Thoughts on the Market In Light of Election Results
Global Long/Short Team Perspectives by Michael Grant
November 9, 2016
Michael Grant leads the team that manages Calamos Phineus Long/Short Fund. Here, he shares his team’s views on the market and current positioning in the wake of the Donald Trump’s election.
The definition of politics: “the art of the possible.” Donald Trump’s first book was The Art of the Deal. If he succeeds as the 45th President, his next book might be entitled The Art of the Possible.
Populism has won. This belief in the power of regular people and their right to assume control over their government has historically been associated with an unmistakable and colorful mood amidst domestically focused politics. These policies have inevitably aimed for the renewal of the average worker, including “protecting” labor from mercantilist trade. Populist policy does not strangle an economic expansion with tight money. Populist policy does not sign trade deals that ignore domestic industries. In short, populism has been associated historically with reflationary impulses and we believe that is the case today.
Policy uncertainty is genuinely high (“the possible”). Trump understands that he knows less about foreign than domestic matters. Some of his international stances will be put on the backburner until he gets the domestic side of things sorted. We anticipate an exceptionally active Congress on a range of issues. We do not see Trump as isolationist by nature, regardless of the campaign rhetoric.
Paul Ryan remains Speaker of the House, but he is vulnerable and under considerable pressure to help Trump get things done. Trump has broken the Republican establishment, the Democratic establishment and the media establishment. Expect that vacuum to be filled with energetic politics that lead to wide-ranging policy initiatives.
The Affordable Care Act has been undermined by excessive cost inflation, but Trump is more likely to fix it than throw it away. Trump has generally supported universal coverage. Drug companies performed strongly in the election aftermath because Clinton was seen as the worst-case outcome. This could be incorrect as Trump might be more effective than Democrats in killing health care costs. Health care is a “right” in a populist world and thus, reform is real and will affect profitability. Until we have more clarity around health care policy, greater caution is warranted.
The president has considerable trade power through existing laws and this gives Trump a wide latitude. In our view, Trump is not “anti-trade.” He has publicly commended the U.S./Canada trade arrangement and offered a free trade agreement to the United Kingdom. Of course, he is against trade deals that have “not worked” for Americans. This will be a problem for Mexico, the source of a $58 billion trade deficit in 2015. Trump may threaten to withdraw from NAFTA, but this is more of a negotiating tactic on route to a new trade agreement. Change should be expected.
Infrastructure and Defense
We anticipate an infrastructure/highway bill or its equivalent to drive up the long-term trend for infrastructure spending. This will benefit a range of construction and engineering businesses. While these stocks had big moves yesterday, we think fundamentals will take time to unfold. Defense spending should also win, though one has to pause and wonder how all of this is funded. Both defense and infrastructure spending as a share of GDP have considerable upside potential.
Corporate tax reform is broadly favorable for equities. We see repatriation of overseas cash as particularly positive for select technology names. Repatriation will help fund some of the infrastructure spending initiatives. As importantly, repatriation of cash should drive a new capex cycle, which has been notably absent since 2008. This is positive for the economic cycle in 2017/2018.
Our core thesis is that Trump moves to “reflate” the economy just as it is emerging from various recessionary forces across specific industries. This favors a range of cyclicals, including banks, autos, consumer finance, machinery, auto components, energy, transport, construction and engineering. Conversely, we continue to see the “safety stocks” (consumer staples, utilities and telecoms) on the losing side of these trends.
If we are right that politics move more visibly in favor of reflation, the 30-year bull market in bonds is over. Reflation implies a more positively sloped yield curve in the U.S. and abroad. We think the Fed lifts the short end of the curve, while inflation boosts the long end. While we expect Chair Yellen to raise rates in December, her intention is to let labor “run hot” and the Fed will stay slow to tighten through 2017. As promised, Trump puts a moratorium on new financial regulation, again very positive for the sector.
We believe average hourly earnings will rise in the 3% to 4% range, which is problematic for industries with high labor content and weak pricing power. This includes health care, transport, retail, IT services, professional services, and hotels and restaurants.
Reagan and Volcker clashed during the 1980 Presidential contest. In their first meeting after Reagan’s election, Reagan asked Volcker to remind him why the U.S. needs a central bank in the first place. The message was clear: Reagan, not Volcker, was the real boss. The Federal Reserve is a political institution and must answer to the will of the people. Volcker lasted another seven years. Commencing in 2008, Fed policy inflated capital and then land, and now aims to inflate labor. Trump and Yellen are on the same script.
Yesterday’s overnight lows in global equities will hold. Of course, there is always the chance of a retest over the next week, but we do not envision a bear market because the recession risks are low and politics are underpinning an improving economic cycle. Bet on higher prices between now and early 2017.
Political events in Europe, such as the Italian referendum in early December, might keep some investors cautious, but this is a mistake. Instead, keep an eye on the sell-off in bond prices. Equities can overcome higher rates as the earning cycle improves, but the outsized positioning in fixed income is potentially worrisome. After years of fretting about equity risk, the real tail risk just might be buried in the bond markets.