Any investor trying to play a Trump agenda investment strategy is setting themselves up for trouble. The hard reality is that no one really knows what parts of Trump’s campaign policy will actually get accomplished. Since being elected, he has already dialed back much of his tough campaign talk, and other items on the agenda may be altered still further. So what is an investor to do under this scenario?
The short answer to this question: Worry more. I’ll explain.
The most concerning area of a Trump presidency is foreign policy. The fact is that Trump is the biggest unknown on a geopolitical basis ever elected to office. With that being the case, any investor looking at the world stage has to meaningfully increase risk premium in their modeling, because with Donald Trump as President, the world is, without a doubt, a riskier place.
Trump supporters may suggest that I am being sensationalist in making these claims, however, saying that our president elect is a foreign policy crap-shoot is not “liberal media” talking – it’s most other world leaders. In fact, the only world leaders who came out and supported Trump as U.S. president were Vladimir Putin, Viktor Orban (Hungarian PM also in favor of border walls), and Kim Jong Un. (link here). After the election, the President of France said “This result leads to uncertainty.”, and German Chancellor Angela Merkel said that she would be supportive, even if the Trump campaign produced “confrontations that were difficult to bear.” (link here)
So how can investors attempt to analyze the situation? There are two main things that investors should keep in mind.
Trade Policy – Winners and Losers
What we know right now is the Trump has promised to work much harder to renegotiate existing trade agreements and to fight much harder against perceived trade manipulators. Specifically, he has sworn to kill the Trans-Pacific Partnership (TPP) and has generally told supporters that he will reverse the tide of globalization.
While we are already seeing Trump back off from the definitive tone that marked his campaign speeches, there is no way to expect that he will totally reverse course and push for more open trade. Therefore, one has to expect that trade with foreign partners will diminish to some degree. The serious people that fall into the pro-Trump camp suggest that the declines in trade will be more than made up by gains in domestic production. While that is a possibility, it is not the most important take-away.
U.S. production could see a pick-up and U.S. jobs could increase as a result of Trump policies but the projections out of the Trump camp are highly optimistic. The decline in trade around the world could have its own direct impacts which will throw markets for another roller coaster.
Take for instance the Trump stance on China. Throughout the course of the campaign Trump has made suggestions that he would increase import tariffs on Chinese goods to as high as 45%. As I mentioned in my last post about Trump (here), that action would inevitably be followed by retaliatory actions which would reduce our outgoing trade. Getting into a trade stand-off with the second largest country in the world may sound like Mr. Trump’s idea of a good time, but the American consumers and exporters would suffer from it.
All else equal, more protectionist policies will lead to higher prices in an economy (by reducing cheaper foreign imports). An increase in inflation will lead the Federal Reserve to raise interest rates at a higher pace which will increase the value of the dollar and reduce our exports even further. I think our big global corporations, especially those in volatile areas, are really nervous. For instance, if Caterpillar sells 200 bulldozers in Europe right now, they would get $1.06 for every euro on the sticker price, but if the US dollar gets stronger and the Euro gets closer to $1, that would be equivalent to a 5% loss in sales.
Who wins and who loses under a more protectionist regime? Investors should look at how companies are positioning themselves for the potential of more hostile international markets. The odds of trade wars popping up have increased materially and that could be devastating for U.S. companies looking to do business in these countries.
The Stakes Have Gotten Higher
Investors who are anything less than very long-term investors (more than 10 year time horizon) need to model in higher risk premium. The stakes are higher, because with Donald Trump as president, the tail outcomes (worst case and best case scenarios) have simply gotten bigger and more likely. As we saw on election day and the early morning after, as the results poured in, the after-hours market dropped by almost 5% before recovering and rallying since. Make no mistake, the market rally does not mean that we are in the clear. It simply means that investors have taken Mr. Trump’s more moderate comments since the election to mean that the high-cost negative potential outcomes of a Trump presidency (starting trade wars, pushing through draconian immigration restraints, tearing up trade alliances, etc…) have lowered in probability from what they were during his campaign. It doesn’t mean those odds have gone to zero.
The key thing to note is that these probabilities will change constantly, and markets will be moved along with them. What will the market think if Donald Trump changes course again and tweets that he will double down on efforts to punish China for manipulating currency? Or if he suggests he won’t do business with Canada because of NAFTA? When these odds of high-cost negative outcomes become greater, the markets will move down just as hard as they did going up. Investors need to be prepared to deal with this increase in volatility.
The Bottom Line
Investors with timelines under 10 years need to be more careful. This is frustrating to me because for the clients that I invest for this may lead to lowering the risk profile and therefore, a lower potential return on investment. For more and more investors, there will be a need to play it safe, because the odds of market crashing incidents happening has gone up. This should not be a controversial statement – just an observable truth.
If you do insist on trying to navigate what could be potentially turbulent waters, you will need to pay very close attention to trade policy and how your investments are affected and responding to it. Above all else, you need to be humble and realize that just because an event or an outcome is not likely, does not mean it is impossible. One of the biggest errors investors make is to treat low-probability events like zero-probability events. The year 2016 has done nothing if not humble investors and professional forecasters – the Britons elected to leave the European Union, the Cubs won the World Series, and a reality television star was elected President of the United States. Anything can happen in this crazy world, so you need to make sure you are prepared for it. In other words, don’t bet the farm because you could come up snake-eyes
Until next time….
“Owning a great golf course, gives you great power.” – Donald J. Trump