J-Money, January 2017
The world was stunned by Donald Trump’s victory in the US Presidential election in October – and then stunned again when markets reacted to it by going significantly upwards. “Despite fears that a Trump victory would be a negative risk-event, quite the reverse has happened,” says David Absolon, investment director at Heartwood Investment Management. What does this tell us about what markets expect from President Trump, and what does that mean for the outlook for the world and for Japan?
Perhaps the biggest beneficiaries worldwide in the week after the election were Japanese banks. This was, at first, mystifying: bank stocks went up everywhere, in expectation of rate rises coming sooner than might have been the case under a Clinton presidency, but Japanese banks outperformed all others. Whereas Morgan Stanley went up 7.7% between November 9 and 14, MUFG – which holds a 22% stake in the American bank – went up 23%.
Part of the reason was because of an assumption that Trump is anti-regulation, particularly in financial services, and that his presidency probably means an end to Basel IV banking regulations, or at least a significant dilution of the standards. Japanese banks were considered particularly exposed to Basel IV, and this explains the rise. Financials around the world are considered to be the sector that may benefit the most from a Trump presidency.
Generally speaking, markets are assuming interest rate rises. “By end-September 1944, we expect three Federal Reserve rate hikes and an early start to ECB tapering, putting an end to the bond party that started in the early 1980s,” says Alain Bokobza, head of the strategy team for global asset allocation at SG. This will have impacts well beyond the banks. One is that it is already triggering a migration out of bonds and into equities, which is one reason the USA enjoyed its largest ever post-election rally in the month after the vote: it’s simply a consequence of assets moving and pushing prices up. According to Barclays, $27.5 billion went in to equities, and $18.1 billion out of bonds, in the week ending November 16.
However, while the flight from bonds appears to have been global, the flight in to equities has been heavily dominated by the US (and in particular smaller companies, financials and industrials). At the same time, money has left emerging markets equities, and they have underperformed. DBS calls this “The Trump Trade – bullish developed market equities and the US dollar, but bearish US Treasuries and Asia ex-Japan/emerging market equities”.
On the US equities side, analysts almost universally predict a good year. BofA Merrill Lynch Global Research calls a year-end target of 2300 for the S&P 500, which at the time of writing assumes a 5% gain in the index and earnings growth of 9%. However it says it could go as high as 2700. At the same time it expects nominal GDP growth in the US to rise from 3 to 4% (and real GDP by 2%) on the back of fiscal stimulus measures.
But what about emerging markets, and in particular Asia? One important question is how trade is affected by Trump policies. The Trans-Pacific Partnership is dead in the water. But what about trade relationships with individual countries? Relations with China already look problematic.
“Trumponomics creates two broad uncertainties for emerging markets,” says Citi. “The first is about what policy mix will emerge from Washington. A second uncertainty would result from US policies that aim to restrict the free movement of goods, people and capital: the small, relatively open economies that populate EM have greatly benefited from the increase in economic integration over the last 30 years.” Generally, one would expect a looser fiscal policy and a strong dollar to lead to capital flows out of emerging markets.
Uncertainty is a common theme. “Donald Trump’s election puts emerging markets on hold until his economic policies with respect to immigration, foreign policy and trade become clear at the beginning of 2017,” says Heinz Ruettimann, strategy research analyst for emerging markets at Julius Baer.
As a macro backdrop, UBS Wealth Management global chief investment officer Mark Haefele expects a “polarized political world” with US growth improving and China continuing to slow. Yet, unlike some, he believes Asian equities will outperform bonds; is overweight on China and India; and thinks global GDP growth will rise from 3.1 to 3.5% in 2017. Nevertheless, like most economists, he thinks US equities are the best investment case for 2017.
In the US in particular, industrial and cyclical sectors are rising, because they are perceived as benefiting from Trump policies like investment in local infrastructure.
“The election of Donald Trump has supported the outlook for global infrastructure investment and lifted base metal prices,” says Paul Bloxham, HSBC’s chief economist for Australia. “Trump’s election has also increased the risk that the Chinese authorities boost infrastructure investment in the face of downside risks to exports.”
One of the more baffling asset moves has been a 10% decline in the price of gold, which normally goes up at a time of uncertainty and perceived high risk. Instead, it has been behaving as if the market perceives a reduction in risk.
It’s important to recognize that the rally in stocks, and the movement in other asset classes, isn’t all about Trump – it’s also about the rise in the oil price, for example, which has more to do with an OPEC decision to cut production than any US policy – but the election is clearly a large part of the move.
What about for Japan? The yen is already falling; SG expects the rate to hit 120 to the dollar by the end of 2017. This, the bank says, should be “a clear support for Japanese equities”. However – Trump notwithstanding – the outlook is not considered to be great for the asset class by most. Toru Ibayashi, head of Japan equity at UBS Wealth Management, says “we see little upside for equities in 2017,” because of disappointment about ineffective Abenomics reforms. Besides, even if the outlook for Japanese banks in a Trump world is positive, that’s surely already in the price; set against that, the end to TPP is considered to be bad for the Japanese economy.
Generally speaking though, all bets are off. People failed to predict Trump, as they did Brexit; they also failed to predict the market reaction to his victory, with most having expected the uncertainty that would follow his election to be bad for markets. This is something of a journey into the unknown. “The outcomes of Brexit and the US election have brought fundamental change, which equate to investor opportunity,” says Candace Browning, head of BofA Merrill Lynch Global Research. “If investors choose asset classes, sectors and stocks carefully, they can meaningfully outperform the market. 2017 could be the year of the active investor.” Equally, it will be a very easy market to be wrong about.