Make America net-positive again
The election of property magnate and reality TV star Donald Trump as the 45th US president on 8 November shocked commentators who had miscalled the result, markets that thrive on certainty, and the world.
As unexpected as it was for US voters to elect a man who had courted controversy after controversy during a divisive and bitterly fought campaign, the billionaire defied doubts that he would even run at all and dared the world to stop him. But the world blinked, and Trump won.
The Asian markets were the first to react to the shock victory, with Japanese stocks on the Nikkei falling by 5 percent, their biggest single session fall since the UK’s Brexit vote in June. Hong Kong’s Hang Seng Index also dropped 2.8 percent before recovering slightly.
In the currency markets, the so-called ‘safe haven’ Japanese yen soared to 103.44 to the dollar as of 4am ET, while others, including the US dollar, fell. The biggest loser as the news broke was the Mexican peso, which fell by 13 percent to historic a low against the dollar before recovering slightly.
Since the election result was announced, attentions have turned to Trump’s presidential team and the likely policy actions in his first 100 days in office, beginning 20 January, leaving markets to calm down somewhat.
An immediate byproduct of Trump’s victory was a lurch away from the traditional safe-haven of US treasury securities, with traders moving back into the stock markets in anticipation of the stronger growth and higher inflation that Trump’s economic policies, in so far as they are understood, might bring.
US bond yields were set for the biggest fortnightly rise in 15 years, as of 18 November, according to reports. Bloomberg’s Barclays Global Aggregate Index recorded a 4 percent fall in the period through to 18 November.
During his campaign for the White House, Trump repeatedly promised to invest $550 billion in infrastructure, while also cutting tax rates for the country’s wealthiest and taking an axe to US banking regulation that currently restricts lending.
Federal Reserve chair Janet Yellen also fanned the flames of speculation by hinting that Trump’s victory make a December rate hike much more likely.
Attention has rightly turned to monetary policy, specifically interest rates. Richard Stone, chief executive at private investment adviser the Share Centre, pinpointed Yellen’s future as one potential surprise that could affect markets.
“Over the coming days and months investors will also look to see the extent to which Trump appears more moderate and conciliatory. For example, investors and markets would likely be concerned if Janet Yellen leaves the Fed early given some of Trump’s rhetoric during the campaign,” Stone said.
Michael Gately, head of real estate research at Barings Real Estate Advisers, agreed, saying after the election result was announced: “Currently, the Fed is telegraphing a very measured approach to rate increases, although Trump has suggested that he may challenge the independence of the Fed going forward, which could impact monetary policy.”
Heads have already started to roll, of course, with Securities and Exchange Commission (SEC) chair Mary Jo White confirming that she plans to step down at the end of President Barack Obama’s administration early next year.
Where Trump could also strike is the Dodd-Frank Act. His transition website, greatagain.gov, lists dismantling the centrepiece of financial services reform in the US as a primary objective.
It says: “Following the financial crisis, Congress enacted the Dodd-Frank Act, a sprawling and complex piece of legislation that has unleashed hundreds of new rules and several new bureaucratic agencies.”
“The proponents of Dodd-Frank promised that it would lift our economy. Yet now, six years later, the American people remain stuck in the slowest, weakest, most tepid recovery since the Great Depression.”
Speaking at the University of Maryland’s Robert H Smith School of Business Center for Financial Policy following the election, Rick Fleming, an SEC investor advocate, defended Dodd-Frank, saying: “The protection of investors must serve as the first principle guiding our financial regulations.”
“We should think of those regulations not as a burden to be repealed or picked apart haphazardly, but as the essential nutrient for flourishing capital markets for a growing economy.”
Fleming cited the example of asset-backed securities (ABS) in his defence of Dodd-Frank. Subprime mortgages that were bundled into toxic ABS and spread throughout the financial system “stood at the epicentre of the financial crisis”, he said. “Many investors were not fully aware of the risks underlying the securitised assets until it was too late, when they suffered heavy losses.”
To address this problem, Section 942 of Dodd-Frank mandated the SEC to adopt regulations requiring an issuer of an ABS to disclose, for each tranche or class of security, information regarding the assets backing that security, including asset-level or loan-level data, if it is necessary for investors to independently perform due diligence.
