While the US election uncertainty may finally be behind us, whether and how pre-election rhetoric will ultimately be reflected in policy shifts remains unknown. With Donald Trump emerging as the winner of the presidential race, the markets are now casting their vote on what this outcome means. Stephen H. Dover, chief investment officer of the Templeton Emerging Markets and Franklin Local Asset Management groups, sees higher volatility, the possibility of more protectionist trade policies—which could have negative effects on the US economy—but also the potential for stimulus resulting from tax cuts and increased fiscal spending which could provide an offset. Here, he examines these and other global market implications from a changing US administration.
Stephen H. Dover
Managing Director, Chief Investment Officer
Templeton Emerging Markets Group
Franklin Local Asset Management
While US election uncertainty may be finally behind us, the economic consequences of a Donald Trump presidency will not be entirely clear until we are in a position to differentiate between campaign promises and real policy action. In the meantime, we would expect equity markets broadly to remain volatile on heightened uncertainties including in the key area of trade policy and the future composition of the Federal Open Market Committee. A large focal point of Trump’s domestic campaign promises had centered on looser fiscal policy built on infrastructure spending and job creation, which could serve as a boost to global demand. More concerning, however, would be a move toward trade protectionism, although we think it seems likely Trump will shift away from some of the more extreme policies he proposed in this area. Insofar as such policies are enacted, we think a shift away from a rules-based trade regime will likely have broader knock-on effects globally. Here are a few of the main general risks we see affecting the United States and other countries globally:
- Rising risk premium on the back of policy uncertainty; markets may face bouts of optimism and pessimism
- More protectionist trade policy likely, but potentially offset by tax-cut stimulus and increased fiscal spending
- Exporters to the United States are likely to face headwinds from increased protectionism
- More controls on immigration and movement of people
- Less support for current defense and security arrangements (which potentially would have significant implications for countries such as Japan, South Korea and Taiwan)
Potential US Growth Supporters
Given the Republican Party’s pre-election focus on a pro-growth policy, more unified executive and legislative branches in the United States should increase the likelihood of meaningful fiscal stimulus, along with reflation. Growing populism in the United States should also see increased public-sector involvement in infrastructure projects and other forms of spending, in our view. Hence, we think it is now more likely the US government will embark on more aggressive spending after experiencing contractionary fiscal policy for much of the past eight years. Admittedly, it remains to be seen how this stimulus will be paid for and what the implications will be for the deficit. This expansionary fiscal policy would likely boost inflation in the United States, which we think could be positive for certain investments.
- Rising inflation could cause a shift from bonds to stocks as policy rates finally begin to rise from zero and as the long end of the US Treasury yield curve may begin to price in more inflation risk.
- Rising inflation would likely be positive for cyclical stocks in particular, including those tied to infrastructure plays, banks and hard commodities.
- Repatriation of US corporate profits earned abroad could boost sentiment, which could have a positive impact on many multinational companies and markets overall—but could bring negative implications for other countries currently acting as a tax haven.
Pre-election rhetoric from both the Republicans and Democrats in the United States confirms to us that the country is following a global trend toward more protectionist and populist sentiment and a reversal in the appetite for globalization, as evidenced also in the United Kingdom’s Brexit vote to leave the European Union (EU). This is not limited to just the United States and the United Kingdom; the EU commission has been looking for ways to bolster the bloc’s trade defenses, possibly by introducing tougher trade measures, and at a recent EU summit in Brussels, increased trade protection and defense were large topics of discussion.
It is important to note that retrenchment in global trade had already begun prior to the election. The World Trade Organization recently slashed its forecast for world trade growth to just 1.7% this year from an estimate of 2.8% in April, and the compound annual growth rate in real exports and real gross domestic product has fallen to 1% from a peak of 3.5%, signaling global trade has slowed.1
We don’t anticipate that the new US government will be against free trade; instead, we anticipate an emphasis on ensuring fair trade. In our view, the electorate’s rebellion against globalization is not about trade per se, but rather a reflection of the focus on income and job growth.
