Will Trump Move the Markets?

Harmen Overdijk, CFA

The soft-landing narrative dominated U.S. markets in June. U.S. equities continued their tech-led gains while lower yields sent Treasuries higher.  

Outside the U.S., however, no clear risk-on/risk-off pattern emerged among developed markets. Euro Area equities and the EUR/USD exchange rate suffered in June amid both EU and French parliamentary elections. Chinese equities also corrected from their May highs, after the release of weak economic data and the government did not indicate any new stimulative policies.

Interestingly, the counter-cyclical US dollar strengthened in June, alongside other pro-cyclical assets despite the resilience in global growth and relatively constant interest rate differentials. The dollar may have gotten ahead of fundamentals and is thus vulnerable to a tactical correction.

The U.S. Presidential Election

The first U.S. presidential debate was held on June 25, 2024. Betting markets were very quick to crown former president Trump the winner. Meanwhile, Biden’s predicted chances to win fell off a cliff. The likelihood that he will be the Democratic nominee in November also fell. Biden’s probability of winning fell more than Trump’s rose, implying that the market-assessed probability for another Democratic candidate like Kamala Harris or Gavin Newsom increased.

The response of several assets to the sharp uptick in Trump’s probability of winning the election gives us a clue as to how markets might react if the former president were to win in November.

Treasury yields rose slightly, as a Trump presidency could result in larger fiscal deficits. The bond market could riot based on Trump’s policy proposals as it has done with similar political shocks elsewhere in the world where worries of fiscal irresponsibility have come to the forefront.

The Mexican peso weakened as Mexico will likely experience trade disruptions due to tariffs if Trump were to win. Exports to the U.S. account for 29% of Mexico’s GDP.

Bitcoin rose as the republican nominee has shown to be more supportive towards crypto assets in his campaign trail. There is some speculation that he would ease some regulations that the Biden administration has put in place.

The Election Outcome May be a Bigger Driver of Policy Change than the Fed

Trump’s economic advisors have recently been floating several unconventional economic policy ideas. Some of them, like abolishing the income tax and replacing it by 60% tariffs on any imports are simply unlikely to happen. However, talking about a sort of Plaza Accord 2.0 to devalue the dollar to reduce the trade deficit could be one of the more realistic options.

The original Plaza Accord was a joint agreement signed on September 22, 1985, at the Plaza Hotel in New York City, between France, West Germany, Japan, the United Kingdom, and the United States, to depreciate the U.S. dollar in relation to the French franc, the German Deutsche Mark, the Japanese yen and the British pound. It was supposed to help reduce the U.S. trade deficit and make its exports more competitive while stabilizing the trade account with Japan. Trump could try to strong arm Europe, China and Japan to revalue their currencies relative to the U.S, which could reduce the US trade deficit. This is something Trump seems to be focused on.

It is also likely that Trump would try to increase his influence over the Federal Reserve, and although the Fed is independent, the President has several tools available to increase his influence. Mostly through the appointments he can make. It is not unthinkable that Jay Powell would resign, and then Trump could appoint a new chairperson, who might be more open to his suggestions.

A potentially weaker dollar combined with looser monetary policy, could actually be positive for the domestic economy in the near term. Although it will likely reignite inflationary pressures and longer-dated US Treasury yields would rise, even if short-term interest rates come down. The prospects of less immigration could also help to keep rising unemployment in check. Therefore, as these election prospects continue to develop, we could see more volatility in the run-up to the election.

U.S. Data Weakens but is Still Resilient

U.S. durable goods orders growth slowed from 0.2% to 0.1% in May, beating expectations of a 0.5% contraction. However other components of the report disappointed consensus estimates. Durable goods ex-transportation declined by 0.1%, below expectations of 0.2%. Non-defense capital goods orders and shipments ex-aircraft also deteriorated. Both measures were below the prior month’s readings and below consensus expectations.

