What Makes America Great: Our Thoughts After the US Elections
In a surprise ending to a long Presidential election, Donald J. Trump was elected the 45th President of the United States last night. As with the Brexit vote in the UK, there is a tendency for investors to jump to quick conclusions. Luckily, the fate of the US economy and financial markets rests more on longer-term fundamentals than on who occupies the White House.
That said, more surprising than Trump’s victory alone was the Republican party winning the Senate, the House of Representatives and the White House (with a likely conservative tilt to the Supreme Court) for the first time since 1928. As a result, the likelihood that Trump can move through some of his major platform issues has risen dramatically. In his speech early Wednesday morning, Trump said, "We’re going to rebuild our infrastructure . . . And we will put millions of our people to work as we rebuild it." The mantra poised to take top billing in Mr. Trump’s first 100 days? “Borrow and build.” However, a Trump White House coupled with a GOP-led Congress promises a few shake-ups on the economic policy front. Possibilities include:
• Tax policy: Possible elimination of estate taxes, cuts in income taxes, a tax holiday on corporate cash overseas, end of carried interest
• Regulation: A repeal of Obamacare, a repeal of Dodd-Frank
• Fiscal and monetary policy: Increased federal spending (particularly on defense and transportation infrastructure), a new Federal Reserve Chair in 2018 (John Taylor?)
• Trade: Surcharges, tariffs, currency manipulation charges
Regarding market impact, though, it is far too soon to jump to too many conclusions. It remains unclear which policy changes will occur first, and it is difficult to assess their ultimate impact on the economy. Our guess is that Trump's policies imply a boost to government spending, a near-term reduction in federal revenues (due to tax cuts), higher long-term interest rates (more borrowing pushes up yields all else equal) and higher inflation.
We continue to feel that the US economic/business cycle should matter more to investors than the results of the election. Investors worry about the cycle's end because when they compare this cycle’s length (88 months) to the post-war average cycle length (61), the conclude the end is near. But calendars do not determine business cycles—nor do Presidential elections.
The best news post-election is that the surest indicators of a recession are not pointing toward a recession. Historically, the single best indicator of trouble has been the US Treasury yield curve. Yield curve inversion has generated only one false positive signal in 70 years of forecasting. If you think central banks have "stepped on the yield curve" in recent years and nullified its forecasting ability, our second-best forecasting tool also shows positive signs. Initial claims for unemployment insurance, to be exact, offer weekly information on layoff activity. In the post-war period, when initial claims head above 320,000 per week on a consistent basis, a recession is just around the corner. As you may have noticed, over the last year, layoff activity has moved in the exact opposite direction, to its lowest levels in more than 40 years.
Of course, the key election-related risk to the above view is the possibility that political uncertainty reduces investment and hiring, and tightens financial conditions. We will keep careful watch. Absent financial market disruptions, we still think a Fed rate move is on the table for December. What makes America great is that in a $17 trillion economy, the economic fundamentals and dynamic institutions matter more for the economy--and therefore for markets in the long-run--than any single person in the White House.
Payden Economics Team