The SEC acted on this mandate in August 2014 by adopting revisions to rules governing the disclosure, reporting, and offering process for various types of ABS to enhance transparency. Among other things, the new rules require loan-level disclosure for assets such as residential and commercial mortgages and automobile loans.
“As expected, these rules enable investors to conduct due diligence to better assess the credit risk of asset-backed securities,” Fleming explained. “Investors can now see a more complete picture of the composition and characteristics of the assets in the pool and their performance. Rather than blindly relying on credit ratings, investors going forward will be better able to understand, analyse and track the performance of ABS.”
The SEC also joined five other federal agencies to adopt credit risk retention rules, which require securitisers of ABS to have ‘skin in the game’ for the securities they package and sell.
Fleming said: “The commission’s rules require the ABS prospectus to disclose the sponsor’s retained economic interest in an ABS transaction. Theoretically, at least, risk retention will discourage the creation and sale of toxic securities in the future.”
A replacement for Dodd-Frank has already been proposed by Texan Republican representative Jeb Hensarling, who chairs the House’s financial services committee.
His bill—the Financial CHOICE Act—would hand the reins back to Wall Street on the premise of a do-or-die offer that would see a three-fold hike in multiple penalty categories and a promise of no further bailouts in exchange for much greater freedom to lend and do business with one another.
The proposed bill would see a long list of Dodd-Frank’s rules repealed or drastically reformed with the main aim being to simplify the legal framework banks must adhere to.
Fleming, in justification of the scale of Dodd-Frank, stated in his speech: “Given the depth of the financial crisis, it took a massive response by our government to keep it from turning into a new Great Depression. And it is not surprising that it resulted in a hefty piece of legislation–the Dodd-Frank Wall Street Reform and Consumer Protection Act–which covered a vast array of topics in its 540 sections.”
But Fleming did concede: “I think it is legitimate to question, six years after its adoption, whether the other pieces of the act have done more harm than good.”
Beyond monetary policy and Dodd-Frank, the jury is still out on what long-term effects a Trump presidency will have on financial markets.
Real estate, what Trump is best known for, is as uncertain. Investment management firm JLL said following the election: “Until the policy particulars start to take form, the ultimate impact on real estate will be uncertain. Financial markets, which tend to react more quickly, have taken this shock mostly in stride, which should create some stability in terms of real estate activity.”
“With financial industry regulation likely to either loosen or at minimum, no longer tighten, capital flows may improve and create a short- to medium-term net positive for investment activity and performance. However, lower regulation could lead to more risk or volatility in the longer term. While cap rates are low, spreads remain historically healthy and the fundamentals are sound broadly across real estate sectors. Fiscal and trade policies that could lead to higher inflation and interest rates could impact pricing if not offset by faster growth, but we do not expect much change initially.”
JLL explained: “Overall on the demand side, US companies are likely to adopt a wait-and-see approach to decision-making as the presidential transition efforts get underway and cabinet positions begin to solidify.”
“The potential of lower regulation, increased defense spending and tax cuts would on their own be pro-growth positive for real estate demand, but the timing, mix, and other offsetting policies or compromises are still unknown. Until the policy details are defined and implemented, we expect political headlines and potentially financial markets to be volatile, but underlying real estate markets to remain relatively steady.”
Alternative investment fund managers surveyed by Preqin following the election indicated that a Trump presidency will have an overall positive effect for themselves and their industry as a whole.
The survey of 125 private capital fund managers, across active across private equity, private real estate, infrastructure, private debt and natural resources, and 57 hedge fund managers on 14 and 15 November, revealed that 53 percent think that the effect of the election will be positive for alternative assets in the US, while just 12 percent think it will be negative.
The policy pledges that fund managers think will be most beneficial are the reduction in corporate tax and proposed infrastructure spending, whereas withdrawing from trade deals will be negative, they said, and taxation of carried interest could adversely affect them.
According to Preqin, managers cited uncertainty over the effects of Trump’s policy proposals as a key consideration.
But while some managers suggested that potential impacts on debt rates and securing investor capital might be negative, others felt that market volatility might serve to benefit alternative investments, and reduce recent correlation in returns between the industry and more conventional financial markets.
It seems that little will be clear about Trump’s presidency until he officially takes over the White House on 20 January.
Until then, markets will continue to guess, all the while hoping that they do better than the political pollsters before them.