On the employment front, initial jobless claims declined from 239 thousand to 233 thousand, broadly in line with expectations of 235 thousand. Meanwhile, continuing claims worsened to 1.839 million to end June, from 1.821 million the week prior, slightly above consensus estimates of 1.828 million.

Overall, the data shows a U.S. economy that is slowing but still resilient. On a year-on-year basis, capital goods orders are holding constant. Meanwhile, once continuing claims are adjusted by the size of the labor force, the seasonally unadjusted number is in-line with prior years when the unemployment rate was below 4%.

The modest rise in the unemployment rate over the past several months is also attributable to firms making modest adjustments to sustain margins and extend the profit cycle. Rising unemployment has often translated into recession in the past is because loss of a job typically reduces that consumer’s spending power. Those typically first laid off first are not likely to have savings to fall back on. In this expansion, a slump in technology hiring did not generate a slowdown, precisely because those workers did have savings or received buyout packages. The recent rise in unemployment has partly been due to a surge in immigration, with the rise in the labor force providing a cushion against lower individual wages.

At the same time, the number of job openings in the U.S. surprised to the upside in May, growing from a downwardly revised 7.9 million to 8.1 million. Not only did the growth in job openings beat expectations of a decline, but even grew compared to the pre-revised April figure. Meanwhile, the hires rate rose a tick to 3.6% from its downwardly revised April level and the quits rate remained stable at 2.2%.

The May increase also contrasts with a several-months-long gradual downtrend. That said, it is still too early to conclude that labor demand will reaccelerate or that the softening trend in the jobs market will turn around.

Ultimately, we remain convinced that the U.S. labor market has embarked on a softening path which will eventually lead to a recession. Although a longer-than-expected expansion powered by continued labor market resilience could mean that a recession is still further away in the future.

Global Economic Policies

The global economy is at a pivot point for economic policies in many countries. China is holding its Third Plenum to discuss economic issues and their goals for the next five years. We don’t expect any significant changes, but there will be increased focus on self-reliance and caution about exposure to the U.S. and increasingly Europe.

Meanwhile, Europe has two major elections in the UK and France, both of which will likely throw out the incumbents and try something new with the UK moving left and France moving right.

Argentina’s libertarian leader Javier Milei has succeeded in gaining approval for his dramatic overhaul of the economy which slid into recession in the first quarter while it waited for new rules. The currency market’s reaction to Mexico’s new President Claudia Sheinbaum has made exports even cheaper and gave a further boost to  Mexico’s robust export led growth. Meanwhile, India’s markets have resumed their climb after the Modi election. After a period of absorption, investors seem to remain optimistic about growth prospects in most nations especially when government is challenged. Perhaps the same thing can happen in the U.S.

U.S. Core PCE Inflation Slows

The PCE inflation index slowed from 0.3% to 0% on a month-to-month basis and from 2.7% to 2.6% on a year-on-year basis, both in line with expectations. Core PCE inflation slowed from 0.2% to 0.1% on a monthly basis and from 2.8% to 2.6% on an annual basis, also in line with consensus.

Treasury yields declined on the back of the report, which showed a broad deceleration in inflationary pressures. Three-month services PCE inflation came back down to the lows of last year following a reacceleration earlier this year. Meanwhile, the same measure for goods inflation continued to hover around zero. The one element in the report which might give pause to the Fed was income. Real personal income rose at 0.5% month on month, the highest rate in several prints.

Markets are currently pricing in about a 70% chance of a first Fed rate cut in September, which appears to be reasonable given our view that inflation will likely trend gradually lower.

The U.S. equity market may push higher over the nearer term as we approach the first Fed rate cut, which could very well occur in September. But for risk asset prices to rise sustainably, interest rates will have to come back down substantially, which is not likely to occur this year outside of the context of a recession. The Fed and other major central banks will have to tread lightly in terms of the pace of easing, given that financial conditions have eased, and household inflation expectations are not falling.

