View From the Top

Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.

View from the very top: In less than 100 days’ time Americans will vote on the election of their 45th President. While most opinion polls and indeed received consensus point to the fact that Hillary Clinton should become America’s next President, the recent Brexit vote shows demonstrably that the seemingly improbable can occur. At the least, we believe it behoves us to consider how markets may react were Donald Trump to win the Presidency, particularly since political risks have become a more significant consideration for allocation decisions ever since the Great Financial Crisis. In summary, under Trump, uncertainty levels would likely spike, undermining the case for risk assets and favouring more defensive and, in particular, uncorrelated asset classes.

Asset Allocation Considerations:

 Equities: US equities are currently in their second-longest bull market since 1945 while, on most valuation metrics, they trade in the 90th percentile relative to recent history (i.e. they are expensive). Whether a Trump victory would prove to be the catalyst that triggers a meaningful equity market correction is not yet clear. Nonetheless, our assessment of Trump’s various policies suggests that listed defence, infrastructure and domestic energy businesses would likely benefit. Meanwhile, export-dependent multinationals, industries highly dependent on foreign workers (such as agriculture and hospitality), the healthcare sector, big banks and renewable energy plays could correspondingly suffer.

 Fixed Income: Recent history would suggest that, in times of uncertainty, the perceived characteristics of US Treasuries as de facto ‘safe havens’ tend to be an important factor driving near-term performance, as evidenced, for example, when the US breached its fiscal ceiling in 2011. In other words, despite the relative unattractiveness of current yields (close to 50-year lows on the US 10-year government debt), they may trend lower in the event of a Trump victory (assuming, of course, that there is no attempt by the President to renegotiate the payment terms of US debt, as has been hinted at).

 Currencies: Following Trump’s rhetoric through to its logical conclusions suggests that the Dollar should strengthen. Correspondingly, under Trump, currencies such as the Mexican Peso and Chinese Renminbi in particular may weaken.

 Alternative Assets: Regardless of the Presidential outcome, our conviction in this asset class only grows, especially given the relative maturity of the current business cycle. We favour investments in uncorrelated private asset class strategies such as catastrophic reinsurance, direct lending and private equity (notwithstanding our earlier sector observations).

“When I am right, nothing bothers me”

The Donald Trump phenomenon is a remarkable one. Worth some $5.4bn and hence the 336th wealthiest person in the world (according to Forbes), Trump succeeded against a field of 16 other candidates in securing the nomination from the Republican Party to run for President. As testament to the interest in Trump, a simple Google search yields 404m hits for him, over 50% more than is the case for Hillary Clinton (253m). Many Trump quotes (including the one above, which comes from a 1985 interview on the 60 Minutes programme) can be easily found and he is also the author of 18 books including Surviving At The Top (1990), The America We Deserve (2000) and The Best Golf Advice I Ever Received (2005). His general output provides many hints of what a Trump Presidency could look like.

There are probably four key salient points that it is possible to conclude about Trump from his various books and interviews. First, what you see is what you get. Next, there is a clear belief felt by Trump in life as a zero-sum game, with only one winner and one loser. Third, he is undoubtedly a tough and determined negotiator. And, finally, Trump is a ratings machine; he will (seek to) do what is needed to be popular. His campaign slogan is a simple yet powerful one, namely to “make America great again” (also the title of his most recent book).

In order to achieve this end, Trump has positioned his agenda as one that emphasises American patriotism, is conservative in many areas (including religion) and has a generally high disregard for political correctness and broadly accepted modes of diplomacy. His platform hence includes measures to combat illegal immigration, opposition to many free trade agreements and mainly non-interventionist views on foreign policy. Although the challenge could be levelled at Trump that many of his proposals lack depth, it is nonetheless notable that a number of them – including the above – happen to be in areas where the President has more freedom to act without Congress. Put another way, the areas where Trump’s policies have tended to attract the most attention, also happen to be those where there is greatest potential flexibility to act.

Below, we provide a brief assessment of what Trump’s proposals might mean for investors (particularly in equity markets) were they to be implemented. Clearly this list is not exhaustive and there is a big difference between rhetoric and reality. In the near-term, however, the change in investor sentiment towards impacted industries/ businesses could be significant.

Trade

Trump claims to favour free trade, but has also come out strongly in his speeches against the Trans-Pacific Partnership (TPP) and the North American Free Trade Agreement (NAFTA), both of which he has said he intends to renegotiate. Furthermore, Trump has also stated his intention to impose duties on Chinese imports, while Japan and South Korea too have come in for criticism over their trade practices. At the same time as restricting in-bound trade, much of Trump’s policy in this area has focused on “making America great again”. In other words, he proposes to reduce American corporation tax to as little as 15% (from its current 35% ceiling), tax US corporates’ foreign profits (in order to incentivise them to repatriate offshore cash) and retain the current level of minimum wages (to preserve American competitiveness). Investment implications: policies that seek to impede free trade are generally negative for global GDP. In particular, Trump’s approach could result in weaker Chinese and Mexican currencies relative to the Dollar (more on Mexico below). Meanwhile, US-listed export-dependent multinationals would also likely suffer were trade policy tightened.

Foreign Policy/ Defence

As with other areas of Trump’s policy, there are clear inconsistencies in his views on this matter. He is said to be both nationalist yet non-interventionist, favouring an increase in military defence spending, but simultaneously decreasing America’s commitment to NATO. Overall, his ambition appears to be to get America into a position where “no-one will ever mess with us again” (a comment from a 1990 interview in Playboy magazine). Investment implications: a Trump victory would likely be positive for US-listed defence stocks such as Boeing, Lockheed Martin and Northrop Grumman. In addition, it seems likely that were Trump President, then also broader security/ cyber-security stocks would benefit since there could probably be an increase in general surveillance expenditure.

