Risks to a Happy and Healthy 2017 - Written for the Council on Foundations' 2017 Trendspotting Series
Over the years, we have learned two solid lessons about investing. The first: "know your downside, and the upside will take care of itself," which is why we tend to focus on risks. Thus the title.
The second: investing is often about understanding the "elephant in the room." The thing that is so obvious, ultimately, driving the course of the markets. Usually it is interest rates, corporate earnings, employment, oil prices or some other economic indicator. This year's elephant is, of course, US president-elect Donald J. Trump.
Deadlines can be tricky things. As we sit down to write this article, a scant few days after the election, a deadline looms over us. By the time this is published, as more facts come out, everything we write could be rubbish. We know very little about the President-elect's actual policies, who his appointees will be, and beyond some broad strokes, what is the economic game plan. What we do know is that markets hate uncertainty.
So to give a little more certainty to an uncertain situation, we thought we might borrow jargon from another administration and divide the world up into the "known unknowns" and the "unknown unknowns."
Known Unknowns, the questions we can foresee:
1. Who'll be steering the ship: The standard line most financial advisors will be telling clients this week is that it doesn't matter who is President, "in the long-run, it all equals out." Well as economist John Maynard Keynes pointed out: "In the long run…we're all dead." The long run is great, if you don't have pesky things like programs to fund on a yearly basis.
Financial markets are fickle, funny, superstitious things. As legendary-trader George Soros has often pointed out, perception often becomes reality. One of the keys to setting confidence and perception is who is at the helm of the country and important agencies, such as the Federal Reserve Bank and Treasury.
We know that president-elect Trump has had some unkind words for Federal Reserve Chairwoman Janet Yellen, but he can't fire her. She has the job, if she wants it, until 2018 and will be a member of the board beyond that. We think Trump econ-advisor, hedge-funder Steve Mnuchin is the most likely nominee for Treasury, which would be welcomed by the markets. But can his nomination get past Senator Elizabeth Warren and the Wall Street-loathing Senate, including the Freedom Caucus, which made significant gains in this election? In the past less controversial figures--here's looking at you Antonio Weiss--didn't make the cut and he was a Democrat.
2. "Banks"-rupt: Speaking of Senator Warren, bank stocks, which had been moribund, rallied on the news. We believe largely for two reasons: the conviction that Dodd-Frank will be repealed (likely replaced by either a higher capital requirement or a Glass-Steagall retread) and the assumed de-fanging of Senator Warren. She and the president-elect had some, ahem, words during the campaign. After more than $24 billion has been spent by banks to comply with Dodd-Frank, we aren't even sure what a repeal will mean. While Senator Warren no longer has the support of the White House, we do not think she will be cowed by the President-elect. The question is whether Dems will have any chance of truly shaping, or only forestalling, the Treasury agenda going forward.
Unknown Unknowns: the ones we don't know we don't know.
3. Reaganomics Redux?: Trump has talked growth, infrastructure, tax cuts for the highest earners, corporate tax overhaul and increased spending by the Federal government. Sound familiar? To misquote Kanye: Trickle down girl, go head, trickle down.
It is beyond the scope of the article to debate the merits of Reaganomics (even internally to my firm, we debate this issue, continuously, ad nauseam, drunkenly, fistfights ensue). US capital markets, however, offered some clues to how they would respond to these presumed policy prescriptions: equities rallied, bonds sold off, which would be in-line with a potentially inflationary, growth-oriented economic policy.
Copper (often referred to as the metal with a PhD in economics, because it predicts expansion) and other commodities, rallied to multi-year highs, on the view of increased infrastructure spend. If we are looking at Reaganomics Redux under president-elect Trump, we can probably expect this trend to continue.
4. One, two, three, four, I declare a trade war: So we are (supposedly) going to build a wall, renegotiate NAFTA, put hefty tariffs on Chinese products, and re-consider our ties to Europe, militarily and economically. While the beneficial effects that tariffs might have on the US manufacturing sector and employment are dubious, it is most likely bad for the US consumer--expect price inflation (where do we think all that cheap stuff at Wal-Mart comes from?), leading to reduced purchasing power. Since consumption is the largest part of GDP, to avoid recession, the government might have to increase one of GDP's other aggregates, government spending, which it has promised to do.
Of course, since we already run at a deficit, increasing spending will require another country (or countries) to fund that spending, which means issuance of government securities. The power to issue new debt partially depends on the ability of other countries to buy it, and their economic status is also partially dependent on trade flows. One of the largest purchasers of US government securities has been China, which has slowed its net purchases tremendously, partly reflecting a decline in global trade already.
But, it's okay, president-elect Trump says he can renegotiate the debt, just like he did on his casinos.