Investment Strategy Insights: Trump and Markets: The Known and the Unknown
When parsing the potential effects of a Trump presidency on markets, it’s a lot easier to frame the positives (tax cuts, regulatory relief, infrastructure) than to scope out the extent of the negatives (trade repercussions). Markets are pricing in a big net plus. Is that reasonable?
Tax cuts and regulatory relief should be easy for a Republican president and Republican Congress to agree upon. While many argue that a large infrastructure program cannot be paid for in the midst of extensive tax cuts, this rules out the possibility of financing most of these infrastructure programs from public-private partnerships (PPPs). One of the world’s biggest problems right now is that too much capital is chasing too little EBITDA. Why not help drain some of the global savings glut and associated liquidity trap by inviting the capital markets in to finance infrastructure like the Australians do? US banks are also in good shape to finance these programs, with historically low loan-to-deposit ratios of only 72%.
While an actual repeal of Dodd-Frank will be difficult, how it is applied can easily be throttled back. Clearly overzealous implementation of Dodd-Frank choked off credit to small and midmarket businesses, which under normal circumstances are counted upon to create most of the growth in the US economy. Removing this wet blanket could pave the way for faster growth, paying for some of the tax cuts. Faster growth from privately financed infrastructure could then pay for much of the rest. Fiscally speaking, the program hangs together better than commonly depicted and is politically implementable, which is why markets are rallying.
This is not to say that there are not uncertainties and unintended consequences. While tax cuts and regulatory push-back are capable of boosting growth by the second half of 2017, infrastructure will not be able to contribute until 2018 and beyond. Less immigration into tightening labor markets sets an inflationary backdrop, despite help from a rising US dollar. Pre-election, Janet Yellen had wondered out loud whether the Fed should allow the US economy to “run hot.” Yet inflationary pressures emerging sooner and in a more threatening manner may incent the Fed to lean against the wind and take away some of the stimulus from Trump-o-nomics.
But the clearest negative from Trump’s declared policy intent is the potential drag on global trade. An outright trade war could turn his whole program into a net negative. While it left some short-term economics on the table by focusing on growing global trade for all, former US trade policy bought geopolitical leadership for the US. Trump will focus more narrowly on the shorter term economics of trade deals, which is how most of the US’s trading partners have always negotiated. Reciprocity is unlikely to provoke a trade war, yet without the largest party focused on growing the market, the risk is that global trade doesn’t grow, or that it grows less rapidly. One of the first signs of Trump’s dedication to his trade rhetoric will be whether he chooses to label China as a currency manipulator. Meanwhile, President Xi’s desire to make China the new leader in globalization is a positive sign, and one inconsistent with a trade war ahead.
INVESTMENT VIEWS & CONVICTION SCORE (CS)
Economy CS 2.50 (-0.25)
Markus Schomer, CFA, Chief Economist, Global Economic Strategy
Although greater uncertainty about US economic policy has increased the tail risks to our central case for global growth, we expect a positive impact from Donald Trump’s likely economic policies. We believe Trumponomics can accelerate the shift from an excess supply environment causing deflation and depressed investment to one of greater balance between supply and demand. More stimulative fiscal policy could boost US growth and, through a wider trade deficit, trickle down to the rest of the world. However, the potential of greater trade protectionism could offset any global stimulus.
Rates CS 3.00 (-0.30)
Roberto Coronado, Senior Portfolio Manager, Developed Markets Investment Grade
Despite post-election volatility, we believe US rates will stabilize and trade within the range. The likelihood of fiscal stimulus from infrastructure spending and tax cuts has raised expectations for higher US growth and inflation. However, we are skeptical about the size and timing of infrastructure spending. We expect near-term headline inflation of around 2%. Our range for the 10-year Treasury has moved to 1.75%–2.25%, though it could be higher near term. In US Treasuries, we recommend a neutral position, given recent volatility, with a bias for the four- to eight-year part of the curve. In global bond funds, we recommend being long Europe versus short US rates, with further European Central Bank (ECB) support likely. Treasury Inflation-Protected Securities (TIPS) remain attractive versus nominal Treasuries over a sixto 12-month period, and we prefer the five- to 10-year part of the curve.
Credit CS 3.00 (-0.50)
Steven Oh, CFA, Global Head of Credit & Fixed Income
The US election results have increased tail risk scenarios, shifting our recommendation to a neutral stance, given less base case certainty. We see greater potential for higher growth and inflationary pressures, which could compress credit spreads, but greater risk of downward volatility from further tapering or follow through on anti-trade rhetoric. Upcoming European elections are also elevating downside risks. We favor less duration-sensitive credit assets such as loans and high yield bonds. With high yield spreads widening versus investment grade tightening, we prefer high yield over investment grade and recommend a neutral stance between high yield and loans. We also see emerging market (EM) debt becoming more attractive, despite potential near-term volatility.