Immigration

This subject has perhaps received more discussion than any other during the Presidential campaign so far. While inevitably controversial, its relevance is perhaps explained by the fact that for the first time since the Great Depression, parents believe that their children will not be better off than they themselves are. In these circumstances, social cohesion has rapidly decreased and immigration has risen in importance, as is clearly evident in Trump’s campaign. Trump’s proposals have included increasing the number of deportations and tightening entry standards, emphasising in particular US border security and the potential to construct a wall on its southern border with Mexico. According to the Migration Policy Institute think- tank, there are currently 11.7m Mexican immigrants residing in the US, equivalent to c4% of the US population. Investment implications: were Mexican and other immigrants forced to leave America, then there would likely be a negative near-term impact on industries that are reliant on foreign workers such as agriculture, leisure and construction.

Infrastructure

Both Clinton and Trump have emphasised the importance of increasing infrastructure spend. This is hardly surprising given that US public infrastructure spend as a percentage of GDP is at a 60-year low (according to the IMF) while gross government fixed investment has fallen by 7.9% in absolute Dollar terms since the Great Financial Crisis (based on Fed data). No firm figures have been provided by Trump but, anecdotally, sums of up to $500bn have been mooted for project expenditure over the next five years. Investment implications: although there is a danger that Trump may ultimately prioritise defence over infrastructure spend, construction-related businesses and other proxies (quarries, freight rail transportation) would likely benefit from a Trump victory. Caterpillar has been explicitly mentioned in several interviews by Trump as being its preferred construction partner for the building of any potential border wall.

Healthcare

Trump has said that he favours replacing the Affordable Care Act (or the ACA, popularly known as Obamacare) with a free-market plan that would allow health insurance to be sold across state lines, enable individuals to deduct health insurance premiums, expand health savings accounts and give more control of Medicaid to the states. Investment implications: how Trump’s (very broad) proposals would work in reality are not yet clear, and repealing the ACA over six years after its formal implementation is unlikely to be easy. Nonetheless, the healthcare sector has outperformed every other equity market sector since Obama has been President and so may inevitably suffer some form of correction. In particular, hospitals, managed services businesses and healthcare IT providers may be most impacted.

Finance

In this area too, Trump has radical ambitions, namely seeking to reinstate the Glass-Steagall Act and also rescind various parts of Dodd Frank legislation. The former was repealed in 1999 and resulted in mergers between investment and commercial banks, creating behemoths such as JP Morgan Chase and Citigroup. Under Trump’s proposals, commercial banks would be prevented from entering capital markets. Additionally, Trump is of the view that some of the regulations put in place after the Great Financial Crisis have restricted consumer behaviour/ expenditure and so he would seek their retraction, in particular, disbanding the Consumer Financial Protection Bureau. Investment implications: under Trump’s proposals, big banks would likely suffer, while regional banks and credit card companies would be beneficiaries.

Energy/ Environmental Issues

The Environmental Protection Agency has been described by Donald Trump as a “disgrace” (New York Times, May 2016) and he has promised to cut its budget. Trump has also spoken of his desire to renegotiate the Paris Agreement, the United Nations framework on climate change listing various protocols that need to be adopted by 2020. Taken together and combined with various other well-documented comments, it would seem that Trump is a clear sceptic of global warming. At the same time, Trump has shown support for domestic energy, favouring drilling on American land and, in particular, the approval of TransCanada’s Keystone pipeline – an oil pipeline system between Canada and the US that was rejected by President Obama in 2010. Investment implications: under a Trump Presidency, renewable energy companies would likely suffer while, conversely, drillers and pipeline businesses would likely benefit as could domestic rail businesses, transporting crude by rail.

Conclusions
Demographics may favour a Democrat victory over a Republican one. Since the last Presidential election in 2012, the number of racial minorities in the US has increased by 7m (according to the US Census Bureau) against a rise of just 300,000 for non-Hispanic white people. Meanwhile, polling agency Gallup notes that 70% of women have an unfavourable opinion of Donald Trump. This is potentially problematic, given that 9m more women voted than men in 2012. However, a Trump victory is still clearly very possible.

Regardless of who wins out on 8 November, investors typically tend to over-estimate the policy impact of candidates proposing radical changes. This dynamic is understandable given the hype and exaggerated rhetoric that generally characterise political campaigns, and has only been inflated this time around, especially given the extent to which both candidates are broadly disliked. Indeed, the combined disapproval ratings for Clinton and Trump are higher than they have been for any two previous Presidential candidates ever (according to Gallup polling).

Furthermore, in reality, the timing of change is generally under-estimated; most things take longer than anticipated. Notably, both Clinton and Trump have highlighted the importance of addressing immigration issues soon after becoming President (even if their approaches are very different). An early debate on such a sensitive and controversial topic may make it subsequently more problematic to address other issues on which there is potentially greater common ground between the parties (such as infrastructure spend). Furthermore, it should also not be forgotten that much practical policy implementation may ultimately be dictated by the extent to which the President has the support of both the Senate and Congress. At the least, all of the above debates will continue to run through until 8 November and potentially beyond. Watch this space.

Alexander Gunz, Fund Manager, Heptagon Capital