The American voters have spoken and we now know the outcome of the U.S. presidential and congressional elections.
The result was a Republican sweep, with a Republican president and Republican majorities in both the House and the Senate, giving the United States a single party government for the first time since 2010. Normally, that kind of clean sweep comes with increased certainty, as the plans laid forward by the winning side during the campaign are usually implemented with weakened resistance from the other side.
An abnormal election points to an abnormal prognosis for macro investors
But this was no normal election. We know very little about the actual policy proposals of Donald Trump, and we have little history to use as a guide. This is the first time the American voters have elected a presidential candidate that has served neither in an elected office nor in the military.
In addition, we now have a Republican president-elect with few developed relationships with the Republican leaders in Congress, much less within the Congress as a whole. This dynamic lowers the prospects for wholesale policy or legislative changes ever making it to Mr. Trump's desk for signature. With a president-elect that in many ways bears little resemblance to other elected Republicans, we may actually face a period with more domestic policymaking gridlock than most seem to expect right now.
With that backdrop, and using a variant of an admittedly tired expression, the only thing we can be certain of is that we are facing a period of heightened policy and economic uncertainty—uncertainty that will stay with us well past Inauguration Day on January 20, 2017. On that point, we agree with most of the commentary surfacing in recent days; however, whether the uncertainty will translate into heightened market volatility in the short to medium term is not a given.
Checks and balances foster incremental domestic policy developments
Looking at the aspects of broader economic policy that are more likely to face changes (including trade policy, fiscal policy, U.S. Federal Reserve leadership, and deregulation), there is no clear aggregate directional consensus on the impact of major macro outcomes (such as growth, inflation, or interest rates) that we can point to with certainty. Of course, changes will come, as we would also have expected in the case of a Hillary Clinton win; however, the U.S. government, through its system of checks and balances, favors incrementalism when it comes to domestic policy developments, and we have no reason to believe this time is going to be different.
At First Quadrant, any change in political leadership—particularly in a country representing one of the world's major economies—prompts careful and ongoing evaluation of the potential impact on the efficacy of our investment models and the risks we elect to assume, and this leadership change is no different in that regard. However, given this particular outcome, the potential for geopolitical disruption is higher than we would have expected in the case of a Clinton win, so that particular area is one we are going to watch with intense vigilance.
Maintaining an outcome-independent investment posture
In terms of tactical currency allocation decisions, we had recently been seeing fewer opportunities than normal ahead of the election and, as such, we had been running risk at below-target levels. At First Quadrant, the immediate impact of Election Day results was muted for that reason. In addition, aggregate positioning was not tied to the outcome of the election. Holding long positions in the New Zealand dollar, the U.S. dollar, and the euro against short positions in the Japanese yen and Swedish krona meant that our outright exposure to a risk event that would come from maintaining a more carry-oriented posture-either long or short-was limited. The long positions in both the U.S. dollar and the euro limited the exposure to a U.S.-centered risk shock. As a consequence of this well-diversified set of positions, our strategy demonstrated a reasonable level of resilience as this surprising development unfolded.
Currency transactions are affected by fluctuations in exchange rates. The fund's losses could exceed the amount invested in its currency instruments. Fixed-income investments are subject to interest-rate and credit risk; their value will normally decline as interest rates rise or if an issuer is unable or unwilling to make principal or interest payments. Foreign investing, especially in emerging markets, has additional risks, such as currency and market volatility and political and social instability. Liquidity—the extent to which a security may be sold or a derivative position closed without negatively affecting its market value, if at all—may be impaired by reduced trading volume, heightened volatility, rising interest rates, and other market conditions.