Currency (USD Perspective) CS 3.50 (+0.50)
Anders Faergemann, Senior Sovereign Portfolio Manager, Emerging Markets Fixed Income
The US dollar is firmly in the driver’s seat after Trump’s victory, with talk of fiscal stimulus and tax cuts, trade protectionism, and reflation paving the way for higher US yields and monetary policy divergence with Japan and the eurozone. Political uncertainty in Europe has started to weigh on the euro, with the Italian referendum, Dutch elections, and French presidential election getting more attention. The trade-weighted Japanese yen shows signs of reversing its rise, with weakness mainly versus the US dollar. We recommend an underweight of the euro and, increasingly, the yen. We favor the Canadian and Australian dollars versus the British pound. In EM portfolios, we recommend reducing allocations to local currency bonds with rates correlated with US Treasuries and EM currencies suffering from the strong dollar.
EM Fixed Income
USD EM (Sovereign and Corp.) CS 3.25 (-0.25)
Local Markets (Sovereign) CS 3.00 (-0.75)
John Bates, Head of Emerging Markets Corporate Research, Emerging Markets Fixed Income
We strengthened both our US dollar and local market CS scores to reflect re-pricing of yields and spreads. The EM macro picture has not materially changed but the outlook has, based on already high expectations of a December rate hike coupled with Trump’s easing rhetoric on trade protectionism. Our credit trend outlook is primarily neutral with a slightly less negative bias. The risk-reward for investing in EM is starting to look more attractive again, against the backdrop of a broadly more positive fundamental outlook.
Multi-Asset CS 2.20 (unchanged)
Hani Redha, Portfolio Manager, Multi-Asset
We are optimistic about potentially accelerating US growth, coupled with the prospect of tax cuts and fiscal stimulus. Financial sector deregulation could also significantly contribute to credit growth. We are cautious about Europe because Trump’s victory raises risks of populist surprises in Italy and France. We think Japanese yen weakness will be positive for inflation and support earnings growth. Despite rising developed market political risk, we find it receding in pockets of EM. We continue to have conviction in Brazil, India, and Indonesia.
In equities, Japan remains attractive, particularly with the recent yen weakness. We recommend increasing exposure to US equities, with a focus on financials, which could benefit from rising yields, credit growth, and deregulation. We view Mexico exposure less favorably, but continue to like India and Indonesia due to their domestic-consumption-focused economies, stable politics, and progress on reforms. In fixed income, rising US rates have pressured EM debt and foreign exchange. In Brazil, intermediate-term inflation is set to fall, leading to falling bond rates.
Global Equity CS 2.75 (unchanged)
Rob Hinchliffe, CFA, Portfolio Manager and Head of Sector Cluster Research, Global Equities
With little information to trade on, investors are repositioning for increasing inflation resulting from lower taxes and higher government spending. Repositioning has been toward more cyclical sectors, including banks and materials companies. Renewed preference for the US dollar has come at the expense of EM currencies. We think this will ultimately benefit EM exporting countries, particularly those with high commodity exposure. Third-quarter bank results have been strong, driven by good net interest income and margins, stable credit costs, and decent expense management. In US transport and logistics, we see early signs of supply/demand tightening among the customer base.
Global Emerging Markets Equity CS 2.50 (unchanged)
Andrew Jones, CFA, Portfolio Manager and Head of Equity Research, Global Equities
EM equities experienced Trump shock emanating from two channels: rising US rates pressuring currencies via the pre-existing EM carry trade and concern over “America First” de-globalization, most notably reductions of bilateral trade with the US. However, Trump’s infrastructure stimulus plan should help commodity prices, and higher rates should benefit EM financials. Although a Republican Congress is likely to mitigate anti-trade rhetoric, some amount of trade uncertainty is already in equity share prices. Recent structural improvements in markets like India, Indonesia, and Brazil give some breathing room on several EM external balances and fiscal accounts. We favor financials and are negative on telecoms. We are positive on Russia and Brazil, while negative on South Korea and Malaysia.
Haibo Chen, Quantitative Analyst, Quantitative Research
The US Market Cycle Indicator (MCI) improved but continued to stay defensive, reflecting a steeper yield curve and tighter credit spreads. On corporate credit, investment grade performed slightly better compared with long-term averages. We favor banking, basic industry, and technology. We dislike electric, communications, and consumer noncyclical sectors. In EM credit, we like Brazil, Russia, and Indonesia, and dislike South Africa and Israel. In rates, we expect yield levels to increase globally, the slope to steepen in G4 countries except the UK, and curvature to increase in the eurozone and UK but stay flat in the US and Japan. We recommend a slightly long global duration and favor core European countries and the UK. In curve positioning, we like the five-year and especially 20-year key rate durations.