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Market Commentary

The Palantir - Vol 4 Issue 2

Brexit Redux: The Dark Horse by Bryan C. Taylor, CFA

November 2016

In many ways the election of Donald Trump as the 45th President of the United States of America parallels the historic British vote to leave the European Union.  Perhaps the most striking example of the parallel nature of these two events is the failure of modern pollsters to accurately delineate the probability of a Trump victory.  Few polls suggested that Trump could effectively contend for the White House, and those that produced different results were largely dismissed by media pundits, political consultants, and the economic elite.  It seems to me that the challenge of most major polling outlets is a combination of confirmation bias and narrowly-targeted survey populations.  Regardless, the pollsters got it wrong, and the market, which seems to have largely discounted a Clinton victory particularly following the Comey testimony over the weekend, was once again surprised by the outcome of the election.

Another similarity between the two events may be seen in the populist nature of the event and the broad-based rejection of the prevailing views of the economic elite.  Despite his personal wealth, Trump’s appeal to the “common man,” his rejection of global trade, and his willingness to boldly reject the “status quo” is similar to the appeal made by the pro-Brexit movement.  Perhaps, more darkly, Trump’s fear-mongering related to immigration and the stark pictures he painted of U.S. inner city “war-zones” are remarkably similar to the concerns voiced by many British citizens related to the European refugee crisis and its impact on British cities, culture, and security.

A final parallel that may be drawn between Trump’s American victory and the historic British vote is the nationalistic focus seen through Trump’s slogan, “Make America Great Again.”  For many Americans the social, geopolitical, and economic changes experienced over the last decade have resulted in massive disillusionment.  Much like the “European Experiment,” Americans have had their fill of economic technocrats expounding on the virtues of foreign trade while watching their incomes stagnate, their jobs disappear, and their status as a world power decline.  In the minds of many, these issues are directly linked to international trade and the weak conciliatory tone struck by the Obama administration in its dealings with ISIS in particular and foreign affairs in general.

The parallels are striking, the deed is done, and the question remains: whither from here…how blows the wind?  We submit that it is “changing and volatile.”  I am reminded of a scene from the classic children’s movie Mary Poppins.  Mr. Banks has announced that he will take over the selection of a new nanny for his children Jane and Michael.  There follows a great deal of upheaval among the house staff, rumblings of revolt, effusive support on the part of his wife, and fear and trepidation on the part of Jane and Michael. A great queue of nannies is seen waiting outside the front door to be interviewed when suddenly the wind changes, the nannies are blown away, and Mary Poppins blows in on the changing wind.  However, just prior to this scene, the old Admiral, an astute predictor of the “weather,” notes, “A word of advice, young man: storm signals are up at Number 17. Bit of heavy weather brewing there.”  We would certainly echo the thought!

Change is brewing, and heavy weather is likely coming although not all brought about by Donald Trump.  Much like the disruption caused by Mary Poppins’ introduction to the stable, proper, and staid household of the Banks, Trump’s move onto the great scene of American politics will not be without disruption.  In the short-term, global equity and currency markets are likely to remain volatile as the world comes to terms with an unexpected Trump presidency.  Furthermore, in our view, regardless of which candidate won the election, the U.S. currently finds itself in the very late stages of an economic cycle which has recently entered its eighth year.  All economic cycles end, and this one will be no exception, so we must remember that a recession is coming.  Whether it appears in the first year of a Trump presidency or not, it will hardly act as a referendum on his policies although many will likely portray it that way.

Longer-term the prospects may be brighter.  While Trump has repeatedly voiced an isolationistic and protectionist rhetoric, he has also attempted to portray himself as a classic deal maker and businessman.  A wholesale rejection of free trade would certainly be negative for America, but a reasonable review of trade policies and perhaps a tougher American stance related to international property rights and the promotion of “fair” trade standards could potentially benefit U.S. business interests and the economy.  Trump’s views on taxes are more closely aligned with our own, and we certainly believe that a reduction in U.S. corporate tax rates and a more focused elimination of loopholes in the corporate tax code would enhance the U.S. business environment and could stimulate both small company formation and the repatriation of funds for larger U.S. corporations.  A reduction in individual tax rates could also prove stimulative from a demand standpoint.  It is significant to note that the U.S. economy is approximately 70% consumer-driven, and so additional stimulus in the form of tax savings could help bolster American economic prospects.  Trump’s views on foreign affairs and immigration are more troubling, but perhaps these views will be tempered by more experienced advisors.

Ultimately, in our view, the building of a wall is not the central issue.  The bigger challenge is a more permanent solution to illegal immigration.  We believe that President-elect Trump would do well to remember that the United States was built by immigrants to this country and that in a simplified fashion GDP growth is largely driven by a combination of productivity improvement and workforce growth.  The U.S. needs immigration along with a higher birth rate to maintain and resupply its workforce, or we are likely to find ourselves facing many of the same problems as Japan and central Europe.

We are hopeful that Trump’s administration may be able to make some progress on healthcare reform.  Flexibility and deal-making skills may prove helpful as the administration faces the real possibility of a complete re-work of Obamacare.  The failure of the Democrats to gain control of either house of Congress has left the Trump administration with a unique opportunity.

In the past such opportunities have proved beneficial for the U.S. economy and the stock market.  We are hopeful that Donald Trump can act as an advocate for positive, substantive change during his presidential term.  The market will undoubtedly continue to experience the buffeting winds of volatility along with the occasional gales associated with bear markets, but the prospect of a Trump administration is unlikely to be the disaster that many on the political Left seem to fear.  To conclude our analogy from Mary Poppins, our sentiments might be summed up in the following quote from Bert, “Wind's in the east, mist comin' in.  Like something is brewin' about to begin.  Can't put me finger on what lies in store.  But I feel what's to happen, all happened before.”  Like Bert we don’t know exactly what the next four years will bring, but we are confident that the U.S. can weather the storm and like the Banks family, we may find ourselves considerably better off when the wind changes!

 

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Bryan C. Taylor attended

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in The Cove, Asheville, NC

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