Risks abound, however, despite the market's focus on the potential positives so far. Although there are early signs that the President-elect is backing away from some of his more extreme campaign bluster and will govern as a pragmatist, it's far too early to make firm judgments. In particular, investors should pay attention to the new administration’s approach to foreign trade, as Trump threatened tariffs against countries like China and Mexico while on the campaign trail, accusing them of unfair trade practices, and in China's case, of currency manipulation. He campaigned against broad free trade agreements including the Transatlantic Trade and Investment Partnership (TTIP) and the North American Free Trade Agreement (NAFTA). Candidate Trump also called into question multilateral organizations like NATO, an alliance near and dear to many Europeans, especially given Russia’s recent actions in Ukraine. In his acceptance speech, he remarked that "we'll get along with all other nations willing to get along with us," but investors have little idea how his administration will react to adverse geopolitical events. Other long-term concerns include the impact of lower immigration on economic growth rates as demographic pressures start to hit, the cost of an increasing debt burden and the impact of a skeptical administration view on climate change.
Europe could be impacted by the indirect effects of Trump’s policy mix too. It's possible that higher short-term growth and inflation may lead the US Federal Reserve to accelerate its removal of monetary policy accommodation. That could have knock-on effects on the US dollar and create a wider policy divergence between the Fed, the European Central Bank and non-Eurozone central banks. European policymakers would then be put in the position of having to respond to the effects of the US policy actions with actions of their own. Tough decision making would be made even more difficult by countries being at different points in the economic cycle, plus potential moves in other exchange rates, commodity prices and market volatility.
Other indirect impacts might stem from changes to corporate tax policy, including the proposal to allow US companies to repatriate cash held overseas at a 10% tax rate. The ability to repatriate cash might lessen US management teams' appetite for deploying it on overseas acquisitions — it would now be available for capital allocation domestically, including buy-backs or domestic M&A, without being subject to today’s high corporate tax rate. Perhaps companies could also reconsider where they base overseas operations, taking into account developing tax legislation in the United States, combined with greater anti-tax-avoidance scrutiny in Europe.
Populist momentum can't be ignored
With anti-establishment political movements gaining strength across Europe, it's reasonable to be concerned that the upcoming Italian constitutional referendum and elections in the Netherlands, France and Germany next year could take a page from the United Kingdom’s Brexit vote and Trump’s surprise election. The Brexit vote and Trump’s victory share populist underpinnings. Both movements were fiercely anti-establishment and opposed to unfettered immigration, which many saw as suppressing the wages of less-skilled workers. Those same sentiments are shared by populist parties across Europe, inflamed by higher levels of unemployment, a slower rate of economic recovery and recent tensions over migrants. Populist parties are performing well to a certain degree by taking heed of the Brexit and Trump campaigns, which attracted voters partly by using the emotional power of social media and criticizing establishment experts.
The key question investors need to ask themselves is this: Is there a new economic paradigm in the wake of the election? For it's true that interest rates are no longer declining and US growth may improve as a result of fiscal stimulus and a lighter regulatory burden, with positive implications for growth and policy reform elsewhere in the world. But we might instead ask ourselves whether we are in the late stages of the economic expansion and approaching market peaks, and thus whether this is the last gasp of the expansion before the US economy heads into recession.
In our view, there is more evidence that we're getting closer to the end, given the length of the economic recovery, the risk that increased debt levels and rising interest costs overwhelm poorly targeted tax cuts, and the potential dislocations from trade and currency moves. European economies and market cycles are at an earlier stage of recovery, but the underlying fundamentals are weak, offset in part by lower relative valuations. We don’t believe Trump’s election will materially change that outlook.
The views expressed are those of Ben Kottlern and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation or solicitation or as investment advice from the Advisor.
This content is directed at investment professionals only.