Understanding the US Presidential elections and the implications for financial markets
The US Presidential elections on Tuesday is another reminder that we live in revolutionary times.
Donald Trump took on the entire US establishment – the Clinton political machine, the Democrats, the Republican party, Wall St, Hollywood, Washington, the US media – and won! And I suspect that most people outside the US, save for Mr Putin, were also fiercely opposed to the conduct of his campaign and his divisive politics.
He won because he understood that the world is in revolt against the establishment and by positioning himself as an anti-establishment figure. By contrast, his opponent epitomized the worst of the establishment.
The revolution we are witnessing derives from the information revolution of the last twenty years which has turned the polarity of information (and power) upside down. Information now flows bottom up, not top down. So the entire social and political establishment that made a living marketing information to the masses is now redundant and is being rejected by society.
The political implications of the elections on Tuesday extend beyond the Presidency. The Republican party now controls the Presidency, the Senate and the House of Representatives a feat it has only achieved once since 1931. The US Supreme Court will also become dominated by the Republicans once President Trump fills the current vacancy. So, President Trump will be one of the most powerful Presidents in US history without the traditional constraints of Congress.
His economic agenda is therefore likely to be passed by Congress. What he has proposed so far is radical: a cut in US corporation tax to 15%; a 10% tax amnesty for the trillions in US corporate cash balances held overseas; and a $1 trillion investment in sorely needed infrastructure spending. This enormous fiscal boost will come at a time when the US economy is showing signs of increasing strength. The unemployment rate recently declined to 4.9% and inflation is rising towards the Federal Reserve’s 2% target. It seems very likely that the Fed will resume rate hikes at its December meeting.
The most significant financial reaction to the election result has been in the bond markets. With the prospect of higher short term rates, higher borrowing by the US government and higher spending, US bonds declined more than at any point since 1991. This collapse in prices and increase in bond yield has spilled over into international bond markets. It is very possible that we have seen secular lows in bond yields.
The main beneficiary of higher interest rates and higher economic activity is the US dollar. After the initial sell-off in the dollar it quickly recovered and will ultimately resume its strong upward trend against most other currencies. I am expecting an initial period of consolidation, especially against the oversold British pound, but a higher dollar is ultimately inevitable.
A stronger dollar is usually correlated with lower commodity prices. After an initial surge to $1331 per ounce, Gold has collapsed to $1255. It looks likely to fall further to $1200 in my opinion. In normal times, energy prices also correlate strongly with the US dollar. But these are not normal times – we expect to see a surge in renewable energy supply over the next five years which will exceed the entire output of the fracking industry. It seems probable, short-term weather effects aside, that energy prices will collapse, providing a further boost to the global economy.
In this environment, equity prices will surge. The initial ill-considered collapse in equity markets, which we expected to be reversed within days or weeks was actually reversed within minutes and hours. The analogy I used early on Wednesday morning was that of holding a ball underwater. Once the pressure came off, equity markets surged to new all-time highs in the Dow Jones, with soaring bank stocks a huge beneficiary from higher interest rates. When financial markets are as wrong-footed as they were on Wednesday, the counter-reaction is often very strong. We are also approaching year end reporting, when fund managers will want to be fully invested to justify their management fees.
In the long run, the prospect of higher global debt levels, a more imbalanced global economy led by the US and the potential for the inflation genie finally to be leaking out its bottle after eight years of unprecedented monetary stimulus is alarming. The coming bust will be the biggest in human history.
In the meantime, whatever my heart might be feeling about Trump and his politics, I will be investing with my brain and carry on holding dollars and equities, no matter the results of the US Presidential elections.
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