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The Trump effect
In the weeks leading up to the presidential election, equities fell anytime Donald Trump got a bump in the polls, and gained when Hillary Clinton rose in the polls. Any observer easily concluded that a Trump win would be bad for equities, while a Clinton win would be positive. An investor with perfect advance foresight of a Trump win would have sold all his equity holdings, with disastrous consequences for his long-term performance.
If any investor needed proof to beware of consensus views, which is one of my recurring themes to avoid making big mistakes in the managing of one’s investments, 2016 gave plenty of opportunities to learn and cement this lesson.
From the initial January-February selloff which presaged a negative year for equities (the much misquoted “January effect”), to Brexit, the Trump win, and the Italian referendum, all proved that consensus did not even closely anticipate the final outcome. Most importantly, especially for the last three political events, the consensus market selloff from the “negative” outcome never materialised.
Markets are clearly pricing in a lot of positives from a business-friendly Trump presidency, especially the reflationary pressures that he is expected to bring, particularly to onshore US equities.
While all the commentary has focused on whether US equities are becoming too overvalued, the fact that inflationary pressures were already building long before Mr Trump won the election is not getting much discussion, and not just in the US, but globally, such as:
- The primary measures of consumer price inflation all moved above 2 per cent year-on-year in Q1 2016.
- Wage upward pressures started to be seen in early 2016. Legislation to increase minimum wages in the near future will only add to this.
- With the exception of perennial deflationary Japan, every other major country in the world is experiencing growing output prices as measured by Purchasing Managers’ Indices, with Turkey, the UK and China being among the highest in the world.
The Trump presidency has merely accelerated the expectations for higher inflation, bringing forward future gains in prices. It is probable that the high expectations placed on Mr Trump are overdone in the short term, as too much credit is regularly given to the president of any country for influencing the economy.
The following expected outcomes are likely to be right over the longer term, but markets will likely be disappointed in the short term, presenting investment opportunities:
- US dollar (USD) interest rates will increase from here, however, the speed and path are unlikely to be anything close to what the market and the Fed are projecting. The Fed has been consistently unable to predict its own actions three months in the future, so any “dot plot” projections can be safely ignored.
- If interest rates rise more slowly, USD strength will not persist. So far in January 2017, we’re already seeing strength in the euro, while expectations were for a break below parity. EM (Emerging Market) equities have issued significant amounts of debt in recent years, so a flat to weaker USD in 2017 will be positive for this sector, though the longer-term outlook still calls for a stronger USD.
- Likewise, the end of the 35-year bond bull market has been widely anticipated for the last 10 years, always too early. If the consensus is correct that the bond bull-run is over and we will have a V-shaped bottom where bond yields consistently and quickly rise from the current level in the future, it will be the first and only time in history that a major top at the end of a bull market was called correctly. Instead, we are far more likely to see a slower gradual rise similar to what was experienced at the start of the last bond-bear market, where yields range-traded for a full decade from 1940 to 1950.
- US equity post-election gains have priced in a permanent upward growth adjustment to US gross domestic product (GDP). It remains to be seen whether the US president’s business-friendly policies can permanently add 2 per cent per annum to future US economic growth, starting this year. Even if the long-term gains in US GDP materialise, it will be unlikely we would see anything close to this in the first year of the presidency, given the lag between policy implementation and results in the underlying economy.
- This expectation of US GDP growth premium is even bigger when compared to consensus estimates for Europe, where the return of inflation is not being priced in at all. Europe has been a big underperformer and offers far more opportunities for contrarian investors, especially in the banking sector if the euro moves off negative interest rates.
The above are all for shorter-term potential portfolio positioning given current over-optimistic expectations. At any time these expectations are proven excessive during the year, it will be an opportunity for investors to add securities that have a positive correlation to higher interest rates, given that the longer-term picture still points towards higher inflation.
AL Wealth Partners is an independent Singapore-based company providing fund management and advisory services to accredited investors