UK stocks fell today as investors took fright at big falls in the US. Here's what you need to know about the unwinding of the Trump trade, why you should look warily at "Trumpflation", and why the new US administration could completely change US business.
What is Trumpflation?
President Trump was in part elected on a campaign promise of a trillion dollars in infrastructure spending allied with big tax cuts, making investors interpret his plans as essentially a giant fiscal stimulus.
Investors anticipated this would raise inflation, causing it to be dubbed “Trumpflation”, and stimulate growth for US companies. On the back of this expectation, the S&P 500, the most watched measure of American industry by professional investors, rose by 12 per cent from its pre-election level to its peak in early March.
Meanwhile, the symbolic Dow Jones Industrial Average rose from below 18,000 to peak above 21,000 at the start of this month before paring its gains.
What progress has Trump made on his plans so far?
Investors have been waiting on tenterhooks for proper detail on tax reform and infrastructure. However, Trump has so far failed to deliver anything beyond vague promises, focusing instead on security, most notably his infamous ban on nationals from some Muslim-majority nations. There is also confusion over domestic issues such as his vow to repeal Barack Obama’s signature healthcare bill.
Why have stocks fallen now?
The latter was the catalyst for Tuesday’s big fall in US stock markets, which set the tone for today’s retreat across the UK and Europe. Trump’s plan faces opposition from both the right and the left of his Republican party, with legislators scrambling to preserve a small majority to pass the healthcare bill.
The political hurdles faced by the healthcare bill have raised fears far more ambitious tax plans may not get through.
What is happening to stock markets?
Stocks in London and Europe followed US indices down as investors start to look through the hype surrounding the election of President Donald Trump.
The FTSE 100 recorded one of its worst days since the election of Trump on 8 November as stocks weakened across the board, with only gold miners benefiting as investors flocked to the safe haven metal. The Euro Stoxx 600 index dipped by 0.44 per cent.
They followed the lead of the S&P 500 after it fell by more than one per cent for the first time in more than 100 days on Tuesday. The so-called “Trump trade” – chasing “Trumpflation” – has seen investors pour money into US stocks, but those bets have started to unwind.
What is Trump’s tax plan?
Trump’s tax plan lacked the detail you would typically see in a Presidential candidate’s tax proposal according to Scott Levine, a Washington-based partner at law firm Jones Day. It has been superseded by the so-called “House blueprint” from Republicans in the House of Representatives: the catchily-named “destination-based cash-flow tax” (or DBCFT amongst friends). This would remove corporation tax, currently one of the world’s highest at 35 per cent, and replace it with a lower tax similar to VAT (with a deduction for wages). It would also crucially, have border adjustments, or taxes on imports.
Why does Trump want this?
As a candidate Trump focused on protectionism with his intention to bring manufacturing jobs back from low-wage countries to the US. The tax would try to do this by massively boosting exporters, while heavily taxing imports. The new tax would theoretically incentivise companies to bring jobs back to the US.
How big a change would that be?
It would radically and fundamentally reorder the tax structure of the US corporate system. The move from the US’s current worldwide tax system to a territorial model coupled with the border adjustment tax would make President Ronald Reagan's major 1986 tax reform “look like a minor amendment to a bill," said Levine.
What would the US dollar do if it goes through?
This is one of the big unknowns. Many economists predict the dollar would appreciate against major currencies – by as much as 25 per cent as soon as the tax is confirmed – balancing out the effects of the tax on imports. However, the effects on the world financial system of a huge appreciation in the dollar could be disastrous for any economies with dollar-denominated debt.
What is standing in Trump’s way?
The new regime would rely on firms being able to monetise a tax asset, which could mean the government has to write out cheques to big corporations. This would likely be unpopular, to put it mildly. There would also be massive issues for international capital flows, and the functioning of the global financial system given its reliance on US banks for credit.
Trump has been one of the most prominent drivers of global markets over the past six months. That is unlikely to change, with investors watching his every legislative move closely. Kathleen Brooks, research director at City Index, said: “If Trump fails to get his way on Capitol Hill then the Trump trade could falter once more.”