The immediate stockmarket reaction to the election of Donald Trump in November 2016 was to christen the resultant series of market movements as the ‘Trump trade’.
This was the notion that the president’s populist political style would lead to more government spending and tax cuts – policies typically inflationary in nature. With Mr Trump’s economic stimulus taking place amid an already expanding economy, this in turn would prompt the Federal Reserve to raise interest rates at a faster pace than it might otherwise have.
It was these expectations that combined to form the Trump trade, with US bonds selling off towards the end of 2016 and the shares of firms such as banks prospering. Banks perform well when economic growth is strong and bond yields are rising, as higher rates allow them to boost their margins.
After a pause in early 2017, the trade took off again at the end of the year. But not all investors drew a positive inference from Mr Trump’s actions. Peter Elston, chief investment officer at Seneca, has sold all of his US equity exposure over the past year.
Mr Elston subscribes to the economic theory of business cycles, as advocated by the Austrian school of economics, which states that economies move from recession to expansion, and then to recovery. The expansion stage is marked by strong economic growth and low interest rates that start to gradually move upwards.
The final stage sees rates ultimately rise at a faster pace than the economy can handle, with the result that they begin to erode economic growth and eventually eradicate it, leading to recession.
By taking actions intended to stimulate further economic activity, such as the recent move to cut the main rate of corporation tax from 35 per cent to 21 per cent, the president may be speeding up these cycles. The theory is that an economy previously in the expansion phase accelerates into the recovery phase – characterised by inflation rising at a faster pace – and the resultant interest rate rises tip the country into a shallow recession.
If rates are not increased, stimulus risks creating an excess of borrowing or even a credit bubble. The bursting of such a bubble is likely to be a far worse outcome for the economy in question than a moderate rise in rates leading to a mild recession, according to Andy Haldane, chief economist at the Bank of England, speaking to the Treasury select committee in February.
Trevor Greetham, head of multi-asset investing at Royal London Asset Management, says the introduction of tax cuts by president Trump prompted the increased volatility seen in markets in February, because investors felt the stimulus would shunt the US economy into the later stages of the cycle.
Keynesian economic theory encourages governments to pursue countercyclical economic policies. If the private sector part of the economy is expanding, the public sector should contract, and vice versa, as a way of preventing the sharp cyclical swings feared by Mr Elston.