Trumponomics and markets

Look past United States President Donald Trump's Twitter storms and focus on the big trends to navigate what will likely be extraordinarily volatile market conditions this year. In analysing markets, the three things I focus on are government spending, inflation and US Treasury yields. All of these had already started reversing before the arrival of Mr Trump.


America had already exhausted fiscal austerity before the Trump election. The budget deficit fell from 10 per cent of gross domestic product at the time of the global financial crisis and appeared to have bottomed at around 2 per cent in 2015.

Globally, politicians, economists and central bankers have been arguing for an end to austerity, calling on governments to spend more. Government austerity was offsetting the stimulus from quantitative easing, so the argument went. But, the Obama administration couldn't meaningfully lift government spending as a result of the obstruction by a Republican Congress.

Now, the Republicans control both the White House and the Congress. Expect much more government spending, much bigger budget deficits.


Inflation was starting to pick up anyway. It started reversing mid-2015. And, as a result, the 10-year US Treasury rose in mid-2016.

Mr Trump did not create these trends, but his mere arrival has already accelerated them. And, his spending will further accelerate them upwards. Near term, the expectation of Trumponomics is bullish US equities.

All other things being equal, increased government spending and tax cuts should boost economic activity, consumption and corporate earnings.

But, it is not quite so simple. All things are never exactly the same from one year to the next. Scholarly research on fiscal stimulus and stock market performance is inconclusive. There are just too many variables at work.

The US market rallies of the early 1980s and the Great Depression - both associated with fiscal stimulus - were the result of multiple factors, including falling interest rates and low stock valuations. Rates are now rising and US market valuation is at a cyclical high.

But, the bottom line is this: Rates are still very low. The economy is still flush with cash. And, most importantly, the market believes - and I borrow here from Mr Ray Dalio, chairman of US investment management firm Bridgewater Associates - that it is not just about government spending and taxes. It is about a profound, pro-capitalist shift in government that could "ignite animal spirits and attract productive capital".


Sentiment could take US equities higher in the near term, notwithstanding the recent hesitation. Along with that, I am also bullish on US banking stocks.

One, on the possible repeal or dilution of the Dodd-Frank regulations (financial reform legislation passed by the Obama administration in 2010 as a response to the 2008 financial crisis) on US banks.

Two, on rising interest rates and yields and higher net interest margins.

But, my bullish US equities call is over three, maybe six months. I am more cautious over 12 months. There are many uncertainties: Can Mr Trump deliver massive infrastructure building on tax incentives, or will the government have to use its own money? Can Mr Trump attract anywhere near the US$2.6 trillion (S$3.7 trillion) he expects through a tax holiday for repatriated US corporate profits?How fast will interest rates rise in response to government spending and borrowing?


Emerging market and Asia ex-Japan stocks look bearish near term. Rising US rates and yields might be good for US banks, but they could prove nasty for emerging market and Asia ex-Japan stocks.

But, I am more positive over 12 months. Valuations are more attractive in emerging markets than in developed markets. Asia ex-Japan is just emerging from a long earnings recession. Value investors should consider buying on the dips, with a patient, long-term view.

European stocks will likely be pushed and pulled by conflicting forces. On one hand, they will benefit from the continuation of quantitative easing and the likely further weakening of the Euro currency.

But, politics will overhang European equities this year, with the countdown to Brexit, elections in France and Germany amid growing populism, unresolved bad debt problems in Italian banking, and the risk of another surge of refugees flowing into Europe via Turkey.


I am underweight on bonds. The US economy is at risk of overheating. Unemployment has already hit the so-called Nairu (the non-accelerating inflation rate of unemployment). That is the level of unemployment below which inflation starts to accelerate. US inflation started accelerating as unemployment approached the Nairu at around 5 per cent.

What do you think is going to happen to US inflation and rates when Mr Trump starts to stimulate an economy that's already operating close to full capacity? Historically, where US inflation goes, the US Treasury yield usually follows.

But, US high-yield bonds are likely to do better than US investment-grade bonds. High-yield bonds are now trading way above where they were before the Trump-related sell-off, while investment-grade bonds have been going lower on the expectation of higher inflation and rates.


Rising inflation and higher US rates/yields will likely continue to support the greenback. The promise of more government spending is inflationary. Opec cuts to oil production are inflationary. Mr Trump's protectionist plans are inflationary.

•The writer is the chief investment officer for DBS Bank's consumer banking group and wealth management.

A version of this article appeared in the print edition of The Sunday Times on January 22, 2017, with the headline 'Trumponomics and markets'. Subscribe