The Impact of Trump on Australia

We consider the trajectory of fiscal and trade policy to be crucial to assessing market reactions to the Trump Presidency. The sharp turnaround in markets over recent days from the initial reaction likely reflects markets factoring in the anticipated favourable impact of the Trump fiscal stimulus.  Clearly tax cuts and infrastructure spending would support growth. Moreover, with the US unemployment rate slightly below 5%, government spending and tax cuts could exert a meaningful lift in growth and, as a result, inflation and inflation expectations. This direction is reinforced by Chinese stimulatory measures through 2016 which at least in part will need to continue into 2017 to maintain growth momentum above 6%.

However, allegations of Chinese currency manipulation and proposed large tariffs directed against China could disrupt Trump’s domestic agenda and hinder growth if a significant trade war with China were to develop.  While we judge that markets have reacted favourably to the expected Trump fiscal agenda, we consider it is premature to judge that the risk of a trade war with China has disappeared. This is likely to be a critical point for markets in the months ahead.

Markets swung sharply on the Trump victory. The initial reaction saw the ASX300 plunge  by almost 4% to a low of 5020, however by Thursday the ASX 300 was trading at 5280, around the level of the end October and a 5% swing from the intra-day low. The intra-day swing in US equities was also violent with S&P 500 futures falling approximately 5% over night to eventually rally back and close 1.1% higher. Within the market there has been a rotation towards cyclical sectors, such as health care, metals and mining, and away from yield proxies. Reflecting the likely impact of anticipated stimulative fiscal policy US 10 year bond yields have spiked from around 1.78% pre-election to around 2.1% after the Trump victory. The US dollar experienced similar volatility with the DXY index, an average of the US dollar versus the other major currencies, initially falling by 4% before more than reversing this in the subsequent 24 hours.

The market reaction over the past couple of days has illustrated the opposing economic forces of the upcoming Trump Presidency. The initial reaction was one of fear and uncertainty, with the potential reversal of trade agreements and a rollback of globalisation coming to the fore. But by late afternoon (AEDT) markets appeared to embrace Trump’s election and clean sweep, with rising bond yields an early sign, only to be followed by the US share market rising through the day and more than reversing the 5% fall in S&P 500 futures. The focus seems to have shifted (rather quickly) to what positive changes Trump may make.

Longer term, the Trump clean sweep does open the window to shift policy from a heavy reliance on monetary policy, with low and even negative rates, to fiscal expansion. This would be a real change from markets being heavily influenced by low interest rates and money printing to actual spending, job creation and earnings. This year China has already moved to an expansionary fiscal policy. While this expected shift will likely place upward pressure on bond yields we consider bond yields would remain capped, at least relative to history, by the US Federal Reserve continuing to adopt a gradual approach to policy tightening. However, we remain concerned that a lift in yields could be a headwind to equities as the sustained decline in yields in recent years has been an important factor supporting higher PEs rather than solid earnings growth.