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: We have wondered for some time what event may puncture the relative calm that seems still to characterise many markets. Politics may provide the answer. At the least, it is a topic which engages and concerns almost all investors. The US election is now just fifty days away and certainly were Donald Trump to win – a scenario which may be more likely than many investors think (or are willing to believe) – the ramifications would be significant. 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. We provide below an update to our note of 10 August (‘What might a Trump Presidency mean for markets?’) on this important topic.

In mid-September, as the sun shone and the temperature topped 80 degrees, the author of your piece spent five days in the US travelling across four different states on the North Atlantic seaboard. In multiple conversations with senior business leaders, prominent figures in finance and healthcare and, of course, many taxi drivers, a reasonably cohesive picture of the current state of America emerges. This matters since arguably the most important Presidential election in some time occurs in less than eight weeks, on 8 November. The ramifications of a Trump victory in particular would be significant.

The key conclusion from this trip is both simple and important: America is a deeply divided nation. This was abundantly evident from my varied discussions. Such division relates not just to the question of political leadership but also to a much broader debate about the role of the state, the extent of its intervention, how it should approach addressing inequality and so on. Moreover, even among the better-educated and more politically informed individuals with whom I met, the apparent dislike and distrust of Hillary Clinton appeared at least equal to that felt for Donald Trump. In other words, the result of the Presidential election may be closer than many investors think (or are willing to believe). The recent narrowing between the two candidates in the polls may also support this contention.

It is precisely because Donald Trump is the anti-establishment candidate that he appears to be gaining momentum. Although part of a broader global trend, Trump offers the prospect of change. This excites people, regardless of what the change is. Thought of another way, Trump can be seen as capitalising on current discontent, which is high in many areas. Whether one likes Trump or not, it is important to recognise his skills in identifying where people are unhappy, dissatisfied and frustrated, offering himself as the only solution and providing a narrative that many people want to hear. The contrast between this approach and that of Hillary Clinton is marked. Meanwhile, the perceived risks relating to a potential Clinton administration appear only to be mounting, with concerns over her health and email integrity potentially poised to mutate into more significant issues.

However, change is by no means always a good thing. As we wrote in our 10 August note about what a Trump victory might mean for markets, the ramifications for all asset classes would likely be more profound than under a Clinton administration. This impression was only confirmed on our recent trip. In other words, investors continue not to discount fully the scenario of a Trump Presidency. Any assessment of such an outcome, of course, needs to be bracketed by at least two important caveats: first, the President’s ability to act will necessarily be somewhat constrained by which political party controls the Senate and the House of Representatives. A ‘clean sweep’ of all three pieces of the US executive legislature by either party looks currently unlikely. Next, history suggests that there is a very large gap between rhetoric and reality. In other words, most candidates end up somewhat moderating their policies once in power.

Nonetheless, it is fair to assert that a Trump victory would raise near-term uncertainty levels. These could endure for some time, even if they do eventually recede. Investors dislike uncertainty and the contrast between the relatively known quantity of Hillary Clinton and the much more unknown quantity of Donald Trump is stark. This could raise the equity risk premium and hence may be the event that finally punctures the US equity market bubble, even if some specific market sectors do prosper on a relative basis. As a reminder, the current bull market in US equities has now endured over seven years. Under a Trump administration, listed defence, infrastructure and domestic energy businesses might benefit, while correspondingly, export-dependent multinationals, industries highly dependent on foreign workers (such as agriculture and hospitality) big banks and renewable energy plays could suffer.

The bigger problem, of course, as we have highlighted elsewhere, is that US equities are currently trading in their 90th percentile on almost all metrics relative to recent history (i.e. they are very expensive). However, US Treasuries may fare no better under a Trump administration. Not only could the prospect of significant fiscal stimulus raise Treasury yields (as inflation expectations would rise), but, of additional concern, Trump also asserted in the past that he might seek to renegotiate the payment terms of US debt.

Meanwhile, Janet Yellen’s term as Chair of the Board of Governors of the Federal Reserve expires in February 2018. A replacement for the role has historically been announced around six months prior, but Trump has made clear in the past that he is no fan of Yellen. An additional risk is therefore represented by possible change at the Federal Reserve, and one that may occur quite soon, possibly even before next autumn. Such an outcome could undermine the relative stability of both Treasuries and equities, not just in the US, but also in other major global regions. As uncertainty grows, so does the logic for investing in alternative and uncorrelated asset classes, a strategy we have favoured for some time.

Alexander Gunz, Fund Manager, Heptagon Capital