Our Insights

About personal finance, investments and markets.
November 10, 2016

Trump is a paradigm shift and most investors are wrong

The consensus before the election was clear: Clinton will get elected and if Trump were to win, financial markets would sell off aggressively. Well, both assumptions were wrong. Yesterday, the major equity indices in the US and Europe closed in positive territory despite a President Trump. One should never read too much into short-term market moves, but we think that it is worth analyzing the winners and losers on the first trading day after the election because it probably tells us a lot about the next few years.

Winners and losers on Wednesday

While equity markets in developed countries rallied strongly, the bond market told a very different picture: the longer your duration, the more the bonds sold off. Gold closed unchanged on the day.

Dow Jones+1.4%
MSCI Emerging Markets-2.5%
German 10 year bonds-1.1%
US 10 year bonds-1.8%
US 30 year bonds-5.2%

Tell me why…

If you think the market moves were random, you are probably making a major analytical mistake. Markets are reasonably efficient and they priced very quickly the key parts of Trumps election promises. While he said many things during the campaign, he has promised mainly five things:

  • Lower taxes
  • Higher issuance of public debt
  • More public spending
  • Tariff increases
  • Restrictions on immigration

All of these are inflationary!  For example if he is true to his promises on immigration, the spending boost will be directed at a shallower pool of workers, protected from competition at the lower end of the pay scale. Pricing pressures will build in an economy that has already a low unemployment rate of around 5%.

In summary: Trump is pro growth and pro inflation. Even if he doesn’t say so explicitly, but this will be the outcome of his policies. The fact that Trump will have a much more cooperative Congress to work with than Barack Obama ever did will also remove many of the constraints to Trump’s fiscal plans.

It is therefore no surprise that US equities rallied strongly after the initial sell-off in the morning. More trade barriers are negative for Emerging Market equities and thus their underperformance can also be easily explained.

While the media likes to focus on the gyrations in the equity markets, we think the real tell was somewhere else. The one market reaction that in our opinion really counts is in the bond market, and here the message is also economic reflation is on the way.

Assets that lead one bull market usually do not spearhead the one that follows

Here’s the problem: investors chase performance. The best performing assets since the last financial crisis in 2008 were government bonds, investment grade bonds and bond-proxies such as low-volatility equities. Put differently, everything that has high duration. However, if interest rates are now bottoming, it stands to reason, that the winners of the next cycle will not be the same as in the previous bull market.

Markets are a discounting mechanism and they have definitely caught onto the story of the reflation trade. Today for example, the dividend growth stocks, i.e. the much beloved bond proxies, that have done so well over the last few years, have taken a beating while the equity markets continued to rally.

Maybe it is time for individual investors to see the paradigm shift before it is too late?

Please read our Terms of Use.