Capital Allocation in Current Markets
President Trump’s policy agenda—with its far-reaching implications for growth, regulation, trade and geopolitics—is likely to be the overarching focus for markets in 2017. What makes this so intriguing from an investment strategy perspective is that embedded in this agenda are themes that speak to elevated risks at both ends of the risk spectrum. The right tail† is dominated by increasing economic growth optimism fueled by a combination of fiscal policy and deregulation. The left tail is dominated by unprecedented levels of political and policy uncertainty that threatens to drive up the risk premium of risk assets.
So far, the right tail has largely dominated as equity markets made new highs since the inauguration. Nonetheless, the executive orders that have accompanied Trump’s first months in office have also served to remind investors of the market risks associated with the President’s pursuit of the anti-globalization elements of his overall policy agenda.
Policy Pivot One: Shift From Monetary to Fiscal Policy
The Trump agenda presents investors with three broad economic policy pivots. The first change is that the engine of the growth stimulus has shifted from monetary policy to fiscal policy, as a pro-growth fiscal agenda sweeps over the economy. This emphasis on lower corporate and individual tax rates, repatriation of over $2 trillion in overseas U.S. corporate profits, and infrastructure spending has already produced significant moves in consumer and business sentiment even as the hard numbers on the economy have come to light .
Policy Pivot Two: The Promise of De-Regulation
Second, the promise of de-regulation is a significant pivot from the previous administration as Congress and the President have quickly settled into repealing a significant chunk of the Obama regulatory regime across a variety of industries, including Dodd-Frank and the Department of Labor (DOL) fiduciary rule. This lessening of the regulatory burden is expected to encourage credit investment and private-sector consumption growth. Sectors such as finance, energy, automobile, infrastructure, and small business in particular should be prominent beneficiaries of this deregulatory push.
Policy Pivot Three: State-Led Industrial Policy and Bilateral Trade Deals
The third notable policy pivot is the pledge to move away from multilateral international trade regimes in favor of a greater focus on state-led industrial policy and bilateral trade deals. This shift embeds within it some of the greatest risks for the economy. What new trade regimes ultimately develop from this reversal may be less important than the heightened uncertainty and the inability to predict process or outcomes which are critical foundations of a stable economic and capital market environment.
Taken together, the economic environment of 2017 has the potential to be an inflection from the “low and slow” backdrop of previous years. The baseline expectation for 2017 is that fiscal stimulus and de-regulation will encourage investment growth and consumption with the potential to add 1%-1.5% to GDP cumulatively over the next two years. The reflationary policies of the Trump administration, coming on top of recent moves in inflation rates, are likely to send inflation expectations higher still. Global growth prospects have also improved, propelled by stronger manufacturing activity in China and a notable uptick in activity in Europe. Indeed, global economies appear to be in the midst of a synchronized cyclical upswing. However, unprecedented uncertainty associated with domestic and foreign policy choices, implementation, and outcomes is likely to be a source of volatility for all asset classes in the near future, even as risk asset markets have moved higher.