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Trumping markets

7 November 2016 By Rob Cox

Donald Trump promised recently that America’s presidential election would be like “Brexit times five.” The Republican contender means that he would, like the British referendum to leave the European Union, defy polls and emerge victorious. An unexpected win over Democrat Hillary Clinton, who leads in most pre-election surveys of voters, would have a similar effect on U.S. equities as Britain’s EU withdrawal did: send them into a downward spiral.

Consider the way stocks broke a nine-day drought on Monday after FBI Director James Comey said a trove of recently discovered emails did not change his conclusion that Clinton should not be prosecuted over how she handled classified information. The 2 percent bounce in the S&P 500 Index is not necessarily an endorsement of her economic policy. It’s more a recognition that Trump’s vows to upend globalization and world trade, two bedrocks of free-market capitalism, alongside the politics of personal animus that characterized his campaign, present a riskier proposition for investors.

Even if the New York real-estate mogul does win a four-year lease on the Oval Office, there’s evidence to suggest the stock market decline might be ephemeral. Here the Brexit analogy is instructive. Ahead of the EU vote, the FTSE 100 Index rallied as polls suggested the “Remain” camp would win, closing at 6,338.10 on June 23. When the opposite happened, the benchmark fell nearly 6 percent by June 27. Today, the index is 14 percent higher and has outperformed the S&P 500 since the day before the ballot.

By contrast, American stocks had slumped 3 percent since the days before Comey’s surprise notice to Congress in late October that investigators had found new emails that might be related to Clinton’s personal server. Though about half that decline in equities has now been retraced, U.S. stocks appear to have priced in the possibility of a Clinton defeat, which arguably was not the case with Brexit.

Despite the instant blow a Trump victory would deliver, money will quickly flow back to those liquid financial assets that represent the least risk and highest return. They’re mostly dollar-denominated ones. The irony is that, after a swift rout, it might actually look like Trump fulfilled his promise to make America great again. Longer-term, a Trump presidency arguably represents a greater threat than Brexit to global prosperity.

There are few other destinations for the world’s bounteous supply of money to flow. A Trump-led American economy might be riskier than one under a President Clinton, but not immediately so. While he unilaterally could fulfill promises to slap tariffs on Chinese imports and rip up treaties like the North American Free Trade Agreement shortly after his Jan. 20 inauguration, the deleterious effect of reduced trade wouldn’t be felt for some time. It took a couple years after the Smoot-Hawley Tariff Act was passed in 1930 before U.S. unemployment spiked to 25 percent from 8 percent.

Similarly, Trump would need Congress to pass his massive tax cuts. Even if a Republican-leaning Senate and House were to approve Trump’s budget – far from given – it would take years for the nation’s precarious finances to scare off investors. These would expand the federal debt by $5.3 trillion, according to the non-partisan Committee for a Responsible Federal Budget. Personal income-tax cuts would immediately stimulate consumption, which comprises two-thirds of economic activity.

Lower corporate tax rates, meanwhile, could flow straight to the bottom line, providing a further boost to many stocks. Moreover, corporations probably would be able to use more of the $2 trillion-plus they’ve squirreled away overseas under a Trump regime to buy back stock and dole out dividends. As an adept, if legal, tax dodger himself, Trump likely would be more forgiving of companies that avoided paying Uncle Sam than would Clinton, who has said she’d target tax-amnesty proceeds for infrastructure investments.

At the same time, a President-elect Trump could get into an apocalyptic Twitter fight with one of America’s enemies, or allies. If that created the specter of military confrontation, then all bets would be off and geopolitical risk would skyrocket. Even in that scenario, however, it’s not as though the world can offer up a bounty of safe alternatives to the mighty U.S. dollar.

European financial assets face an imminent threat of their own. In yet another abdication of representative democracy, Italians are due to vote on Dec. 4 on a constitutional amendment that could topple Prime Minister Matteo Renzi’s government. That risks throwing the fate of one of the continent’s most indebted nations, and the single currency, into turmoil again. Even if Renzi survives, next year’s elections in Germany, France and the Netherlands may see far-right, anti-EU political parties gain substantial ground.

Similarly, Britain’s ongoing struggles with abandoning the EU make the country a poor financial steward, as evidenced by the volatility in sterling. Having reached a three-decade low against the dollar following the referendum, the currency rallied last week after England’s High Court ruled that the government needs parliamentary approval to begin EU divorce proceedings. Most currency strategists predict the pound will keep falling, to as low as $1.15, according to Deutsche Bank estimates, from the $1.25 where it trades now.

Further afield, there are no obvious safer bets than the United States. Certainly not China, with its looming debt crisis, overvalued currency and absence of rule of law. The yen, a traditional safe haven in times of crisis, is a terrible option. The outflow of Japanese corporate money to the United States represents an indictment of a domestic economy that is shrinking, along with its population, and a government that has resorted to desperate fiscal and monetary policy. Plus, negative interest rates.

“The flow of funds out of Asian nations with low or no population growth is an economic boon for the United States and promises to keep interest rates low for the foreseeable future,” Kroll analyst Christopher Whalen wrote to investors last week.

The likelihood of Trump becoming the next president stands at just 32.1 percent, according to the widely followed FiveThirtyEight.com. That’s not far from what many bookies predicted for Britain’s “Leave” campaign. Investors this time aren’t putting their faith in the odds. And they have few other options available. For markets, at least in the short term, a Trump win is bound to be more like Brexit times 0.5.


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