What a year! Malcolm Turnbull won government by a slim majority, the United Kingdom voted to exit the European Union and now Donald J Trump is President-elect and will become the 45th president of the United States.
What can President Donald J Trump do?
We Australians have struggled watching the US presidential race. The rhetoric and style are definitely things we are not used to.
What powers will Trump have exactly when he moves into the White House?
Firstly, the US president is not a lone ranger. It is the US Congress (Senate and House of Representatives) that pass law. The president is responsible for the execution and enforcement of the laws created by Congress. Essentially, the US president oversees that day-to-day administration of the US federal government.
Why is the role of US president so powerful? As president, Trump has the power either to sign legislation into law or veto bills enacted by Congress, although Congress may override a veto with a two-thirds vote of both houses. The president also has the power to negotiate and sign treaties, but these treaties need to be ratified by a two-thirds vote of the US Senate. As you can see, there are a number of checks and balances in place. The US system of government has true separation between the legislative function (Congress) and the executive function (president) compared to Australia where our executive (the prime minister and ministers) come from the legislative body (Senate and House of Representatives).
What are Trump’s policies?
• Taxation: Trump promises significant personal tax cuts including a cut in the top marginal tax rate from 39 per cent to 33 per cent, a cut in the corporate tax rate from as high as 39 per cent to 15 per cent and the removal of estate tax.
• Infrastructure: Trump wants to increase infrastructure spending.
• Government spending: Trump wants to reduce non-defence discretionary spending by 1 per cent a year (the ‘penny plan’), but increase spending on defence and veterans.
• Budget deficit: Trump’s policies are likely to lead to a higher budget deficit and public debt.
• Trade: Trump wants to renegotiate free trade agreements and has proposed various protectionist policies, e.g. a 45 per cent tariff on Chinese goods and 35 per cent tariff on Mexican goods.
• Regulation: Trump generally wants to reduce industry regulation, which would be good for financials and energy.
• Immigration: Trump wants to build a wall with Mexico, deport 11 million illegal immigrants, ban Muslims entering the US and require firms to hire Americans first.
• Healthcare: Trump wants to repeal Obamacare and allow the importation of foreign drugs.
• Foreign policy: Trump wants to reposition alliances to put America first and get allies to pay more, confront China over the South China Sea and bomb oil fields under IS control.
It is interesting to note that no president since Franklin D Roosevelt has been able to enact a truly far-reaching agenda such as the New Deal with little change through the US Congress.
Secondly, around 70 per cent of the US economy is driven by the private sector and consumer spending. Fundamental factors such as company’s earnings growth, economic growth and monetary policy (how the US Fed Reserve manages interest rates) are more likely to influence investment market activity.
There is no doubt that a President Trump will try and introduce major social policy changes, but as a businessman, the overall economic policy may not change too much. When have you ever heard of a Republican voting against tax cuts?
What should Australian investors consider?
1) Prepare for an inflationary environment
President-elect Trump’s main policies of tax cuts, increased infrastructure spending and protectionism are a cocktail that will likely see inflation rise in the US, which will drive global inflation. Inflation is when the price of goods and services rise.
Inflation will have an impact on bond markets. This will impact interest earned from cash deposited in banks and interest rates on loans.
Thus, it is important that any fixed income asset/bond allocation in investment portfolios be of short duration. This means that these bonds are likely to mature within the next three years. If you have a long-dated bond with a low interest rate, the value of that bond become less in an environment where there is inflation and rising interest rates.
To prepare for this, reviewing fixed-income asset/bond allocations will ensure the return on these bonds will remain relatively the same in a rising inflation/interest rate environment.
Higher inflation will lead to the increased likelihood of interest rate rises over the medium to long term (two years and beyond).
2) Good time to consider starting to fix interest rates
As mentioned above, rising inflation will likely result in rising interest rates. We still have to see if a President Trump is dogmatic in trying to implement his agenda. Or will he be pragmatic? This may cause some short-term market volatility and if that continues, there may be a case for another interest rate cut locally.
However, the odds are pointing to rising interest rates to counter inflation. Thus, now is a good time to consider fixing interest rates on your loans.
First, you need to determine how much of your loans should have a fixed interest rate. I never recommend a fixed interest rates on all debt. Look at your free cash flow and determine how much debt you could actually pay down over the time period you are considering fixing interest rates for. I generally add a 20 per cent margin on this amount and leave this portion under a variable interest rate. There is nothing worse than having capacity to pay down debt but being restricted by the fact that your debt has a fixed interest rate. The penalties for breaking a fixed rate loan can be high.
The portion of debt that you cannot pay off within a set period of time can be fixed. Any investment debt should be placed under a fixed rate ahead of non-deductible debt such as a home mortgage.
For example, let’s say a couple has $400,000 of home loan debt and $350,000 of debt used for an investment property. Over the next five years, they feel it is achievable to save $20,000 a year to make additional repayments to reduce their home mortgage. Thus, they would keep $120,000 of the home loan as a variable loan with a variable interest rate. At this stage, they may hold off on fixing the $280,000 of home loan debt, but fixing all of the investment property debt now makes sense as this is tax deductible. They would focus on paying down the home mortgage before any investment debt is paid down.
3) Don’t be afraid of using market volatility to top up your investment portfolio
Warren Buffet – one of the most successful share investors of all time – famously said “Be fearful when others are greedy. Be greedy when others are fearful”. I’m not advocating spending all your spare cash now by buying shares. However, when the market drops in volatile times, we need to stand back and look at the broader fundamentals. The US and Australian economies are performing well. The result of the US presidential election is not going to have major impacts on our finance, tourism, mining and mineral, healthcare and agricultural sectors.
Yes, it is likely we will see some short-term volatility with share markets until we get a feel of the style and substance of President-elect Trump.
Let’s look at a simple example of the iShares Core S&P/ASX 200 Exchange Traded Fund (IOZ) which invests in the top 200 companies on the Australian stock exchange. This Exchange Traded Fund (ETF) is currently providing a dividend yield of 6.45 per cent (after franking credits that yield increases to 7.79 per cent). Since 1970, Australian shares have returned an average of 10 per cent p.a. in both dividends and capital growth. For the dividend yield component to be so high is not normal. Thus, we would only need to see an annualised capital growth rate of between 2.21 per cent to 3.55 per cent to achieve long-term returns. The average capital growth of Australian shares has been around 4.5 per cent per annum.
If your investment time frame for deploying cash is beyond five years, now may be a good time to top up your share portfolio given the good dividend yield from Australian shares relative to the risk of buying a diversified basket of shares through an ETF as shown above.
Remember Brexit in the middle of this year? The share market reacted negatively immediately to the news of the UK deciding to leave Europe. But once the dust settled, global share markets quickly recovered within the next month.
The political pendulum is always swinging. Bad news and fear sells newspapers or gains clicks online. The global economy is made up of a complex relationship between governments, corporations and individuals. Change will not happen quickly from an event such as an unexpected win from an underdog US presidential candidate like Trump.
We see changes ahead with inflation, interest rates and market volatility that are somewhat, but not entirely, influenced by the US presidential election outcome. Thus, planning your financial strategy is always about reviewing the current economic, social and political environment conditions. The three strategies of preparing for an inflationary environment with increasing interest rates and market volatility will help to ensure smart management of cash flow and positioning yourself to create wealth over the medium to long term.
This advice is only general in nature. I have not considered any person’s objectives, financial situation or needs. You should, before acting on this information, consider your personal objectives, financial situation and needs. I recommend investors obtain financial advice specific to their situation before making any financial, investment or insurance decision.
Andrew Zbik, senior financial planner, Omniwealth