For what comes next in markets, look back to 2016
Summary
Selecting which Trump trades turn into Trump investments is just as difficult this time around as it was in his first term. The right bets might seem obvious now, but they did back then, too.
The Trump trade is over. Now markets are thinking about the Trump investments.
The challenge is to split out what he really plans to do, and in what order, from what was merely campaign rhetoric. Before the 2016 result, the Atlantic wrote that Donald Trump supporters take him seriously, but not literally, while his critics take him literally, but not seriously.
Markets are currently putting everything they like into the seriously camp, and dismissing all the bad stuff as literal, mere campaign rhetoric. This smacks of too much optimism, the same mistake they made last time.
After taking office in January 2017, Trump prioritized things that markets didn’t like. He moved fast on immigration, especially from Muslim countries, pulled out of the Trans-Pacific Partnership trade deal and renegotiated trade with Mexico and Canada, then wasted energy trying to ditch Obamacare.
He didn’t literally make Mexico pay to build a border wall, but he was serious about reducing illegal immigration. Investors had to wait until the end of the year to get the tax cuts they anticipated, while regulatory easing took a long time too.
This time the same four big policies are in play. Again two are broadly bad for investors, and two broadly good. Clampdowns on immigration and high tariffs would hurt the economy, while lower corporate taxes and less regulation would help economic growth and stock prices.
The order they come will be critical, and remains entirely unknown. Yet investors have been piling on the happy thoughts as they buy U.S. stocks, especially smaller companies, and dump Treasurys. The bet is on higher growth and less red tape.
This might be merely a trade. Already the most obvious—and deeply flawed, in my view—Trump trade has imploded. Trump Media and Technology Group, or DJT, the money-losing social-media operation which he part-owns, had plummeted on Friday morning to half the value it hit during bets on him winning in late October, before a partial rebound. It is down 30% from its high the day after the election. The initial surge in banks and the dollar and the plunge in the Mexican peso all had big reversals.
Trump trades lasted longer after the 2016 election, but then faded before he entered the Oval Office. Could this week’s jump in stocks be a similar short-term bounce?
One argument is that the gains are what normally happen after an election, but on steroids. There was a lot of uncertainty ahead of the vote, because the polls—which proved deeply flawed—were 50-50, and many investors were concerned that Trump would not concede defeat if he lost. The VIX index of implied volatility hit 23 at the end of October, before plunging to 15. The trope that investors hate uncertainty has some truth to it, and that fall in the VIX almost mechanically pushes up stocks.
Chris Brightman, chief executive of Research Affiliates, says stocks have tended to trend upward after past elections for about 20 trading days as uncertainty is resolved, before the effect fades.
Another argument is that it is much easier for Trump to implement the stuff markets don’t like than to cut taxes and regulation. He can quickly impose tariffs and limit immigration with executive orders, even if he is highly unlikely to follow through literally on using the army to round up illegal immigrants for deportation. Cutting taxes needs Congress—where the House election outcome remains uncertain, although looks likely to go Republican—while regulatory moves are sure to be challenged in court.
Even if we were willing to ignore the timing and invest for his full term, it isn’t obvious how his major policies would interact. Supply shocks from ejecting immigrants and from higher tariffs are in principle inflationary in the short run. But in the long run they slow growth, which should lower stocks and Treasury yields.
Tax cuts are inflationary and pile on even more government debt, which should lift stocks and Treasury yields. Removing bad regulation should raise productivity, which increases growth without inflation and pushes up Treasury yields, while lowering the cost of compliance is great for stocks.
Worse still, we don’t know how far he will go with his policies. Whether Trump should be taken literally about the scale of tariffs, or whether this is just a negotiating tactic as some tariffs proved in his last term, is unclear. Likewise, the current administration has already clamped down on immigration. Trump can do more to secure borders but if he doesn’t literally force millions to leave, the impact on the economy wouldn’t be serious.
On taxes, again it was right to take him seriously but not literally. One example was the estate tax: In 2016 Trump said he would abolish it, then kept it, but with much larger exemptions. The broad direction would clearly be lower taxes and an extension of the 2017 tax cuts, but don’t assume he will follow through on the (very problematic) promise to scrap taxes on tips.
He has said he will make billionaire Elon Musk his “efficiency czar," which suggests a return to the pre-Nixon days of light-touch regulation. But voters like clean air, clean water, safe vehicles and reliable banks. Picking which rules to ditch and which to keep will require time-consuming assessments, while a slash-and-burn approach to red tape could alienate many supporters.
Selecting which Trump trades turn into Trump investments is just as difficult this time around as it was in 2016. They might seem obvious now, but they did back then, too.
Write to James Mackintosh at james.mackintosh@wsj.com
