Are defensive shares a tonic for the Trump presidency?

Since Donald Trump’s election victory, share prices have not performed as many investors anticipated. Global share prices have failed to collapse, as many had feared.

Similarly, defensive shares have not been the place to invest in the days following the election. Instead, riskier, cyclical stocks have become increasingly popular as the market has begun to anticipate a period of ‘Trumponomics’ which could see the US economy deliver higher growth in the long term.

The Plan

Trump’s plan to boost the US economy is focused on borrowing. He is seeking to reduce taxes on individuals and businesses in order to positively catalyse the economy. This should mean that individuals have more cash to buy goods and services, while more profitable businesses should have more capital to invest for future growth.

This could improve the US economy’s growth rate over the short to medium term, assuming that those individuals and businesses spend their tax savings rather than save them.

In tandem with reduced taxes, Trump is also seeking to increase infrastructure spending. Although there are no definitive figures in terms of how much he intends to spend on infrastructure, it seems to have been warmly received by the market because it is an obvious way to increase jobs and GDP. It should also help the US economy to become more efficient relative to other developed nations, which could lead to a higher sustainable growth rate in the long run.

Alongside this, Trump aims to reduce regulation in order to make the economy more efficient, with the financial services sector in particular likely to benefit.

Clearly, regulations since the credit crunch have become increasingly onerous as regulators have sought to ensure that another banking crisis will not occur. By reducing regulations in financial services and other sectors, the wider economy could produce a higher growth rate.

The Risks

However, the above does not take into account the potential risks caused by Trump’s apparent economic plan. As mentioned, the consequence of reducing taxes and increasing spending is likely to be higher debt levels for the US.

This could cause doubts to emerge regarding the country’s ability to make interest and debt repayments. Although this would be unlikely to cause severe economic challenges for the US, it could lead to reduced confidence in the global economic outlook. Asset prices may suffer as a result.

This situation could be made worse by higher interest rates, which are more likely to occur since inflation expectations have risen since Trump’s election victory. Trump’s apparent plan to run a budget deficit could cause the price level to rise at a rapid rate. In order to cool inflation, the Federal Reserve may raise interest rates and this could make the cost of servicing debt even more expensive.

There is also the risk posed by Trump’s Presidency from a political perspective. Putting to one side the popularity of Trump’s policies and the potential for division within the US, the views he held during the campaign of renegotiating trade agreements, taking a tougher stance on China and an apparently softer view on Russia could cause uncertainty to rise over the coming months.

Following a period of relative stability under Obama, the US and global economies now face a volatile, uncertain and potentially challenging future.

The Solution?

The obvious solution to the risks faced by the US is to buy defensive shares. However, as discussed, they have proven relatively unpopular since the election. For short-term investors, this may have caused a problem, but for long-term investors it presents an opportunity to buy high-quality stocks at discounted prices.

Furthermore, the current bullish sentiment of investors towards the Trump presidency is unlikely to last. Even if his policies prove to be successful over the medium to long term, there is likely to be a period of difficulty in the short run. This is simply because of the scale of change which he is attempting to implement, which could cause investors to adopt a risk-off rather than risk-on mentality over the coming months.

In such a scenario, defensive shares could gain in popularity thanks to their relatively low volatility, as well as their robust and resilient business models.

Although they may not always offer the same level of profit growth as cyclicals, defensive sectors such as utilities, tobacco and healthcare could return surplus cash to shareholders. And with their yields generally being high and well covered, the total returns on offer over the medium term from defensives could prove to be index-beating.

Certainly, all shares may be set for a difficult period. Uncertainty is likely to rise as Trump begins to implement his policy manifesto. However, defensive stocks offer greater certainty of capital return, lower volatility, less risk and higher income prospects than cyclicals. As such, they appear to the tonic for the risks associated with a Trump presidency.

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