Nevertheless, it is becoming clear to us that large regional trade pacts involving both developed and emerging countries will be less likely to pass in the future since the mutual benefits are often too diffused to justify relative to the costs, especially for individuals in affected industries who might lose jobs to competition. We think this will necessitate more bilateral trade deals between individual countries.
Impact on Emerging Markets—and Investment Opportunities
While we have seen some short-term shocks, overall, we think greater US fiscal stimulus and pro-growth policies could bring positives for many emerging markets, while domestic consumption fueled by decade-long trends of demographics and urbanization remains the core driver for the growth of emerging markets longer term.
For Asian countries in general, the primary impact of the US election appears likely to be negative in several key dimensions. These include protectionist trade policy, more controls on immigration and movement of people, less support for current defense and security arrangements (particularly relevant for Japan, South Korea and Taiwan) and the likelihood of capital repatriation from US companies back to the United States amid comprehensive tax reform that seems likely. That being said, we believe there remain significant investment opportunities in emerging-market economies propelled by domestic growth and reform, including India and Indonesia.
In regard to China, there is clearly heightened uncertainty, primarily over potential US trade and security relations with China given Trump’s past statements. As much of the value of Chinese imports comes from imported parts, notably from Japan, South Korea and Taiwan, those countries would all likely suffer if Chinese exports fell. However, it is worth noting that while the longer-term supply chain might shift from China to South Asian countries (as represented in the Association of Southeast Asian Nations)2 expertise in mechanical components could be hard to replicate at scale outside China. At the same time, external pressure may push China’s determination on internal consumption, market reforms, and innovation. Separately, Trump’s foreign policy could actually benefit China in some aspects, as he has been advocating a smaller presence in Asia Pacific.
Elsewhere, Latin American markets were broadly negatively affected by the news of Trump’s win. Mexico has been a focal point for the Trump campaign in regard to immigration and trade, and following the election, the Mexican peso fell sharply against the US dollar and Mexico’s stock market likewise plummeted. However, we think the country is overall well-managed and its supply chain is integrated for US companies. So, it seems the initial market reaction to the US election outcome may have been too negative. In addition, we have already seen a strong reversal of expectations regarding commodities (particularly metals), which should likely benefit a number of resource-rich countries in Latin America.
It is important to note that for the emerging-markets equity asset class at large, domestic demand and reform remain the secular drivers—India being a good example of this. Specifically, in the past decade, the emerging market countries themselves, and their respective equity markets, have changed significantly, often making them less dependent on commodities or goods exports, and more driven by domestic consumption growth, technology and services. This continues to provide a favorable investment backdrop for emerging-market investors. In our current environment, we are focused on opportunities presented by regions with strong domestic growth and consumption, and on firms with diverse geographical revenue exposure that may be less exposed to damaging (protectionist) country-specific policies that may arise in the coming years. In terms of individual companies, we see opportunities in companies with cost-curve adaptability that can drive margin expansion. For example, firms that are proactively investing in automation look attractive as the unit cost of labor is likely to rise in light of rising protectionist policies, and firms that invest in automating processes are likely to see less pressure on margins.
The US election result brings to mind the popular phrase that “all politics are local,” since there was an unexpectedly large groundswell of support for Trump in many disaffected and dissatisfied communities across the country. What is most remarkable in the recent election is the degree to which the major press got the direction of the election sentiment wrong. So it is an important lesson for all analysts and investors that we must be very cautious in our studies and not rely on a limited selection of sources or the consensus view, but rather we need to obtain information directly. This is the reason that our emerging market teams do not rely on the popular press or sell-side analysts, but make a point of being on the ground in countries around the world and getting firsthand information. We also believe active management has a strong place in this type of environment and can add value for investors.
In conclusion, a Trump presidency has clearly elevated risk. However, it is too early to credibly assess the economic and political ramifications of this result. We have highlighted a number of risk areas which we will continue to closely monitor. We believe that our strategies are currently well-positioned to withstand the risks we see. Whatever happens next in the United States or elsewhere in the world, we believe that from every situation comes potential opportunities. It is our job to uncover them.
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The comments, opinions and analyses are the personal views expressed by the investment manager and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The information provided in this material is rendered as at publication date and may change without notice, and it is not intended as a complete analysis of every material fact regarding any country, region market or investment.
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