Trading Trump

Donald Trump’s executive order on immigration from Muslim-majority countries has firmly put to rest any hope that he would back away from his more extreme campaign pledges in office. Until late last week, markets had been cheered by his conciliatory tone and sensible economic appointments. However, it should now be very clear that he fully intends to implement policies that will be incredibly divisive. Investors have been viewing Trump as a second coming of Reagan. They should remember his presidency may yet end up bearing much in common with Nixon’s – a period marked by widespread civil unrest and extreme animosity between the White House and press.

The question is does it matter for markets? No-one can say they didn’t see these immigration measures coming -- Trump spoke of them repeatedly during the campaign. And while the economic consequences of the measures themselves will be small, the controversy around them could well cause a wobble in markets – particularly US equities, which seem to have adopted the most rose-tinted view of Trump. 

With senior Republicans speaking out against the policy, the episode is a reminder that Trump’s relationship with the GOP has never been a solid one. If the new administration overplays its hand and the relationship deteriorates, there’s a risk that Trump’s program of infrastructure spending and tax cuts gets delayed or downsized. And a prolonged political upset could weigh on growth, as we saw with the debt ceiling shock of 2011. All those business surveys showing confidence at multi-year highs could quickly reverse if team Trump gets bogged down in the kind of gridlock that was supposed to have come to an end with the Republican clean sweep of 2016. That would cause quite a reversal in the Trump reflation trade.  

We’re not at that stage yet. The administration has quickly backtracked on the clumsier aspects of the executive order – for instance, excluding green card holders from the entry ban – as they try and smooth ruffled feathers. And Trump’s new friends in Washington are likely to give him a little more time before turning on him. Furthermore, given today's solid US economy, it looks for now as if the market response to political gridlock should be relatively contained. This is not 1969, when Nixon had to contend with the inflationary consequences of the 1960's boom. Nor is it 2011, when the growth backdrop was much weaker than it is today.

Still, Trump's badly-handled migrant entry ban shows how political missteps could sow doubts about the reflation narrative. That may or may not happen with this issue -- but it’s unlikely to be the last upset in the first hundred days of this inexperienced team. Markets are certainly vulnerable to such a shock. The major equity indices have been inching higher for weeks now and it feels like we could be heading for an "escalator up, elevator down" sell-off. Given the extremely depressed equity volatility of the last couple of months, even a garden variety 5% dip in the S&P would feel pretty vicious.