As the US president-elect Donald Trump begins assembling his team, it is becoming clearer what his proposed policies might look like. This in turn allows us to begin fleshing out an investment plan.
To begin with, the election of a president of the world’s most influential nation in politics, economics and culture always creates uncertainty. A relatively known politician who has held several political positions over a long time, such as Bill Clinton, creates the least uncertainty as one can usually extrapolate his behaviour.
A less well-known politician with a short political life, such as Barack Obama, will cause an increase in uncertainty. Relevant for us is the example of his attempted disengagement of America as global policeman, or, in political jargon, the beginning of the end of America as the indispensable nation. This was a bit of a shock in our region.
Mr Trump is a complete game changer in the sense that he does not have a political career that investors can review to glean information from, he did not outline any detailed policies instead giving his vision, and he was courting what appears to be a completely new demographic that is focused on issues the traditional two parties have ignored. These three issues create tremendous uncertainty and therefore the first conclusion is that geopolitical and economic risk premiums need to go up. If they don’t then you are not being paid properly for your risk.
The first area where there might be some clarity on an important issue for the GCC is Mr Trump’s CIA nominee, Mike Pompeo, who has promised to “roll back” the Iran deal. This signals a reversal on Mr Obama’s Iran position that would have the effect of both a military and economic constriction for Iran. As a result, initial turmoil could result in short-term geopolitical risk premiums in the region picking up before the situation stabilises and the GCC reaps a longer-term peace dividend.
In terms of other emerging markets (EM), there are two opposing forces. A more inward-looking and protectionist America will harm EM trade and therefore their economies. On the other hand, massive economies, such as China, have promised to step into the void. On the former point, it is difficult to see America move too far from the status quo as trade is two way: if you stop it coming in you will stop it going out.
However, even a small-to-moderate pullback by America would allow the flourishing of trade with other large economic blocks as well as increased intra-EM trade. The net result would be EM economies that are not negatively affected, as is currently priced in. Furthermore, the wider trade networks should decouple to some extent the strong global market correlations. The world will no longer catch a cold when America sneezes, or at least it will be a mild cold.
Russian markets are in serious trouble. They have overpriced what they think will be a warming of the American-Russian relationship. First, two big egos never remain friends for long. Second, America taking apart Iran will not sit well with Russia. Third, even if Mr Trump allows Russia to carve out a sphere of influence in, say, some of the former USSR and Syria, he will want something in return. Vladimir Putin has used a couple of small airfields and an ailing single Russian aircraft carrier to project power into the void that Mr Obama has created. If push comes to shove, Mr Trump will have no problem and will, with great glee, project power right back with 10 advanced US naval carrier strike groups.
Western Europe and Japan, ceteris paribus, will also face problems as America demands that they start paying for their own defence. At some point someone in the American administration will remember that it was America itself that initially demanded that Germany and Japan not build any military capability and they might even remember why (nobody in their right mind wants Germany or Japan to re-arm, they’re too good at it.) But it is highly likely that there will be some expansion required. If this is simply a financial bill, this is good for America. If this is actually building a military it will be bad for NATO but possibly a good fiscal stimulus for Japan.
The final question is America. Mr Trump has been going on about infrastructure building at home. Given he also wants to cut taxes, this would mean a massive increase in debt and the Fed, under Janet Yellen, has already signalled that it will not play ball and make it cheap by keep rates down. If Mr Trump goes forward with this and if he picks the right projects he will add fiscal stimulus to what has been a near-constant monetary stimulus known as quantitative easing.
The result will be much higher US debt. If the economy grows appropriately, this debt will be manageable and US interest rates will stay relatively low. If the fiscal stimulus does not grow the economy as Mr Trump expects, he will have massively increased debt without increasing the economy’s ability to service this debt. Interest rates will skyrocket.
So what’s the conclusion? Although the areas and issues of focus for an investor are beginning to narrow, there are still far too many unknowns. With risk this high at this time there doesn’t seem to be anywhere paying the right rate of return. It might make sense to stay in liquid low-risk assets and be ready to move when things become clearer.
This article was originally published in The National.