Banksy's Elephant in a Room. Ignore it at your peril.
This post is part of our inaugural Trendspotting Series profiling important ideas that will be shaping some major fields of interest in 2017. Each piece represents the views of its author(s) and not the views of the Council.
1. UNCERTAINTY ABOUT U.S. PRESIDENT ELECT DONALD TRUMP
Investing is often about understanding the "elephant in the room." The thing thatis so obvious, but ultimately, will drive the course of the markets. Usually it is interest rates, corporate earnings, employment, oil prices or some other economic indicator. This year's elephant is U.S. president-elect Donald J. Trump.
As we write this, we, and the markets, know very little about the President-elect's actual policies, who his appointees will be, and beyond some broad strokes, what is the economic game plan. What we do know is that markets hate uncertainty.
2. WHO'S STEERING THE SHIP
Financial markets are fickle, funny, superstitious things. As legendary-trader George Soros says, perception often becomes reality. Key to setting confidence and perception is knowing who is at the helm of important agencies, such as the Federal Reserve Bank and Treasury.
President-elect Trump has had some unkind words for Federal Reserve Chairwoman Janet Yellen, but he can't fire her. She says she is staying in the job, which she has until 2018 and will be a member of the board beyond that.
We think Trump econ-advisor, hedge-funder Steve Mnuchin is the most likely nominee for Treasury, which would be welcomed by the markets. But can his nomination get past Senator Elizabeth Warren and the Wall Street-loathing Senate, including the Freedom Caucus, which made significant gains in this election?
Bank stocks, which had been moribund, rallied on the news of Trump’s victory. We believe largely for two reasons: (1) the conviction that Dodd-Frank will be repealed (likely replaced by either a higher capital requirement or a Glass-Steagall retread) and (2) an assumed reduction of status for Senator Elizabeth Warren. She and the president-elect had some ::ahem:: words during the campaign.
After more than $24 billion has been spent by banks to comply with Dodd-Frank, we aren't even sure what a repeal will mean. While Senator Warren no longer has the support of the White House, we do not think she will be cowed by the President-elect. The question is whether Dems will have any chance of truly shaping, or only forestalling, the Treasury agenda going forward.
4. REAGONOMICS REDUX?
Trump has talked growth, infrastructure, tax cuts for the highest earners, corporate tax overhaul and increased spending by the Federal government. Sound familiar? It’s Reagonomics aka Trickle-Down.
It is beyond the scope of this series to debate the merits of Reaganomics (even internally to my firm, we debate this issue, continuously, ad nauseam, drunkenly, fistfights ensue). U.S. capital markets, however, offered some clues to how they would respond to these presumed policy prescriptions: equities rallied, bonds sold off, which would be in-line with a potentially inflationary, growth-oriented economic policy. Copper (often referred to as the metal with a PhD in economics, because it predicts expansion) and other commodities, rallied to multi-year highs, on the view of increased infrastructure spend. If we are looking at Reaganomics Redux under president-elect Trump, we can probably expect this trend to continue.
5. ONE, TWO , THREE, FOUR, I DECLARE A TRADE WAR
We are (supposedly) going to build a wall, renegotiate NAFTA, put hefty tariffs on Chinese products, and re-consider our ties to Europe, militarily and economically. While the beneficial effects that tariffs might have on the U.S. manufacturing sector and employment are dubious, they are most likely bad for the U.S. consumer--expect price inflation leading to reduced purchasing power.
Since consumption is the largest part of GDP, to avoid recession, the government might have to increase one of GDP's other aggregates, government spending, which it has promised to do.
We already run at a deficit, increasing spending will require another country (or countries) to fund that spending, which means issuance of government securities. The power to issue new debt partially depends on the ability of other countries to buy it, and their economic status is also partially dependent on trade flows. One of the largest purchasers of U.S. government securities has been China, which has slowed its net purchases tremendously, partly reflecting a decline in global trade already.
But, it's okay, president-elect Trump says he can renegotiate the debt, just like he did on his casinos.
Steve Zausner is a partner at OFFICE:FMA, an advisory firm delivering strategy and financing solutions to effectively achieve growth, economic development, and improved social outcomes, globally.
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