Market Update – Will the “Trump Rally Continue?

By February 22, 2017News

To the surprise of many commentators share markets have performed strongly since the election of Donald Trump. The Australian ASX200 index is now trading at close to its highest level in two years, while the US S&P500 index has hit a record high. In this note we explore the reasons for the equity market rally, particularly given its contrast to the way the Trump presidency appears to be unfolding outside of financial markets. We also discuss the rally’s sustainability and the implications for Australia.

Reasons for the rally

In the lead up to the US election many economists and market pundits predicted a major share market sell-off in the event of a Donald Trump victory. Not only has that not happened, but equity markets have gone on to record strong gains. Ultimately the main reason is that Trump’s economic policies are highly stimulatory. Despite his controversial social policies and at times strong right wing rhetoric, populist Trump is borrowing pro-growth economic policies from both sides of the political spectrum. On the one hand he plans to cut the US corporate tax rate, decrease personal taxes, loosen banking regulation and par back Obamacare. Typical liassez-faire policies you might expect from a Republican. Yet on the other hand he plans to spend significant amounts on infrastructure (even more than what was proposed by Hillary Clinton), close tax loopholes for large corporates and implement pro small business measures expected to generate employment and growth. Importantly these plans are being introduced at a time when the US economy is already on a strong upward trajectory, with Janet Yellen recently declaring recently that the US has almost reached full employment. All this has put a rocket under short term economic growth expectations.

However, just like “the Donald” himself, these measures as a total package are highly controversial. Firstly, cutting taxes at the same time as introducing large spending plans will see a big increase in US public debt, right at a time when debt levels are already at record highs after almost 10 years of post GFC stimulus. Secondly the measures are likely to be inflationary, pushing up the prices of goods and services which will force the Federal Reserve to raise US interest rates faster than previously anticipated. This is likely to have a number of flow on effects, the first being that debt will become more expensive. Unlike shares, bond markets have sold off since Trump has been elected, for precisely this reason.

Can the rally last?

There are a number of threats to the current rally. To start with there are no guarantees that all of Trump’s policies are going to be implemented. Increasing US debt is strongly at odds with traditional republican policy. With house republicans controlling the Congress Trump will have his work cut out convincing even his own party to go along with his plans, particularly given the growing number of Trump dissenters lead by Governor John McCain.

The second major challenge to the rally is that US equity markets are looking expensive on traditional valuation multiples (price vs company earnings). Many argue that markets are currently “priced for perfection”, that is that Trump can implement all his plans and that they will work exactly as intended. This remains to be seen.

The third and perhaps most important consideration is whether this is the right policy package to begin with. Economists and commentators are roughly split into two camps on this. The first camp, who are generally positive, are hopeful that the economic growth resulting from Trump’s policies will outpace the rising debt burden associated with them, essentially “deflating” away the debt. The second camp however are fearful that the burst in growth will be short lived, quickly being overcome by the drag from the rising costs of the growing debt. There are also questions around who will fund the rising US government debt. It is likely that traditional buyers of US treasuries such as the Chinese will demand higher interest repayments on those treasuries because of the risk associated with financing potentially ballooning debt. There is also likely to be a political element to this also, given Trump’s antagonism towards China.

This leads to the last risk factor, which is Trump’s impulsive nature and unpredictability. Conflict, including trade wars (and worse), are a real possibility under Trump. If that were to occur it could easily derail the still somewhat fragile recovery in global growth.

Given the above, while we feel it is important to participate in the rally by maintaining US and global equity market exposure, we remain somewhat cautious given the risks. As we’ve maintained consistently over the past 18 months, broad portfolio diversification remains Libero Capital’s number one priority in the current economic and political environment.

What are the implications for Australia?

The Trump presidency brings some important economic challenges that Australia will need to navigate. Firstly, US interest rates rises are likely to drive global interest rates higher. While the RBA will likely try to keep a lid on Aussie domestic rates for as long as it can to stimulate our local economy, it can only do so much. Many of our companies (including importantly our banks) are reliant on global bond markets to finance their debt. Sooner or later they will need to pass on these rising funding costs to consumers, which means Australian mortgage rates are likely to go higher. We’re already starting to see the first stages of this. Given high private debt levels in Australia and the loan sizes now required to purchase housing in our major cities, a material rise in mortgage interest rates could weigh on residential property prices. If severe, this could also have ramifications for Australian bank share prices and for the construction and related industries.

Another threat is the negative impact from a potential trade war between the US and China. This would likely lower the demand for Australian commodities, which would hurt government revenues and put Australia’s credit rating at risk.

Despite these challenges however, the US is still the main driver of the global economy. If Trump’s plans do indeed provide a sustainable boost to global growth Australia will ultimately benefit. The Australian economy is already showing signs of an uptick from rising commodities prices, which is also being spurred on by the East Coast construction boom. Furthermore, the biannual company reporting season which is currently underway in Feb has so far been mostly positive, with the ASX200 index looking reasonably priced given the earnings that have so far been reported.

In the coming weeks Libero Capital will be performing a general rebalance across client portfolios to reflect the changing economic environment and to reposition individual holdings in the wake of company reporting season.

If you have any queries, or would like to discuss the markets or your portfolio in general, please don’t hesitate to call my direct line, 02 9119 3698.

Glen Holder, BCom, DipFP, CA, MAppFin
Director – Investment Management

Disclaimer: The Information within this article does not constitute personal financial advice. In preparing this document, Libero has not taken into account your particular goals and objectives, anticipated resources, current situation or attitudes. You should therefore consider the appropriateness of the material, in light of your own objectives, financial situation or needs, before taking any action. You should also obtain a copy of the PDS of any products referenced before making any decisions. The data, information and research commentary in this document (“Information”) may be derived from information obtained from other parties which cannot be verified by Libero and therefore is not guaranteed to be complete or accurate, and Libero accepts no liability for errors or omissions. Libero and NWAG do not guarantee the performance of any fund, stock or the return of an investor’s capital. Past performance is not a reliable indicator of future performance.