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Perspectives

New Era of U.S. Policy Uncertainty

Steven Wieting

By Steven Wieting

Chief Investment Strategist

Malcolm Spittler, Investment Analyst

November 9, 2016

The U.S. electorate voted for change.  In other circumstances, the united government under Republican leadership achieved with the U.S. election would seem to offer policy clarity.  However, political newcomer Donald Trump provides anything but predictability.  

World financial markets have been stunned again as polls failed to capture the agitation to dethrone the establishment. U.S. equity futures have fallen 4.5% in early trading. Global equities have plunged roughly 3%.  Mexico, in the crosshairs of candidate Trump, has seen the peso drop 10% in early trading to a record low.  

We do not believe markets have over-reacted.  We do not believe investors should immediately “fight” the market reaction to the election results despite the proclivity for markets to rebound quickly from sharp one-day losses. Much is uncertain, but the election results and policies that follow could well change the fundamental outlook for the U.S. and world economy.  Like the period following Brexit, the Citi Global Investment Committee will carefully reassess our views rather than react abruptly in disorderly market conditions.

As we’ve detailed many times previously, of the 12 U.S. Presidents since World War II, eight have faced recession during their first year in office either because of new or existing downturns.  The chance of one that is driven by policy mistakes is substantial. Markets should listen carefully to statements from Mr. Trump on his immediate priorities now that he is President Elect.  Significant, but of less importance, they should listen to House and Senate leaders.

For those worried over the economy’s future, the immediate concern should be trade relationships.  Candidate Trump has suggested efforts to control cross-border commerce that can be immediately disruptive for consumers and business. Unlike fiscal policy, U.S. Presidents have significant discretion in setting such policies.  If President-elect Trump chooses to take a more careful approach to trade matters than he suggested as a candidate, such risks could be mitigated. As a related issue, we believe immediate risks to global markets lie ahead if he keeps a vow to label China a currency manipulator upon taking office.

Away from Mexico and many other emerging markets, the U.S. dollar has weakened as U.S.-specific uncertainties have emerged with the surprise election results. Falling risk assets have also pulled down U.S. interest rates. The Federal Reserve might refrain from tightening monetary policy as a result of the new growth uncertainties in December, yet we see heightened interest rate volatility ahead.  Candidate Trump attacked Fed Chair Yellen for what he described as political manipulation of interest rates.  Barring a complete change in tone from the campaign during his administration, we would not be surprised if Fed Chair Yellen and others offer the new President an early chance to appoint successors.  Such steps alone would drive greater policy uncertainty across world markets.

The possibility of wide-ranging tax cuts and increased domestic spending rises significantly under the Republican sweep. Reduced regulation may also play a role in offsetting downside risks to the U.S. economy.  However, we believe the uncertainties led by international trade relationships and the choice of new policy leaders will dominate the outlook in the near-term.  While the opportunity exists to invest in assets that become significantly discounted as a result of any market panic, we see a less certain, higher risk outlook for the world economy and markets that must be fully grasped first.

Figure 1: Eight of the eleven post-World War II recessions overlapped a new President's first year in office

New-Era-of-US-Policy-Uncertainty-Figure1

  

Source: Haver Analytics as of July 25, 2016.

 

Figure 2: Eight of the eleven post-World War II recessions overlapped a new President's first year in office

New-Era-of-US-Policy-Uncertainty-Figure2

  

Source: Haver Analytics as of July 25, 2016.

 

Figure 3: Annualized real S&P 500 total return and GDP growth by Presidential term

New-Era-of-US-Policy-Uncertainty-Figure3

  

Source: Haver Analytics as of July 22, 2016. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Past performance is no guarantee of future results.

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