Trump Presidency – What happens now?
The Chief Justice of the Supreme Court John Roberts will swear in Donald J Trump as the 45th President of the United States on January 20th 2017. The Republican Party that he represents will hold a 52-48 seat majority in the Senate and a 241-194 majority in the House of Representatives. This is significant because the latter years of the Obama administration were hamstrung by an inability to get proposals passed by the Republican controlled Congress leading to an extended period of legislative stagnation. It is worth remembering that both houses of Congress must approve any new laws or amendments to existing laws, which the President then either signs or vetoes. The US Constitution does not allow the President to unilaterally make new laws. In the past few weeks, Trump has announced his key cabinet nominees, all of which must now be confirmed by the Senate given that these are unelected appointees. While only a simple majority is required for their confirmation, which should be carried by Republican votes, there will be vigorous debate from Democrats over several nominees including the proposed Attorney General Jeff Sessions and the proposed Secretary of State, former ExxonMobil CEO Rex Tillerson. While they will ultimately be confirmed, there may a delay before they are able to take up their cabinet positions, which may hobble the start of the new Trump administration.
“Trump Reflation Trade” now fully priced in
In the wake of populist anti-establishment electoral victories in the UK (Brexit) and the US, there are similar movements in Europe which will provide electoral challenges in 2017, adding to concerns about the potential for further erosion of the Eurozone. Firstly, there are parliamentary elections in the Netherlands in March 2017, a Presidential election in France around early May and a general election in Germany in September where Angela Merkel will contest a 4th term as Chancellor. In addition to this, UK Prime Minister Theresa May is likely to formally commence the process to extricate the UK from the EU by April, after which they will have a maximum of two years to complete the separation process. The contentious issues will revolve around immigration, the mobility of labour and trade agreements with the EU. The very large financial services sector in the UK will be particularly exposed if there are restrictions on dealing across the channel with the EU.
The End is Nigh for the 30-year bull market in bonds
As expected the US Federal Reserve raised the Fed funds cash rate by 0.25% in December and foreshadowed up to three additional moves of a similar magnitude over the course of 2017. The pace at which rates will be hiked is dependent upon the inflationary implications of the Trump economic plan although it must be emphasized that the conditions for increasing cash rates were already in place prior the November election based on a tighter labour market and nascent wages pressures becoming evident. In response to this we have seen a sharp increase in US (and Australian) government bond yields and a strengthening USD.
While it is likely we will now see some consolidation in these markets in early 2017, it is clear that the almost three decade bull market in bonds is nearing its conclusion as stronger economic growth and inflation will lead to tighter monetary policy conditions around the world and an increase in bond yields. In response to this we have seen a large-scale rotation out of bonds and into equities since the US election. After a long period of positive correlation between bonds and equities largely driven by central bank liquidity measures, the divergent performance of both markets since November is clearly evident in the chart below.
Following the sharp rally in equity markets over the past two months, it is likely we will see a consolidation, if not a modest correction, in the first few months of 2017. The market advance has been almost exclusively based on positive sentiment and prices now are discounting the most optimistic scenario possible. Equity valuations are no longer cheap and remain vulnerable to a negative surprise. It is almost certain there will be some roadblock or policy hiccup along the way that will give markets an excuse to correct. This will provide some respite for the beleaguered bond market and the surging USD which will likely consolidate in early 2107. Taking a medium term view, i.e. 12 months and beyond, we remain constructive on the outlook for growth assets such as shares, property and infrastructure and bearish on the outlook for defensive assets such as government bonds and cash. We have a preference for international over Australian shares based on a better earnings growth outlook and the prospect of currency gains from a likely depreciation of the AUD as a result of a narrowing interest rate differential with the US. Any significant correction in equity markets in Q1 2017 will be used as a buying opportunity to further build equity positions at cheaper prices.