The markets got it wrong … again
Eric Stein, Co-Director of Global Income
Boston - If 2016 has taught us anything, it's that anything can happen.
The Chicago Cubs overcame a 3-1 deficit to win their First World series in 108 years. In the NBA, Cleveland Cavaliers also staged a stunning 3-1 comeback against the seemingly invincible Golden State Warriors. And in the political arena, Brexit shocked and unnerved investors.
Continuing that streak of surprises, Donald Trump will be the 45th U.S. president. In a night eerily similar to the Brexit vote when financial markets, exit polls and most pundits got that outcome dead wrong, Trump secured an unexpected victory. In Congress, the Republicans kept their majorities in the House and Senate.
So what now for investors?
The initial overnight reaction in U.S. stock futures was negative, although the major indices flipped positive in early trading Wednesday after Trump's conciliatory acceptance speech. Meanwhile, U.S. Treasury yields were higher with a steeper curve, and the dollar was little changed versus most of its currency rivals.
The main takeaway of a Trump presidency is the distribution of expected outcomes has widened dramatically. This election has been an incredibly polarizing event with two main party candidates who were essentially at record disapproval ratings. However, it's important for investors to put their emotions aside and dispassionately analyze potential policy outcomes now that the result has been decided.
That means closely watching the tone and rhetoric from Trump. If he focuses on building walls, banning certain people from the U.S. and throwing Clinton in jail, that would have ominous consequences for the markets.
On the other hand, markets would be reassured if Trump focuses on pro-growth tax and regulatory initiatives. In his acceptance speech, Trump said he would "harness the creative talents of our people and … call upon the best and brightest to leverage their tremendous talent for the benefit of all." He also pledged that his economic plan would double U.S. growth.
My expectation was that a Clinton victory would mean more of the slow growth that has characterized the recovery after the financial crisis. With Trump winning, the "tails" on both sides have increased.
If Trump calls for tariffs and ripping up trade agreements, that means a bigger chance of recession. If, however, he focuses on pro-growth tax and regulatory policies, and infrastructure investment, then there is a chance that U.S. economic growth could exceed 2% or even 3%.
Bottom line: Trump's victory means more uncertainty and volatility for markets, and a wider distribution of potential outcomes to consider from both a market and economic perspective. I do expect to see the market continue to price in a significant fiscal expansion and also higher inflationary outcomes. In the coming weeks, the president-elect's tone and rhetoric could provide clues on where his administration will focus from a policy perspective. Given the wider distribution of economic outcomes, there is the potential for significant market reaction in both directions.