A more defensive portfolio positioning is appropriate even in the face of falling interest rates because a gradual pace of easing will not likely be enough to prevent a rise in the unemployment rate. Sizeable interest rate cuts will occur only when the economy falls into recession but when equity markets will be correcting.

Can Artificial Intelligence Boost the Economy?

One argument why the global economy can surprise to the upside in the coming years is the potential productivity gains artificial intelligence (AI) can deliver. Investors who are optimistic about the potential for AI to impact economic growth have several bullish private sector estimates to point to. At the same time, other credible estimates point to a minimal impact of AI on economic growth. Bullish estimates of AI’s growth potential rely significantly on expectations that AI models will be able to conduct new tasks, and/or a much higher share of existing tasks that can be profitably performed by AI than existing studies show.

The information technology revolution of the 1990s appears to be the most obvious comparable episode to the potential for generative AI. The IT revolution boosted real potential GDP growth by roughly a percentage point for a few years, which we regard as a very high-end estimate for AI’s possible economic impact. We doubt, however, that AI will end up truly boosting economic activity by this magnitude.

U.S. growth stocks have seen a $4.3 trillion increase in market capitalization since late 2022 from multiple expansion, and the broad market has seen a $7 trillion increase. This suggests that the U.S. equity market is overvalued, unless the deployment of AI technology causes a 10-to-20 year productivity surge in line with what occurred during the IT revolution of the 1990s, with persistently high profit margins on the revenue generated from the improvement in growth. The jury is still out on this one.

A shift in sentiment about AI is certainly a possible trigger that could hurt growth stocks. Although, a potential recession remains the most likely trigger for the AI bubble to burst.

The Third Plenum, China’s Big Policy Meeting

The Chinese Communist Party’s top ranks gather this month for one of the country’s biggest annual policy meetings, with everything from chip technology to land reform and a revamp to the nation’s biggest tax source possibly on the cards. What isn’t expected is the kind of major policy pivot that’s often been seen in the past.

The Third Plenum gathers 400 government officials, military chiefs, provincial heads and academics in Beijing to steer the political and economic course. But investors this year have low expectations for the kind of reforms that would revive market sentiment. A slew of official readouts, articles and state media editorials over the past weeks suggest instead a reinforcement of President Xi Jinping’s long-term goals.

The equity market would need to see some positive surprises coming out of the Third Plenum meeting for investor sentiment to turn around. The upside is that equity valuations are low and just slightly better than expected news can trigger a rebound. There is enough dry powder sitting on the sidelines. Private sector savings in China are rising fast now that people stopped investing in property. In the long-term this might become a tailwind for the Chinese equity market.

For several decades, China’s exponential credit growth funded a housing and construction boom that fulfilled Chinese households’ insatiable demand for investment properties. Without a comprehensive pension or welfare system, Chinese households save a lot. It was rational to channel those savings into the double-digit gains coming from investment properties. But with Chinese house prices falling for two years now, the illusion of risk-free property investment has been shattered, and investment property demand has collapsed.

China’s command economy will ensure that its housing market adjustment comes from a reduction in housing development and construction activity to equilibrate supply with collapsing demand. Yet, this also carries implications for the world economy because China’s construction and infrastructure boom was a key growth engine.

Portfolio Positioning

In the past month we have rebalanced our core portfolios. We took profit on our overweight positions in Japan and Global Financials, and we are now neutral against global benchmarks.

We have added a new position in the Global Healthcare sector, which we expect to outperform because of future lower interest rates, the reacceleration and launch of successful drugs and treatments.

We are also removing two ETFs that were focused on International Value and International Quality stocks and replace with one multi-factor driven ETF which we believe will outperform over the longer term with a controlled risk process against global benchmarks.

In model portfolios that include fixed income, we are bringing our target split between equity and fixed income back to neutral weights. Equities have outperformed, hence we are taking some profit off the table and are investing, at higher yielding, fixed income.


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