Donald Trump’s election victory and the Republican party’s clean sweep means fiscal loosening in the US is now a ‘foregone conclusion’, with the dollar and interest rates set to move higher according to Bank of America Merrill.
In its commentary on the election outcome, BofA Merrill notes that a clean sweep is an exception rather than the norm in the US, with only 18 years since 1965 that a single party controlled the presidency as well as both houses of Congress. It also represents a recipe for fiscal easing, as during those 18 years the US structural budget balance worsened by 0.4 percentage points of potential gross domestic product (GDP) a year.
Fiscal easing, in turn, signifies bearish rates. A fiscal stimulus of 1% of GDP has been associated with a 48 basis points increase in 10-year yields. BofA Merrill expects 10-year rates to test 2.25%-2.5% by the first or second quarter of 2017.
Higher rates are bullish for the US dollar (USD). The last time the US unleashed fiscal stimulus when the economy was not in a recession was under Ronald Reagan’s first term as president (1981-84). This emboldened the Federal Reserve to enter a hiking cycle propelling the USD 60% higher.
The bank believes that the “lowest hanging fruit” for the Trump administration will be tax reforms to encourage repatriation of the US$2 trillion that US companies are sitting on. Its estimates suggest that nearly $400bn of overseas cash could be converted to USD, providing a positive USD tailwind. The only year from 2001 to 2008 in which the USD rallied was in 2005, during the first Homeland Investment Act (HIA).
History suggests that investment returns for the next four years will be muted. Over the past 80 years average annual returns have been stronger under Democratic presidents (+14%) than Republican presidents (+10%), and the make-up of Congress has not changed the line-up.
The Standard & Poor’s (S&P) index also saw better returns the year after elections that resulted in a leadership change within the same party rather than both a leadership and party change. But the initial post-election reaction has favoured Republicans, where the S&P has gained 3.4% on average in the final two months of the year when a Republican was elected against 1.5% when a Democrat was elected. Ultimately “profits have been a more important driver of the S&P than politics”.
Assessing the likely winners and losers under Trump, BofA Merill believes that across-the-board-tax-cut for individuals and corporations could benefit equities broadly through the wealth effect. Tax cuts plus less upward wage pressure could benefit discretionary stocks, especially higher-end retailers. Corporate tax cuts would favour domestic companies over multinationals, though the latter could see a one-time benefit from the repatriation of cash held overseas and largely go to the tech sector.
Biotech and pharmaceutical stocks may be lifted given potential for less pricing scrutiny under Trump, which financials stocks could benefit from volatility, less regulatory risk, the potential for lower investment taxes and higher interest rates over time.
Trump has also called for the replacement of Federal Reserve chair Janet Yellen when her current term expires in 2018, where risks of a more hawkish Fed could hurt levered sectors and those with high dividend yields, which have seen performance erode as rates have risen. But in the near term, BofA Merrill sees a downside risk to interest rates and a potential delay in the next Fed rate hike – which many had expected to happen next month – amid the uncertainty and risk-off reaction.