President Trump’s ascent to power and commitment to fiscal stimulus has superheated investor sentiment. From the depths of bearish sentiment, the bulls have risen and stock valuations continue to defy gravity in the light of a new economic rhetoric. While optimism continues to quell any market jitters three key factors could derail the Trump train.
(1) History shows protectionism has catastrophic effects
Protectionist advocates would do well to brush up on the Smoot-Hawley Tariff Act. Reed Smoot and Willis Hawley designed a highly controversial U.S. bill enacted in June 1930 which resulted in the average tariff on dutiable imports to hit 45%. Economists besieged the then President Hoover not to pass the act, but it was signed and had catastrophic consequences.
The increased tariffs piled economic pressure on to countries during the Great Depression. As a result, banks in foreign countries foundered and international trade nearly ground to the halt, declining 66% between 1929 and 1934, sending the world into economic abyss. The international reaction was evident from Canada and Europe via the imposition of a raft of similar protectionist tariffs, which arguably deepened the global depression.
Given the Republican Party’s relentless pursuit of this ‘America first’ quest and bellicose beggar-thy-neighbour strategy, it may be prudent to factor in a degree of international retaliation. Such a strategy may escalate latent tensions between countries imperilling global stability – creating serious tail risk for markets.
(2) The integrity of the companies could be impaired
Trump’s twitter-based attacks on companies have ripped up the diplomatic rule book and represents dangerous implications for markets. The recent precedent of CEOs adjusting their business model to placate the Trump administration is a concern, and should naturally lead to a reassessment of the investment case. Capital allocation is typically a long-term decision, consistent with the Company’s stated strategy. In this case, relocating a factory may well stack up in the short-term based on the incumbent Administration’s policy. However, we believe, the soundness of a company’s strategy is more prudently judged over periods longer than a presidential election cycle.
It also puts into question the governance and ethical standards of companies, CEOs and Boards that are willing to appeal to the new Administration. Recent social media rhetoric surrounding Uber has illustrated that companies should not forget how easily alienated their customer base can be. More broadly we are concerned that decades of positive progress on numerous sustainable issues could be undermined by political intervention. If companies are very willing to kow-tow to Trump on operational locations, will they lie-down in terms of diversity, good governance and investments in sustainability for the sake of American competitiveness?
(3) ‘Trumponomics’ is largely priced in
Last week the Dow Jones Industrial Average breached a landmark 20,000 for first time ever and global markets reached a 19-month high. Much of the fuel for markets has been optimism over the fiscal stimulus President Trump has promised to deliver in an attempt to turbo-charge US growth.
Amid the prevailing optimism our concern is that much of market exuberance and potential upside over expected tax cuts, looser regulation and fiscal spending has already been priced into US stocks, particularly infrastructure plays. Investors should question prevailing assumptions and assess the risk that the ‘Trump trade’ could unwind.
The level of optimism is more astounding given the severe bearish sentiment that preceded it. The genesis of that optimism stemmed from the moderate tone that Trump struck in his acceptance speech. If the early signs are indicative, such as trade protectionism and immigration bans, it would appear that hopes of moderating the campaign policy promises are misplaced. As valuations continue to reach historically elevated levels, any unintended consequences could expose significant downside risk.
Hunting for opportunities regardless of political climate
Trump has heralded a new optimism but as investors, we always question prevailing assumptions and consensus. Given the continued level of uncertainty around upcoming policy priorities, we continue to monitor developments and assess the political and macro outlook in the US.
Notwithstanding this outlook, we continue to look for companies across the globe that have strong, sustainable business models with competitive advantages, that are capable of performing regardless of the prevailing political climate.
David Osfield is co-fund manager of the EdenTree Amity International fund.