Fourth Quarter 2016

The rise of populism, culminating in the surprise win of Republican presidential candidate Donald J. Trump last November 8th, has already made a significant impact on both the fixed income and equity markets around the world. We suspect this is only the beginning, as markets digest Britain’s exit from the European Union and Republican control of the Senate, Congress and White House in Washington.

Brexit will have major implications on the global economy. However, with the uncertainty over when the negotiations between Britain and the EU will actually begin, it is not expected to have a significant impact in the short run. On the other hand, with Trump’s imminent inauguration, the new administration will potentially bring a number of fundamental changes to the modern world’s most important functioning economy.

First, a cut in both personal and corporate income tax rates, coincident with an increase in domestic infrastructure spending, will accelerate American economic growth in the short run. However, these actions will likely lead to a widening U.S. Government deficit, inflationary pressures and higher interest rates, especially in light of the relatively low unemployment rates in the U.S. While spurring economic growth is good, the long-term focus should be on sustainability. High government deficits and increasing interest rates can be damaging, should they rise too far too fast.

Second, a serious attempt to repatriate large corporate cash reserves held offshore by U.S. multinational corporations via some sort of “tax amnesty” could accelerate the rate at which these companies return cash to shareholders or otherwise boost shareholder returns. This would be positive for equity investors.

Third, a significant number of President-elect Trump’s daily tweets (other than those attacking his detractors) have focused on trade and the adoption of protectionist measures to “Make America Great Again”. It has been widely shown that an increase in protectionist measures is not economically beneficial, either for trading partners around the globe, or for the U.S. consumer. While tariff barriers may protect some jobs, or even bring them back in the short run, it will inevitably result in increasing the cost of goods to the consumer in the longer run. Globalization of free trade has generated economic benefits for decades now. It would seem almost impossible, and detrimental, to put that “genie” back in the bottle.

As active investment managers, it would be naïve of us to pretend that this new U.S. administration will have no real impact and that we should carry on with “business as usual”. In our opinion, the next four years will feature unpredictable U.S. leadership and an attempted economic pivot away from multinational activity towards an emphasis on domestic economic benefit. To this end, companies active domestically in such areas as infrastructure, construction, engineering, and energy and resource extraction will be beneficiaries. To the contrary, companies with a large emphasis on globalized multinational operations may face headwinds, depending on their business model and where they operate.

An increasing rate environment does not harm everyone. For example, large banks and financial institutions, which can operate on a wider “spread” with higher rates, have much to gain from a rising interest rate environment. On the other hand, increasing rates are bad for the bond market and for equities better known for their dividend yields than for any meaningful growth.

As 2017 unfolds, we will be mindful of these new dynamics and will be implementing changes to your portfolio in order to both protect its current value and to take advantage of new growth opportunities.

 


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