Trump term 2.0: what we know, what we don’t

Two choices in the game plan: act or watch

As we embark on a four-year journey with President Trump at the helm of the world’s largest economy, there are many unknowns and many knowns. Given the sizeable sweep of all three branches of government, policy will be easy to implement. From a market perspective, the clearest known is there will likely be lots of headlines. Many are likely inflammatory and with the likelihood of moving markets, at least temporarily. Currently, the big topics are tariffs, regulation, and tax/spending.

But who knows which announcements will move markets the most?

Investors clearly have a positive memory of Trump’s first term, based on market gains. And as humans, we all like causal relationships – it makes us feel better and more in control. Unfortunately, this is rather simple thinking. In our opinion, markets started to perform better earlier in 2016 before the election because, for the first time since before the 2008 financial crisis, we had global synchronized economic growth. After 2008, the U.S. and Asia started to recover, but Europe faltered. Then, when Europe improved, the U.S. hit a soft patch economically. Then, when the U.S. re-accelerated, Asia fell flat. But in 2016, the three major economic zones started all growing together! That is what moved markets higher over the coming years.

Then and now

The other challenge is starting points; they really matter. Looking at the economy, GDP growth for the U.S. and globally was moving from a tepid to a higher growth pace in 2016. Today, economic growth is more decelerating. Back in 2016, interest rates were super low and accommodative, and quantitative easing was flowing. Today, much more restrictive and higher yield, with quantitative tightening on the go.

And then the equity markets. In 2016, the equity markets were much cheaper and had modest earnings growth expectations. Today, it is more expensive with high growth expectations. The tax cuts in 2016 were a lift because corporate taxes started so high. Will we get the same impact trying to cut corporate taxes from a much lower start point?

In the Trump game plan, we think there are two choices here: Act or Watch.

Act

The act option is to take announcements at face value and try to adjust exposures quickly. For instance, at the time of writing in late November, Trump announced tariff plans that would hit Canada and Mexico. If you took it at face value, that would have us reduce Canadian equity exposure, notably exports (think there are still a few) or reduce exposure to the Canadian dollar. This approach has some benefits, including the positive emotional impact of taking action, and it may sound smart.

But we think there are a number of challenges with this approach. Trump is going to say a lot of things over the next four years, and based on the previous term, many of these will not come to reality. Or the policy announcement is the first move in a longer process that will become evident over time. For instance, the recently announced 25% tariff on Mexico may turn out to be a bargaining chip in future discussions to see if Mexico will aid in border security. We also think the frequency of announcements will make it really challenging to try and react. You could very easily just be chasing your tail.

Watch

There are very few constants when it comes to investing and the markets. However, one constant is the markets often overreacts in the short term. We could blame the financial media, which will cover the bejesus out of anything Trump-related but lightly glance over important economic news. One is more fun to talk about and certainly gets more clicks/eyeballs. We could blame fast money algo trading systems. It doesn’t matter though.

Watch the market, and only if it really overreacts should any action be taken. Of course, we are not sure how much the market will react under Trump Term 2.0. Markets adapt pretty quickly, and in the first term, the style of announcement and frequency was unprecedented. That increased the market reaction function. Now, we are all a bit more numb to the headlines, as is the market.

Nonetheless, we can expect to hear more announcements that grab the headlines, which could increase the noise in the market. Underneath this noise, there is the economy that drives earnings, and earnings drive the market. Policy can nudge the economic path, but the macroeconomic forces are likely much more powerful.

Of course, listen to the noise, but don’t necessarily react. In fact, watching to see if the market materially overreacts and then acting may prove better for your portfolio.

Craig Basinger is the Chief Market Strategist at Purpose Investments Inc. and portfolio manager of several Purpose funds, including Purpose Tactical Thematic Fund.

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