But that the dread of something after death,
The undiscover’d country from whose bourn
No traveller returns, puzzles the will
And makes us rather bear those ills we have
Than fly to others that we know not of?
–William Shakespeare, Hamlet, III.i
In his famous soliloquy, Hamlet ponders whether the Great Unknown is better than the familiar misery of life on earth. Eventually, with the help of a poisoned sword, he finds out.
Tomorrow we will find ourselves in a very similar position.
Donald Trump’s inauguration is a big day. We’re getting rid of a failed president, but we have big questions about the man replacing him. Mr. Trump’s track record is a blank slate and his policy statements are often contradictory and inconsistent. Though highly intelligent, he’s not a deep thinker; he’s instinctual, spontaneous. These may be good qualities for a businessman, but statecraft requires vision, patience and discipline. We have yet to see our President-elect exhibit these qualities.
Trump is pro-business and pro-tax cuts but he’s also pro-chaos, and markets don’t like chaos. Many of Mr. Trump’s policy statements, regardless of their merit, are destabilizing and would be better handled privately or diplomatically, not in the media.
For instance, in a recent pair of confounding interviews with London’s Sunday Times and Germany’s Bild, Trump called NATO obsolete, predicted that “more countries” would leave the EU (he is correct but this is not something an American president should say to the press), and threatened to impose a 35% import tax on BMW’s Mexico-made cars. Perhaps most alarmingly, in an interview with The Wall Street Journal, Mr. Trump departed from a long tradition of presidents refraining from commenting on the dollar – and if they do from talking it down – by saying the dollar is “too strong.” This resulted in the dollar falling 1.3%, which means it has given up half its post-election gains. Talking down the dollar is not what markets were expecting of the man who wants to make America great again.
Markets crave stability and they’re not getting it from the President-elect. So far he’s been somewhat constrained, but became more aggressive in his comments as inauguration day came closer. When he’s president there will be little to constrain him.
The bottom line is that Trump constitutes a monumental policy shift, not just away from Obama but from all previous presidents. On foreign policy he is saying some very disruptive things as he breaks not only from Obama’s disastrous policies but also from George W. Bush’s failed policies of nation building in the Middle East. He is challenging the status quo on trade which may prove to be enormously damaging to markets. And he may cut taxes as much as Reagan but would be doing so with the United States in a much weaker economic position than in the 1980s and little way to pay for it, resulting in much larger deficits that would freak out the bond market.
There is honestly no way to predict what this man is going to do, but I can tell you one thing for certain.
Here’s what I know we can expect as we move into these uncharted waters.
Trump Is Going to Create A Stock Picker’s Market
Pro-growth policies may all SEEM good for markets, but markets crave predictability and Trump doesn’t offer a cohesive or predictable policy platform but instead a series of pragmatic, transactional positions. This is potentially very disruptive for markets because he doesn’t approach government and governance as a politician but as a businessman where the bottom line rules. But politics, unlike business, is not a zero sum game. In politics – especially geopolitics – all parties generally end up with less than they ask for in order to keep the peace.
If you read Mr. Trump’s 1980s bestseller The Art of the Deal (and every American should to get an idea of what the next four or eight years will be like), one can reasonably conclude that Mr. Trump is “talking his book” by setting out positions on various subjects on which he will ultimately compromise. The problem with taking a “deal-making” approach to governance, however, is that markets will react to every negotiating maneuver until the final deal is cut. That will bring much higher volatility in a highly leveraged financial system vulnerable to accidents.
I can predict one thing about Trump’s unpredictability: You can expect to see market volatility increase. I’m defining volatility as drastic changes in stock prices – some good, some bad. The CBOE Volatility Index (VIX), which traded at extremely low levels last year, is likely to rise in the year ahead. But the VIX is only one sign of higher volatility; we can also expect to see more bond market and currency volatility as well.
Volatility is, of course, a two-edged sword. Trump’s policy decisions (whether considered or off-the-cuff) will drive some sectors up and others down. Here is what I think will happen to a few specific sectors’ prices.
- Financials should benefit from higher rates and lower regulation.
- Defense stocks should benefit from more defense spending.
- Technology should benefit from repatriation of offshore cash.
- Energy should benefit from EPA restraint but will still be heavily influenced by the US Dollar and supply/demand.
- Building and construction should benefit from infrastructure plans.
On the “down” side, some of Mr. Trump’s proposed policy changes would have huge consequences for some sectors.
- A trade war would hit exporters big-time. Anything that diminishes global trade would be a huge deal and damage the global economy.
- If Trump reduces or eliminates agriculture subsidies (something that is long overdue), that would hit specific stocks that make soft products (i.e. grains) and hard products (machines).
- On a more general level, leveraged companies will be hurt by higher interest rates and if Trump can actually pull off reducing the deductibility of business interest expense, that would be a monumental change that would affect the housing market as well as how corporations finance themselves in ways that cannot be predicted but are likely to be unsettling.
Bottom line, policy changes will create big winners and big losers and create a stock picker’s market with lots of long and short opportunities for us to recommend. We’ll be watching all the sectors I mentioned above as we move into Trump Year 1 and beyond.
On a broader level, I don’t see the overall bull market grinding to a halt any time in the near future because of the powerful structural factors I mentioned in this piece earlier in the week. Markets are currently celebrating the election of a pro-business Republican to replace an anti-business Democrat in the White House. But while a more economically enlightened policy environment may offer a reasonable basis for buying stocks, the structural factors that favor money flowing into stocks make an even more powerful case for a rising market. Even if US stocks struggle with higher interest rates and a strong dollar, the gravitational pull of enormous amounts of capital looking for decent returns into a shrinking pool of US stocks may make it much more difficult for a sharp sell-off to occur, certainly one that would last very long before all that money would come back into the market looking for “bargains.”
We’re in for an interesting ride in 2017. Hang on to your hat.