The key story in November was Donald Trump’s surprise victory in the US presidential election. With prospects of a Trump victory increasing as results poured in from key battleground states, equity futures sank, with the S&P 500 futures hitting limit-down of 5 per cent at one point.

By the early morning it became clear that Republicans would retake the Senate and the Presidency and hold on to their large majority in the House of Representatives. With the world on edge Donald Trump’s acceptance speech came across more measured than his tone during the campaign which proved to calm investors.

The US market opened the day slightly lower but closed up over 1 per cent despite previous fears that a Trump victory could lead to a crash in equity prices. Sentiment shifted from concerns over Donald Trump’s temperament and his ability to act as “Commander and Chief” to the potential benefits that a Republican sweep would have on the US economy.

The remainder of the month was highlighted by sharp rallies in equities which resulted from the anticipated benefit brought about by increased promises of spending on infrastructure and the spectre of higher inflation.

The outcome of the US election could prove to be an economic inflection point. Although the current expansion in the US has been one of the longest on record, it has also been one of the weakest recoveries since the Second World War with economic growth and inflation well below the potential rate for 6½ years. The proposed policies by president-elect Trump have the chance to be a game changer but the markets’ enthusiasm may be excessive. Here are some market implications to consider:

Inflation

The bond market told investors something in November. It screamed inflation. On Election Day, market participants made a volte-face and a “bigly” move in interest rates followed. The ten-year US Treasury security yield rose 56 bps in November, which was the biggest monthly move since December 2009. Yields spiked to 2.06 per cent the day after the election and closed the month at 2.38 per cent.

Whether much higher rates materialise at this point is somewhat suspect to me but the rationale is not. Real economic growth will likely be accompanied by higher inflation due to increased trade protectionism and less immigration on top of a relatively tight employment market. Such an outcome has been reflected in the entire yield curve which adjusted sharply upwards shortly after the election.

The market now expects a rate hike this month, two more in 2017 and another two increases in 2018. Research by the International Monetary Fund has shown that even before the US election the output gap of advanced economies has narrowed from a high of 3.8 per cent of GDP in 2009 to 0.8 per cent at present. Once the gap has been closed some additional inflation pressure can be expected.

One of the Federal Reserve’s favourite measures of inflation, the five-year forward breakeven inflation rate, soared to 1.94 per cent at one point and very near the Fed’s targeted inflation rate of 2 per cent. The 30-year secular bond rally looks to be ending. The Bloomberg Barclays Global Aggregate Total Return Index lost a record 4 per cent last month, the deepest slump since the gauge’s inception in 1990. Investors also voted with their feet, pulling $10.7 billion from US bond funds in the two weeks after Trump’s victory — the biggest withdrawal since the 2013’s “taper tantrum”.

Infrastructure

Fiscal stimulus could increase federal debt by trillions over the next few years and provide a not immaterial boost to GDP growth per annum. Even a watered down infrastructure and tax accord will provide stimulus to the US economy.

It’s not likely that we will see the full $1 trillion spending plan Trump initially proposed and it is far more likely that its full effect will not truly be felt until late 2017 at the earliest and more likely not until 2018. The last fiscal spending bill during the Obama administration was not very effective and a lot of funds became trapped in administrative morass and found little traction to spur “shovel ready” projects. The market immediately latched on to the potential upside and drove most infrastructure names in the industrial and materials sector meaningfully higher.

Taxes

Lower corporate taxes and an overall simplification of the tax code would be a very fast and effective boost to corporate profits. This is especially so for domestically oriented and small to medium sized businesses within the US. The Russell 2000, a gauge of small cap stocks, soared nearly 13 per cent after the election. Lager multinational corporations, however, will see less of an overall benefit given their blended global effective tax rates are already much lower. They would, however, benefit from a repatriation holiday which could free up trapped capital sitting offshore that they may use for debt reduction, share buy-backs, dividends and/or investments within the US.

For large multinationals, I would also suggest that the earnings gains from lower taxes will be offset by foreign exchange translation losses from overseas profits as the US dollar has soared.

International Trade

Probably the greatest risk to markets is protectionism. Despite the hype around Trump’s plans, the outcome may be positive for the US but not necessarily for the global economy. World trade has slowed down considerably with the year-over-year change in global export volumes essentially unchanged. The proposed renegotiations of existing trade agreements (e.g. Nafta) and additional protectionism measures will likely improve the US trade deficit but consequently hamper growth prospects of other economies, especially emerging markets.

So far the visible adjustment has happened in the foreign exchange market. Primarily vulnerable is the Mexican economy — the peso lost 9.1 per cent in November alone. Other emerging market currencies, like the Turkish lira, the Indian rupee, among others, have sold off to record lows. De-globalisation will not only impact growth prospects but has also the potential to reduce foreign direct investment into emerging markets and reverse capital flows back to developed economies, putting further upside pressure on the US dollar. Any restriction on free-trade, like Trumps recent warning that companies that plan on moving jobs to Mexico will be “taxed heavily at the border”, will only stoke US inflation or crimp corporate profit margins.

What exactly comes of a Trump administration is by no means assured. While we are hopeful that a Trump presidency will lead to a lower corporate tax rate and higher investment spending, we are always mindful of valuation. Many of the “Trump Triumph” plays are now pricing in a near perfect scenario that assumes benefits will be realised almost immediately. Although narrative “trumps” numbers in the short run, it cannot replace true fundamental value. We would caution chasing trades that reflect excess optimism.

Nathan Kowalski CPA, CA, CFA, CIM is the Chief Financial Officer of Anchor Investment Management Ltd. and the views expressed are his own. Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisers prior to any investment decision. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.