How Donald Trump's victory affects our portfolios

Hollywood isn’t Donald Trump’s biggest fan, yet the greatest political comeback in US history would make one hell of a film. Some believe Trump’s second presidency will just be plain hell, but has the combustible passion of America’s election races set securities markets on fire?

Bond yields leapt on Wednesday morning – meaning US Treasuries were being sold – as investors factored in a greater risk premium at the prospect of a president whose fiscal discipline could be as loose as his famously sharp tongue. By the end of the week, however, yields had fallen back with markets taking more of a cue from Federal Reserve Chair Jerome Powell's tone which suggested normalisation of the post-pandemic labour market now exerts less inflationary pressure. 

Equities meanwhile got a rocket under them (appropriate given SpaceX boss Elon Musk’s backing of Trump), with the S&P 500 trading up strongly soon after the result. The stock market momentum was also maintained following the Fed's decision to reduce target interest rates by a quarter percentage point and signalling a further cut in December is still on the cards, albeit core inflation could keep that on ice. 

This matters for our Alpha asset allocation models, as their global focus inevitably includes heavy exposure to US shares and bonds. Strategically, we have a large chunk of the allocations focused on US dollar-denominated bonds and tactically, after our November rebalance, the granular investments included short-maturity US Treasury Inflation-protected securities (Tips) as well as US dollar corporate bonds, both investment-grade (IG) and their riskier high-yield (HY) counterparts.

Our Tips holding includes bonds with less than five years to mature, which means they also have a lower weighted average time to achieve the market interest yield. This time in years is known as duration, and it effectively represents the sensitivity of bond prices to interest rates. Our Tips’ shorter duration means their prices must fluctuate less to reach yield equilibrium. Therefore, as well as being gentle insurance against the real value of fixed payments eroding, they aren’t so prone to market gyrations.

Trump’s agenda – tariffs, tax cuts and no reduction in spending – risks inflation, so the low-duration Tips are a defensive holding. Hetal Mehta, head of economic research at St James’s Place, warns about tariffs in particular: “This could have a short-term inflationary impact, especially on sectors such as traditional energy, financials and defence as companies seek to pass on costs through price increases.”

Furthermore, a new administration raises the possibility of changing personnel at the Federal Reserve, which is walking a fine line controlling inflation and maintaining stability in the financial system: “With Trump potentially preferring an alternative Fed Chair [to Jerome Powell], policy uncertainty could increase,” suggests Mehta. 

Even left alone, the Fed may have its work cut out. Underlying US growth indicators were strong anyway, argues James Bilson, fixed income strategist at Schroders. Loose fiscal policy (primarily tax cuts in this case but this incudes government spending) will make it more difficult for the Fed to keep inflation to target and increases the risk of a ‘no landing’ scenario for the economy where high prices remain sticky and the Fed’s target interest rates must be kept higher for longer.

Corporate bonds always carry the additional risk of default, so the underlying strength of the economy and other demands on companies’ cash generation must be factored in. On that score, the likelihood of cuts to tax and regulation is a positive, and sectors such as oil and gas companies, which typically issue a lot of the paper in the high-yield space will benefit. It is possible Trump’s “Drill, Baby, Drill” mantra puts downward pressure on energy prices (good for the wider economy), so a cash glut for explorers may not materialise, but the business environment for the industry will be favourable.

Against a strong growth backdrop, valuation risk could be a problem for our credit holdings. Schroders’ Head of US Fixed Income, Lisa Hornby, points to credit spreads (the excess corporate bond yields must offer over government bonds with similar maturity) being in the bottom decile of their historic range. “This suggests an asymmetric risk/reward framework with a much higher probability of downside than upside.” Positing the effects of the Republicans winning the House of Representatives, too, Hornby adds that uncertainty ought to suggest “more risk premium should be embedded in markets, not less.”

Global shares form the backbone of the Alpha strategies, principally via the MSCI World index of developed markets and US mega-cap stocks make up the lion’s share. Trump’s victory is accompanied by a flip of the Senate to Republican control and, at the time of writing, it also appears probable the GOP will retain its majority in the House of Representatives. This, on the one hand, would facilitate decisive pursuit of policy but, on the other, a Republican sweep of all branches of government might entail carte blanche for sweeping change, which itself could cause the uncertainty markets hate. On the plus side for US shares, if backed by both houses of Congress, Trump could extend his 2017 tax cuts beyond their expiry next year.

