NewsTrump effect: Why investors are bullish despite economic fears

Trump effect: Why investors are bullish despite economic fears

The financial markets' reaction to the results of the US elections, with Republican candidate Donald Trump's victory, suggests that, from the investors' perspective, this is a positive scenario. How is it possible, though, when most economists believe that Trump's return to the White House would harm the world's largest economy?

On Wall Street, Trump's victory delighted not only his supporters.
On Wall Street, Trump's victory delighted not only his supporters.
Images source: © Getty Images | Bloomberg
Grzegorz Siemionczyk

7 November 2024 10:19

Optimism on Wall Street, alongside the dollar strengthening observed on Wednesday, was also seen during the election campaign whenever the balance tipped in favour of the former US president. This phenomenon was dubbed "Trump trades," where investors take market positions that could yield profits if the Republican candidate wins.

The rise in the prices of American company shares and the strengthening of the dollar does not necessarily mean that investors love Trump. The stock markets and other financial markets resemble a popular "beauty contest" once organised by the British press. Participants had to choose the prettiest faces from among 100 photographs, not based on their taste but rather on the taste of others. The winner was the one who most accurately picked the photos chosen by the majority of participants. Therefore, it was necessary to predict which photos would be most popular among those trying to predict this.

This metaphor by John Maynard Keynes, one of the most prominent economists of the 20th century, remains relevant today. Investors bet on those assets which they believe others will also invest in. Those who assumed others would play for a rise in share prices in the event of Trump’s victory also played that way. If this scenario materialises and the former US president returns to the White House, investors might start cashing in on profits and "Trump trades" disappear without a trace.

why investors believe trump will grow their portfolios

But why does the market "beauty contest" currently yield such results? Could it be that the financial world suffers from Stockholm syndrome? Probably not. There is a convincing (which does not mean true) narrative regarding how Trump's reign would benefit investors' portfolios. This allows market participants to predict what positions others will take depending on the election's outcome.

The results of a June CNBC poll indicated the existence of such a narrative—or rather a fairy tale—although, at that time, the president-elect's opponent was Joe Biden, not Kamala Harris. Among the 400 investors who participated in the survey, 67 per cent believed Trump would be better for the Wall Street climate than Biden.

One source of this belief could be history. During Donald Trump's first term, 2017-2021, the main American stock index, the S&P 500, rose more (by 68 per cent) than under Biden’s administration – up until that time and to date (51 per cent). However, considering the period from election to election, Trump's advantage disappears. From November 2016, when he first came to power, to November 2020, when Biden won, the barometer of the American stock market jumped by 62 per cent. However, by the next election day, it had risen by 65 per cent. This approach makes sense in that the economic climate on Wall Street from the presidential elections to the time the winner takes office can already affect their account.

The justification for the narrative that Trump’s reign would be good for Wall Street might also be his programme. As the 47th president of the USA, Trump promises tax cuts for companies, especially domestic manufacturers, and economic deregulation, including the extractive and energy sectors. These promises are credible because he managed to reduce corporate tax burdens during his first term – despite needing to cooperate with a divided Congress on fiscal matters. It might be even easier now if both houses of Congress are controlled by Republicans, which is likely. Meanwhile, Kamala Harris has announced corporate tax hikes.

Strong dollar attracts capital, strengthening the dollar

The market seems to believe corporate profits will grow faster under Trump's rule than Harris's leadership. Additionally, there is a strong belief that his economic policy will result in the dollar's appreciation (increase in value). This, in turn, enhances returns on US assets from the perspective of foreign investors. Therefore, the prospect of a stronger dollar attracts capital to the USA, which also supports rising share prices. It is a self-reinforcing mechanism.

However, the dollar's appreciation in response to Donald Trump's triumph—as the second president in US history to hold the office for two non-consecutive terms—is not, in fact, unequivocal proof that his reign inspires investor enthusiasm. Moreover, if it persists, it could harm the US economy and the performance of its firms.

First, the American currency is considered a safe haven in financial markets during turmoil. Its appreciation is expected partly due to Trump’s stance towards Russia, which increases geopolitical risk. His promised radical increases in tariffs on goods imported from China and allied nations will have similar effects.

Second, tax cuts will probably worsen the state of US public finances. A few days ago (link to the article below), fulfilling all of Trump's promises would lead to the US national debt explosion to 160 per cent of GDP by 2035 from about 100 per cent. In almost any other country, such a prospect would weaken capital flight and weaken currency. However, due to the role of the dollar, the USA will not face this threat soon. Yes, treasury bond prices will drop slightly, but this – and also higher interest rates, which are coming shortly – will increase their yield and thus their attractiveness to foreign investors.

trade war? unpredictable consequences

Thirdly, such a trade policy, if it results in a reduction of the US trade deficit, will also directly support the dollar's exchange rate increase. However, its consequence will also be, as economists widely expect, higher inflation and, as a result, higher Fed interest rates than in an alternative scenario in which Kamala Harris won the elections.

Inflation might also be fuelled by the reduction of immigrant inflow to the USA, a key point of Trump’s programme. Simultaneously, higher tariffs across the Atlantic will harm the economies of America's trading partners, resulting in a more lenient monetary policy there. A greater difference in interest rates between the USA and other major economies will also favour the dollar's appreciation.

The problem is that the global trade war threatened by Trump's policy will likely have negative long-term consequences for the American economy. Higher inflation and higher interest rates will limit American consumers' spending. And the dollar's appreciation will negatively impact the competitiveness of American businesses.

Trump himself is aware of this, as he has repeatedly signalled that he would prefer a weaker currency, and his high value is attributed to currency manipulations by trade partners.

Can the new president weaken the dollar? Possibly, if, for instance, he uses the threat of tariff hikes to urge other countries to take coordinated action towards lowering the rate of the American currency – similar to those in the mid-1980s (the so-called Plaza Accord). However, this is an unlikely scenario. However, if it does come true and the dollar finds itself in a prolonged downward trend, the attractiveness of American assets would likewise decrease. The same will happen if Trump’s reign harms the long-term economic climate in the USA, prompting the Fed to ease monetary policy.

Ultimately, we are dealing with a paradoxical situation: US company shares and the dollar are rising in price for reasons that might, in the long run, be disadvantageous for the American economy, and the dollar’s appreciation itself will be a burden for it. Due to the exceptional role of the dollar in the global economy, this state of affairs may persist for some time. Especially since investors like fairy tales and simple narratives, like the one that Trump “is good for the market.” However, the reality of the unpredictable Republican's reign will certainly not be simple. Hence, we should expect that the market "beauty contest" outcome will change several times over his presidency.

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