Donald Trump has been Elected President: More Volatility In The Short Term

• Donald Trump has won the Presidential election.
• The initial consequence of the Trump victory was a rise in uncertainty: interest rates, dollar and equities fell
• After the initial rise in uncertainty, investors would probably consider that US tax cuts and reforms, coupled with increased spending on infrastructure, would boost economic activity. This supports our positive medium term view on equities.
• The increased expectations for higher Fed target interest rates should gradually support the dollar.
• We maintain our anticipation for a gradual rise of bonds yields beyond an initial period of volatility.
• We expect an initial rise of volatility in the coming days/weeks but we suggest to not sell in the panic. Depending on market evolutions, we expect opportunities to materialize especially on dollar denominated assets.

The House and Senate elections

Americans voted for 34 senators and 435 representatives.  Before the election, the Senate was controlled by the Republicans by a 54-46 margin. In the House, the same majority applied, but with a larger margin (246-186).

Full details are not yet known but both Senate and House are very likely to remain in the hands of Republicans.
 

The impact on the economy and the financial markets

After a few weeks or months, we think that economic agents will realize that Trump has no intention of increasing budget deficits

unsustainably and that the US Constitution stipulates that any US president has limited room for manoeuvre.  

The focus on stimulating economic growth through domestic spending will probably outweigh the negative effects on trade.

Economic activity could gradually bring positive surprises and inflation would likely follow suit. This, in turn, would allow the Fed to hike rates beyond current market expectations. We would see a similar pattern to the base case.

The economic impact on the US’s main trading partners would be gradual and would probably hurt some emerging markets more than others. All in all, global economic growth and that of emerging economies would probably be revised down. Even if the dollar falls further in the short-term, its role as a safe-haven currency in periods of stress would limit downside (at around -5% according to us).

The progressive improvement in US economic growth and the Fed’s rate hikes should gradually support the dollar and translate into expectations of a rising interest rate differential. A 12-month target of around 1.08 remains realistic. US bond yields would probably follow a similar pattern. The initial rally in safe-haven assets – i.e. Treasuries - would eventually be followed by a bond sell-off. A temporary fall in 10-year Treasury yields to levels around 1.60% is possible. The 2% target for late 2017 is still realistic. The Bund would share a similar pattern. Emerging market bonds could see a sell-off given the negative effects on trade and especially as the Fed moves on in the rate cycle.

The initial stock market reaction would have been a sharp selloff (by around 10%), with investors even talking of a “black swan” event. This reaction would translate into the markets pricing in a substantial risk premium into valuations (PE compression) due to political uncertainty.

By comparison, the S&P500 index lost 5.3% in the two days following the Brexit news (last June) in line with the drop in the FTSE100 index (-5.6%) but the euro area lost 11%. Note that on this occasion the correction began after the results of the vote had been released, whereas this time, the markets began a correction before the election outcome was announced.

Stock markets in countries with safe-haven currencies (such as Japan and Switzerland) would be harder hit (~12%), as would emerging markets (~15%), because of trade protectionism risks. The euro area would also suffer more (~12%) than the US because of the euro’s strengthening and its pro-cyclical nature.

Subsequently, but with a much longer lag than for Brexit (because Trump should only take up office in January), investors would probably consider that US tax cuts and reforms, coupled with increased spending on infrastructure, would boost economic activity.

In addition, if Donald Trump cools his protectionist rhetoric, then stock markets should be able to stage a substantial recovery. In such conditions, the US dollar would make up for the moderately lost ground, given the impact on growth and interest rate differentials, without, however, hurting the EU and Japanese stock markets, as both would benefit from their pro-cyclical nature and renewed risk appetite.

Bottom line scenario:

In the event of a substantial decline in global stock markets, we might consider upgrading the US stock market to Outperform, thanks to the positive impact of the moderately weaker dollar (versus other developed country currencies) and the fiscal stimulus on earnings forecasts. Subsequently, depending on the extent of hits to emerging market currencies and the degree of protectionism under the new Trump administration, emerging stock markets could also be upgraded to Outperform, with a clear preference for Asia.

To summarize, we expect an initial rise of volatility in the coming days/weeks but we suggest to not sell inon the panic. Depending on market evolutions, we expect opportunities to materialize especially on dollar denominated assets.

Initial market reactions:

The dollar has fallen while defensive currencies Yen, Swiss Franc etc. have surged. Gold is also up quite noticeably.

Stocks markets have fallen sharply, especially in the US.

Bond yields have fallen slightly across the world. The 10-year Treasury bond yield has fallen to 1,80 and the yield on the German Bund to 0,19. Finally, oil prices have trended lower since the announcement.
 

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