“A more favourable corporate tax regime, full extension of the Tax Cuts and Jobs Act, and a lighter regulatory touch should outweigh the potential headwinds from increased tariffs and reduced immigration on corporate profits,” writes Jeff Schulze, head of economics and market strategy at Clearbridge Investments.

Looser regulation may be even more of a boon than tax cuts to the US economy, but the downside of the Trump agenda could be disruption of supply chains and higher component prices should he start trade wars (something he could do by executive power alone). That said, it takes more than one protagonist for such disputes to escalate and many countries around the world are in a weak state economically and may baulk at risking access to US markets. In other words, Trump’s brinkmanship may come off or his bluff could be called: either way it makes for uncertainty.  

Trump’s tone discussing America’s porous Southern Border has been incendiary, and from an economic perspective, immigration is a crucial factor in supporting growth. In his victory speech, however, Trump said he wanted people to come who do so legally, which suggests that despite scathing comments about undocumented people he is not dogmatically anti-immigrant, per se.

The outlook for US and global shares 

Addressing our portfolio holdings specifically, the bias in the MSCI World is towards the big tech stocks, and largely misses out on some of the US market sectors that could outperform. Clearbridge Investments’ Schulze expects value stocks, small-caps and the equal-weighted S&P 500 index to outperform growth stocks, large-caps and the cap-weighted S&P 500 as a result of the election. Specifically, Schulze identifies Financials, Consumer Discretionary and Industrials as sectors where stronger earnings growth could begin to be priced in.

Other Alpha equity holdings initially rallied strongly, including the FTSE 250. So why should UK mid-caps react positively? There are already reports of recessionary risk in Europe and the threat of Trump tariffs is surely a bad thing for companies exporting to the US. London shares rose on the result “in sympathy” with their New York counterparts, writes Ben Conway, chief investment officer of Hawksmoor Fund Managers, although he reasoned the end of US election uncertainty coming on the heels of the Budget meant UK investors may just “now feel comfortable putting money back to work”.

Fear of US protectionism may be keener for Japanese manufacturers, although the country probably jumped through enough hoops agreeing trade deals in the first Trump presidency. Indirectly, however, Japanese companies’ supply chains could see them caught in the crosshairs of aggressive US tariffs against China. In the short term, the leap in the US dollar against the yen is good for Japanese exporters on the massive proviso Trump’s bluster targeting friendlier countries’ exports is more an opening gambit.

Our emerging markets position may be more tenuous, however. Dollar strength places strain on companies that have hard currency borrowings denominated in the currency, but it also helps exports – again what actually happens with tariffs will be crucial. One country that will inevitably be the focus of hawkish trade policy is China, so its 28 per cent weight in the MSCI Emerging Markets index could hurt our portfolios. That said, Chinese stocks were already cheap and, as Neil Wilson correctly speculated in The Trader, Trump’s re-election provided impetus for the communist party to announce further huge stimulus: a 10 trillion renminbi ($1.4tn) economic programme.

Whether the projection of American strength will act as deterrent and maintain peace between the two superpowers, or Trump’s belligerent stance proves disastrously provocative second time around, ought to be the biggest fear for global citizens who didn’t get a vote. Taking an optimistic view, the contrast with the Republican administrations of yesteryear is stark (neo-con foreign policy interventionists such as the Cheney family hate Trump and endorsed vice-president Kamala Harris). Furthermore, vowing to be a president who ends wars is hardly rhetoric aligned with the Hitler reincarnate trope trotted out by Democrats in the campaign.

Hedging inflation risk

Catastrophic miss-steps aside, the biggest risk to investors from this virulently America-first strain of Republican government is the potential inflationary and even stagflation policy consequences. On that basis, the final holding of our asset allocations – gold – is a reassuring presence, despite the haven asset pulling back from its price highs. Longer term, Trump boasts his pro-growth agenda will see US real GDP overpower the near $36tn (and rising) US national debt and give a more prudent feel to America’s debt to output ratio. Should that prove wishful thinking, then gold provides some protection from erosion of fiat currency’s purchasing power.

Outside our asset allocations, digital assets soared on the results. Bitcoin broke the $75,000 mark and so-called ‘crypto bros’ believe Trump’s administration will lessen regulatory scrutiny of their industry. Holding some bitcoin has also in the past been touted as a way to mitigate against governments creating money when they borrow too much. That’s certainly a risk of the incoming administration, so there is reason to think both the planned and unintentional consequences of Trump can help crypto. Like that most turbulent of asset classes, we could be in for a bumpy ride, but hopefully our strategic asset allocations can help smooth it somewhat.