our secular stagnation, right?

Maybe. On the surface, the Trump agenda should create a more favorable macroeconomic landscape. At first blush, this backdrop should increase growth, push up inflation, and boost business performance (i.e., revenues and earnings). This positive outlook was (naively) reflected by markets in the early weeks after the election with real rates, stocks, and the U.S. dollar soaring. But there are few easy solutions, and even with both houses of Congress in line, legislative progress will take time. Infrastructure projects have to be planned. Even simple tax reform can get messy and the Trump plan is wide-reaching. Deregulation can create unintended consequences (more on this later). Moreover, Trumponomics can’t immediately reverse weak labor force growth in the U.S. (and much of the developed world) due to Baby Boom generation demographics. In the last month (mid-December to early January), the post-election, risk- on euphoria has given way to a more modest and more realistic assessment.

David F. Lafferty, CFA
SVP – Chief Market Strategist

Productivity: The Linchpin of Optimism

So what does the “Trump upside” look like? Lower individual tax rates should boost personal consumption while infrastructure projects boost government spending. But our hopes within the Trump agenda rest largely on jumpstarting productivity growth that has been weak for several years (partially for reasons that remain a mystery). Infrastructure spending will provide a short-term jolt, but its real upside will only come if it’s correctly targeted at improving the long-term productivity of the economy. This includes projects like transportation upgrades, greater access and bandwidth across technology, better education and worker (re)training, safeguarding clean air/land/water, and improving cyber protection and reliability. In short, solving 21st century problems. Alternatively, bridges to nowhere, pork-barrel Congressional favors, and fruitless attempts to bring back low- skilled industries will fail to create any lasting effects (other than to increase fiscal deficits).

Second, lowering corporate tax rates will, by definition, improve corporate profitability. That improvement could stoke capital expenditures, which have been sub-par for several years, thereby improving productivity (or so the theory goes). Will corporate executives flush with higher after-tax profits reinvest in their businesses? Or will they simply return those profits to shareholders in the form of dividends and stock buy- backs? This of course will depend on the business environment. Here, a wide-ranging deregulatory agenda could prove most important. Without doubt, red tape has taken its toll on business (particularly small business) in recent years. The U.S. economy has lost dynamism and business formation has languished. The new president’s pro-business, anti-regulation message is being viewed enthusiastically. As if on cue, the NFIB Small Business Optimism Index, which has been stalled in recent years at levels not consistent with actual growth, skyrocketed in November and December. Perhaps the post-election growth euphoria will be justified if Trumponomics can get entrepreneurs and fraidy-cat CEOs to emerge from their bunkers.

Now, the Downside...

The very nature of tail risks makes them hard to quantify or classify, so here is a simple list:
1) Inflation, higher rates, and an unfriendly Fed – Larger

deficits tend to be inflationary, and major spending programs are likely to push up wages in an economy already approaching full employment. Nominal rates out the curve could rise on both higher real rates and inflation

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CAPITAL MARKET NOTES

expectations. This would likely be met by a less accommodative central bank. Some expect these factors to drive the U.S. dollar higher. There is certainly a risk that these tighter financial conditions could derail the economy before lasting growth can materialize.

1. 2)  Trade and tariffs – It’s hard to argue that infrastructure spending, lower taxes, and less regulation wouldn’t push growth at least modestly higher. But Trump’s “America First” protectionist ideas fail even a basic understanding of macroeconomics and put at risk what is otherwise a relatively strong pro-growth agenda. When properly measured, trade (fair or otherwise) raises wealth and living standards in aggregate – not for everyone, but on average. In a world where global trade is already flagging, a trade war between the two largest economies (the U.S. and China) is potentially a recipe for disaster. Due to higher income standards, the U.S. has few competitive advantages in low-skilled manufacturing. Punitive tariffs are unlikely to change this. They will simply drive up the costs of imports (see inflation above) and worse, hurt the export sectors (through retaliation) where the U.S. does have competitive advantage. Trade wars have no winners no matter how popular they sound at home.

2. 3)  Externalities – Even pro-growth policies have unintended consequences. While a broad platform of deregulation may help unlock entrepreneurial spirit, it will also undoubtedly come with some fallout. Repealing Obamacare will alter the behavior and productivity of citizens who lose coverage. Sweeping changes to energy or environmental policy can reduce safety or the quality of life (clean air/water/land). Financial deregulation may increase systemic risks for investors and taxpayers, and so on. To be sure, the “butterfly effect” (small changes that can have large impacts) will be accentuated during the Trump presidency.

3. 4)  The Trump Factor – Love him or hate him, there are some characteristics of the new president that are not in dispute. He is politically inexperienced. His style is to be outspoken and reactive. He is more confrontational than diplomatic and is willing to make both news AND policy via Twitter. None of these characteristics are necessarily fatal flaws. (In the right situation, many are strengths.) They do, however, increase the downside risk of policy or execution errors. As we wrote on election night, Trump is volatility personified.

Our Outlook: Underweight Confidence

President Donald Trump is a game-changer. The upside and downside extremes of his policies, along with his inconsistent and often contradictory views, literally defy analysis.

Forecasting is difficult under the best conditions, and he has no historical equivalent. Be wary of anyone who says they know what he’s going to do, much less what it will mean for the economy or markets. Don’t forget a “hard Brexit” and European elections if you want to add even more confusion to the mix.

For investors, this is a great time to reassess portfolios. This examination doesn’t necessarily mean a radical repositioning. It is difficult to have much confidence in this environment or decisive views to reposition around. (If you’re looking for some guesses, see the Capital Market Notes from December for our 2017 outlook.) However, extreme divergences between upside potential and downside risk can be instructive in and of themselves. Knowing what you don’t know has value. And if you don’t have the answers, you can at least ask the right questions:

Is your portfolio ready for a correction or sell-off? Is the portfolio liquid enough to take advantage of opportunities that will present themselves? Have you thought about rebalancing and what you’d buy (sell) in a Trump-induced rout (rally)?

Are you ready for a sell-off emotionally? Is your portfolio built to a risk budget that you can stomach, or will losses make you sell at the wrong time? Is a correction coming? Of course it is; we just don’t know when.

Are your political views impairing your portfolio? Be careful not to get too bullish (bearish) simply because you like (hate) the new president. Also remember that markets usually overreact to geopolitical events.

What should you be watching for? Be on the lookout for higher inflation in the near term and productivity in the long term. If inflation rises too much, it will push up yields and force the Fed’s hand. If infrastructure spending and corporate tax cuts don’t result in business confidence or productivity gains, growth will remain lackluster.

David F. Lafferty, CFA®

Senior Vice President – Chief Market Strategist

@LaffertyNatixis

David T. Reilly, CFA®

Vice President – Investment Strategist Investment Strategies Group (ISG) 

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