The real Trump surprise
This time last year, the street was debating whether Trump’s policy mix of tariffs, fiscal deficits, de-regulation, and border controls would be inflationary or deflationary. We have now passed through several weeks of Trump 2.0 – and investors have still not arrived at a clear answer to the question.
The spread of potential inflationary outcomes is wide. But the real surprise since election day is that market volatility is remarkably tame despite the risks we are confronted with. One possible explanation is that the Trump administration has convinced investors that it is so aware of the risks and is able to address them through market sensitive rhetoric, and policy flexibility. Indeed, the appointment of former hedge fund manager Bessent as US Treasury Secretary seems to have been well received by the market. Also, it is worth noting the recent soothing effects of the US Treasury’s messaging that: (1) disinflation is the priority; (2) fiscal restraint is desirable; (3) the private sector needs to drive growth rather than the public sector. Against the backdrop of an equity market nervous about government policy, this messaging suggests that officials understand investor sensitivities and are looking to protect against volatility.
Trade wars
Trade headlines are now coming in thick and fast. Markets are clearly responding to this news. Optimists take the view that trade wars could be quite short-lived if trading partners see the real political motivations for them, and act to appease the Trump administration accordingly. For example, we note that Trump suspended his threat of 25% tariffs on Mexico and Canada at the last minute, agreeing to a 30-day pause in return for concessions on border controls and crime enforcement. But pessimists highlight that tariffs are still in play and are merely being delayed. They also argue that there could be self-reinforcing retaliatory actions from major trading partners. Indeed, we note that China has already responded by slapping a 10% tariff on selected US goods.
The inflation debate is particularly topical with regards to tariffs. Tariffs can be inflationary because they directly increase the cost of imported goods and potentially disrupt supply chains. But they can also be deflationary to the extent that they are a tax on the private sector curbing demand. For the better part of the past year, investors seem to be finding more reasons to believe that tariffs are deflationary. But as noted earlier, the uncertainty bands around inflation forecasts are wide, and there is room for the pendulum to swing the other way.
Investing through uncertainty
Looking through the noise, we think there are a few things to be aware of from an investment perspective.
Firstly, if austerity is a risk, then positioning in best-in-class companies that have pricing power to offset the potential headwind to corporate profits will be important. Corporates should be keenly focused on driving productivity gains, and the use of technologies such as artificial intelligence have the potential to help in this regard. Maintaining discipline about owning stocks with strong valuation support at a point where certain equities are priced for fiscal largesse and lower rates is prudent. To minimize the impact of austerity the government will be keen to see the trade balance improve and the USD stop strengthening to make imports more competitive despite tariffs, and policy makers need to encourage households to consume, supporting asset prices and borrowing.
Secondly, companies and investors today can benefit from the examples from Trump’s first term, when tariffs on certain goods and services were implemented. This enables companies to more proactively and effectively respond to the threat of tariffs, and to communicate with investors the impact of tariffs on their business. The need to stay close to companies has never been higher. As part of the WAM Global investment process, we interview company management teams hundreds of times a year. These conversations are irreplaceable in their ability to get up to date information on the risks and opportunities presented by tariffs, and as such position the portfolio to benefit.
In these circumstances, diligently applying our process of investing in high quality, undervalued growth companies with a catalyst, and maintaining our high pace of company meetings and conversations, remains the best approach to investing through this uncertainty.