The good news: As you may recall from our last blog posts, markets don’t like uncertainty. Therefore, removing the political ambiguity is a relief, both to risk appetite and business activity. Stocks will begin to look forward to additional tax cuts and deregulation in a Trump second term. This comes at a time when underlying growth remains resilient and disinflation is still in place. Meanwhile, most central banks (except the Bank of Japan) are cutting borrowing costs across the globe, and fiscal stimulus is now here to stay in the U.S. and is ramping in the world’s second largest economy, China. Stocks will celebrate deregulation and tax cuts, in the short term but we are still cautious as the S&P500 is already quite elevated from a valuation perspective when benchmarked against historical averages.

 

The bad news: Borrowing costs, which have been falling for a year, could face upward pressure due to this administration's lack of appetite to address massive fiscal deficits plus inflationary pressures from tariffs and tighter immigration (which could cause wages to move higher in the U.S.). This is occurring against a backdrop of elevated valuations (~22x forward earnings for the S&P 500 assuming a ~$268 EPS number for the S&P). Also, Trump comes to power against a very different backdrop than 2016. At that time, 10-year yields were <2%, the corporate tax rate was 35%, stock valuations trading at 18x earnings, and US total debt/GDP was 75%. Today, 10-year yields are >4%, the corporate tax rate is 21%, stocks trade for 22x earnings and US debt/GDP is >125%, so the playbook he outlined in his campaign (eg. tax cuts, protectionism) could be less effective in this environment. Closer to home, a protectionist U.S. is not good for Canadian businesses - tariffs are a real risk.

 

Here is what we’re seeing in the market:

• U.S. 10-year bond yields are rising 12bps to 4.40%, and this is pulling borrowing costs slightly higher around the world. As expected, rising inflation expectations are the primary driver, but the bond market is also pricing in higher growth expectations.

 

• The U.S. $ is rising in tandem, which is placing downward pressure on commodity prices (and the commodity sensitive Canadian $).

 

• Cyclical sectors (banks, industrials, tech) rose the most as they are considered beneficiaries of a reduced regulation / pro-growth agenda. Retailers, consumer staples and renewable energy stocks fell as they could face margin pressures if tariffs come to pass.

 

What about the Fed and a soft landing? During a press conference last Thursday afternoon, Powell said he would not step down from his position as Fed chief even if the President-Elect asked him to. More importantly, the rising U.S. deficit and overall fiscal policy remain headwinds to the economy. “The federal government’s, fiscal policy, is on an unsustainable path,” Powell said. “The level of our debt relative to the economy is not unsuitable, the path is unsustainable." Trump’s fiscal agenda is very expansionary while immigration restrictions could impact the supply of workers, the path of Fed easing will likely be more gradual than was the case before. 

 

The bottom line: the last Republican administration (also under Trump) was filled with a lot of noise but ultimately was very good for the stock market, and, to a lesser extent, bonds and real assets. The biggest downside risks going forward are tariffs, the return of inflation and rising geopolitical tensions boiling over into larger conflicts. But this is occurring against the backdrop of a global economy that is gaining momentum and has multiple tailwinds behind it in the form of stabilizing prices, ongoing stimulus, and resilient corporate structures. We'll stay tuned to political appointments in the weeks ahead and will reach out if any fine-tuning is needed, but see no reason to make major shifts to asset allocations as a result of this news.