For now the market is rightfully focused on the potential for a large debt-financed fiscal stimulus. Trump’s economic plans were criticized during the campaign as unworkable, but concentrating on the details misses the point. He might as well have said he wanted to do a “Bazillion” dollars worth of stimulus. We know he wants it big, we know he wants it focused on infrastructure, and we know he wants to generally cut taxes,* so by definition spending would be debt-financed. Depending on whether the stimulus is successful in raising productivity (this is the true test of its efficacy), such spending can result in inflation, durable growth, or both.
Fiscal stimulus can bring about inflation primarily because our labor markets are tightening. If Trump and congress agree to build a bridge, qualified workers need to be hired to build the bridge. There are surely some sidelined infrastructure workers remaining, but in the big picture, our unemployment rate sits at 4.9%, not 10%, and certainly not 20%, as it was at the outset of the New Deal. We are at a different spot in the business cycle than when typically a large fiscal package is unleashed. What’s more likely is that qualified infrastructure workers are in other non-infrastructure jobs. Stimulus-related hiring will bring them back to their core competencies, but leaving their old jobs vacant. Wages will need to increase to re-fill their old jobs.
Fiscal stimulus can bring about durable growth if it lifts our sagging potential growth rate, and the easiest way is through raising productivity. (See Touchstone). When the infrastructure worker leaves his or her old job, his or her productivity is certainly enhanced because their skills were underutilized in a suboptimal job. They’ll earn more income as builders, and they’ll deserve it. This is a temporary effect though, unless the act of constructing new roads, bridges, airports, power plants, and physical technology like high bandwidth internet, actually leads to lasting high-impact job opportunities for workers. This is especially true of workers who have taken the brunt of globalization and the progressive cultural wave. Productivity will benefit from a different mix of job creation, and I am very optimistic for this under a Trump presidency. These are the voters which really awarded Trump his victory, as shown by his performance in Wisconsin, Michigan, and Pennsylvania.
In either case, whether inflation or durable growth dominate the outcome, this should lead to higher interest rates. In the case of inflation without lasting productivity enhancements, the Fed may choose to take the opportunity to further normalize policy rates, in which case long end rates may not move much higher from here. The Fed may choose to let inflation run above target or even raise their target – “the high pressure economy” – in which case long end rates have considerably further to go. In the case Trump’s plan succeeds in achieving the panacea of productivity enhancement, higher (i.e. above 2%) growth will be durable and rates, too, should be headed higher.
So what to own? Inflation and/or durable growth are good for creditworthiness of virtually all borrowers — whether corporations or individuals. So we favor credit, and favor a mix of Investment Grade, US High Yield, and US securitized (individual consumer) credit through the Asset-Backed Market. The first two are susceptible to fixed income outflows forcing selling, but over the medium term are strongly supported by a growth-or-inflation economic backdrop. Consumer credit is more insulated. Carry remains king in the US fixed income markets. The exception would be vanilla residential mortgage products, to which interest rate volatility (in this case, a sell-off) is unfriendly, and which have consistently benefited from aspects of bank capital regulations of prior administrations. We’d be underweight those.
Other Trump Implications:
The Trump victory is the clearest voter-endorsement yet for anti-globalization themes, broadly defined. That is protectionist, anti-immigration, and domestic-populist. Classical economic theories suggest that these policies are anti-growth. I have long questioned this orthodoxy however, in these pages, at least for domestic growth. See: Voters Challenge a Creed of Economics, The Ultimatum of Policy and Politics. I am willing to maintain my skepticism.
That said, anti-globalization is unequivocally unfavorable for emerging markets. EM economies have for two decades benefited from open borders for capital, labor, and trade. Tightening down those borders is simply likely to run that process in reverse. Leaders like Mr. Trump and those in his mold recognize the electorates in DM have simply had enough. EM is going to have to swap the long end of the stick for the short end. Global trade volumes were already on the decline, and global trade correlates with global growth. I expect the slope of that decline to intensify, probably dragging down global growth with it, but this will be a shift in growth back from EM to DM, perhaps with the whole growth pie shrinking a bit. To the extent DM growth gains some momentum, it also allows more pro-global-growth trade policies to creep back into the discourse. For now, no.
Domestic growth and/or inflation are also bullish for US equities. Equities are, after all, a real asset with floating earnings and dividend streams. They are, to a degree, inflation hedged. Equities also have at least two more advantages in a Trump administration: first, since stockholders have a claim on the post -tax earnings of a company, cuts in the effective corporate tax rates benefit the earnings stream directly. How policy changes affect the effective rate (as opposed to the marginal rate) is complex, but they’re certainly not going up! Secondly, a rationalization of both the ACA to eliminate deadweight losses, and a sensible streamlining of the regulatory burdens in many industries will improve earnings streams, all else equal.
*repealing the beneficial treatment of carried interest is an exception, but that is but a rounding error