Anti-Globalization Part II
President Trump. That title might take some getting used to. We meant to have commentary out sooner, but the truth is we really don't know much of what the future might look like under President Trump. With that disclaimer out of the way, we'll share our thoughts on the US government, financial markets, and geopolitics.
We've all heard the campaigns and read the commentary, but the bottom line is we really don't know what a Trump presidency will look like. It is likely Trump will moderate from his extreme promises on the campaign trail and must endure the checks and balances of our system. However, given the Republican support in Congress, it is likely that infrastructure investment, health care reform, tax reform, restructuring trade agreements, and immigration reform will be on the table. Time will tell if these discussions will lead to actual changes and if these changes will be good or bad. The media is drowning in commentary from both sides predicting the impact of these changes, so we'll leave the predicting to more courageous people for this topic.
The stock market was down 4-5% the month prior to the election, at one point the market futures were down dramatically overnight on news that Trump would win, and now the market is up 4% this past week – right back to where we were for most of the summer. Interpretation: the stock market has no idea what the future looks like from here. Longer-term Interest rates in the bond market have spiked dramatically recently. Interpretation: the bond market thinks higher inflation is coming. The Fed is poised to raise rates a little in Dec, but future Fed actions will be influenced by how things actually play out and if Yellen remains the Fed chair.
Despite what many voters want here in the US, the world financial system is very inter-connected, so let's take a step back and look at the global picture. Europe and Japan are following negative interest rate policies and remain stuck in low-to-no growth economies. China is facing several years of trying to digest its former actions of financial repression used to grow its economy and is currently dealing with a fragile exchange rate situation, lots of bad debt, a real estate bubble, and an imbalanced producer/consumer ratio. The US is expecting higher inflation and the Fed is raising interest rates. All of these signs pretty much point to a stronger US dollar.
Most large US companies get a big part of their sales from overseas, a stronger US dollar will pressure corporate earnings. While 3Q earnings were OK, most companies gave negative guidance citing higher wages as pressuring profit margins. This, of course, could lead to higher consumer spending as well but also resemble a more late-expansion phase of the business cycle. The S&P 500 is trading at an expensive level around 22-24x earnings right now.
On June 23, 2016, the majority of England's voters opted to leave the European Union. In our commentary following that event, we wrote “ more and more countries are moving toward protectionism.” Trumps victory here in the US only affirms and accelerates this trend. In 3 weeks, Italian voters will go to the polls to approve amending the Italian constitution but has morphed into an opportunity for voters to express anger with the current establishment. Italian Prime Minister Matteo Renzi has said he will resign if the voters do not support his reforms. The main promotions of the anti-establishment campaign is to have Italy withdraw from the single-currency Euro system. Also, now gaining ground in France are the extreme populist movements heading into the presidential elections in the Spring. These campaigns are also leading with anti-EU and anti-immigration rhetoric. People in the US and Europe are unhappy with sluggish economic growth and the status-quo and enough anger has built up in the system to force democracies to change course.
While there are inevitably some marginal winners and losers, we believe that globalization has benefited the countries participating by accelerating economic growth and improving living standards. Therefore, we think that the growing chorus of anti-globalization might do the opposite. While peaceful changes are always possible, history shows us that they are not as likely. In the long-term journey, it is possible the world may arrive at a new phase of peace and prosperity, however, the short-term road to get there will likely be bumpy and full of hazards – especially if we are all driving in different directions.
Time will tell if Trump and the Republican led Congress can successfully steer the US toward greater economic growth. In order for this to be sustainable, however, it must also include and bring along the rest of the world. Higher growth and higher inflation can bail out debt problems, monetary policy failures, and cure a lot of dangerous imbalances in the global economy. While this is possible, we don't think it is likely to be a smooth process as the world is very inter-connected and fixing these global imbalances will be challenging. In the meantime, stocks are expensive and a stronger US dollar is likely to pressure earnings making the stock market unattractive. The bond market has been under pressure lately as many expect higher inflation in the future. The geopolitical backdrop is extremely fragile as anti-globalization sentiment spreads. The Italian referendum and France elections are just two examples where this sentiment may cause further instability. We think the odds favor more volatility going forward and risks are more to the downside.