WSDKWTWD – We Simply Don’t Know What Trump Will Do

WSDKWTWD – We Simply Don’t Know What Trump Will Do

07-12-2016 | 月次アウトルック

President Trump will have to deal with many well-known acronyms when he takes office, including NAFTA and NATO. But here's a new one that is rather more difficult to pronounce, and which will worry markets rather more: WSDKWTWD.

  • Lukas Daalder
    Lukas
    Daalder
    Chief Investment Officer

Speed read

  • Outspoken campaign promises may not come to pass in presidency
  • Six areas remain unknowns, from immigrants to infrastructure
  • Limited good news for bonds, details determine the fate of equities

‘We Simply Don’t Know What Trump Will Do’ is likely to be the main concern for investors as his inauguration as the 45th President of the United States looms on 20 January, says Lukas Daalder, Chief Investment Officer of Robeco Investment Solutions.

Markets have already reacted in a bipolar fashion following his surprise victory, with equities eventually opting to give Trump the benefit of the doubt, while bonds weakened on the risk of higher inflation and higher debt, Daalder says. What actually comes to pass now will be key for returns going forward.

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Far-reaching promises

“Trump has made a lot of far-reaching promises during the past 12 months, from overhauling the current tax system to renegotiating trade relations, and from deporting millions of illegal foreigners to pledging a big boost in infrastructural spending,” Daalder says.

“The problem is that, as loud and outspoken as Trump was during the campaign, as quiet as he turned out to be once victory was secured. Although he has repeated some of his earlier promises – the Trans-Pacific Partnership will not be implemented and there will be the biggest tax cut since Reagan – he has not put more beef on the bone with respect to the details of his plans. We are basically all still guessing what his actual program will look like.”

Daalder cites six areas in which there may well be a divergence between rhetoric and reality:

  • Taxes: Will a planned corporate tax cut from 35% to 15% be combined with the abolition of what is tax deductible, thereby potentially canceling it out?
  • Immigrants: Will the deportation of undocumented immigrants (which means a hit to GDP) be the three million that Trump spoke of, or just 800,000?
  • Infrastructure: Will new spending be government financed via an infrastructure bank, or will it be done through tax-incentivized public-private partnerships?
  • Trade: Has it all been tough talk, or will the US indeed label China as a currency manipulator, with the prospect of a trade and diplomatic war?
  • Deficits: Will Trump become the modern-day Reagan boosting the economy with deficit-widening fiscal stimulus, or will he make spending cuts elsewhere?
  • Fed: Will the newly arriving members that he appoints indeed be more hawkish as everyone expects, or will Trump opt for a more accommodative policy committee?

“It is the details that are all important, and details are what’s currently missing,” Daalder says. “We Simply Don’t Know What Trump Will Do, or to make it into the worst acronym ever, WSDKWTWD. That is the disclaimer that currently applies to all of our forecasts with respect to the economy and financial markets. We can make some educated ‘guestimates’, but it should be stressed that much if not all depends on the details of the plans, which are not expected to be released in the short term.”

Rare divergence

Daalder says the markets are equally in the dark, creating an uncertainty that has manifested itself in an unusual disconnect between equity and bond markets. “The best way to show this is by looking at the volatility indices of both the stock market (the VIX index) as well as the bond market (the MOVE index) in the days following the election outcome,” he says.

“The VIX index declined sharply on the election news while the MOVE index spiked, resulting in a pretty rare divergence. Normally it is the stock market that is far more sensitive to political and economic news, while the bond markets are helped by the flight-to-safety flows that act as a support for bonds. In fact, the only time we have seen such a divergence in recent history was during the taper tantrum episode in the middle of 2013; even during the bond sell-off in 1994 we did not see this big and lasting divergence.”

“Of course, the development in both volatility indices is just a simple reflection of what happened in the underlying markets. US stocks on balance hardly reacted (if we ignore the Asian sell-off on the day of the outcome) and in fact drifted to new all-time highs in the weeks following the election, while US bond yields rose sharply, as ‘reflation’ became the new buzzword for financial markets.”

He says it means there are hardly any positive elements for bonds, while equities can go either way, as shown in the chart below:

Source: Robeco

Current positioning

Daalder says the uncertainty has led to changes in Robeco Investment Solutions’ multi-asset fund. “Looking at our current positioning, it is clear that the WSDKWTWD premise is dominating the portfolio,” he says. “We are neutral on stocks, although with a regional split, and on balance we are neutral on bonds, with an underweight in government bonds being matched by an overweight in credits.”

“And we only have a small position in the dollar/yen currency pair. This may come as a surprise given the assessment that we expect the euro to weaken further, but this is related to the fact that we have temporarily closed our short position. The market has now discounted a mid-December rate hike by the Fed by 95%, which means there is little room for a surprise on that side.”

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