Investment Outlook 11.2016
Thomas TrauthEconomist, Dr. rer. pol., CFA, FRM
The sun will rise in the morning
What can we expect from Trump’s presidency?
The US elections caused major market volatility around Election Day. It looked to us as though whenever the odds of a Trump victory rose, equity markets sold off, suggesting that market participants feared a Trump presidency. But after the Trump presidency became a fact, markets calmed almost instantly, recovering most of the pre-election losses. There are, however, a few exceptions, like the Mexican Peso, which has remained under selling pressure and reached historic lows.
It is as if market participants reminded themselves of President Obama’s words the night before the election, that whatever the election result might be “the sun will rise in the morning”. In our view, the first market reaction seems to confirm Obama’s words and the notion that a Trump presidency will not turn out as bad as many expect.
In our opinion, the major question is whether we will see a tamed and constructive President Trump or a continuation of the campaigning Mr. Trump. In the first case, Mr. Trump will be able to calm his temper and surround himself with enough competency to implement a liberal but sensible economic policy. It will be crucial for the Republican party, which struggled to cope with Trump during the campaign, and which has the majority in Congress and Senate, to be able to integrate Mr. Trump in a constructive way. This could prove to be positive for the economy and financial markets, as deregulation and lower taxes will boost economic activities.
If, however, Mr. Trump should continue with inconclusive policy ideas and were to, for example, run large fiscal deficits, implement protectionist measures, and provoke social unrest in the US, this could turn out to be very negative for economic growth in both the USA and globally, creating serious uncertainties and downside risks for financial markets.
We give the constructive Trump outcome a fair chance but remain aware of elevated political risks associated with the Trump presidency.
October started on a positive note after strong September growth indicators were published and Mrs. Clinton was leading the polls with a clear lead. However, on 28 October investors’ sentiment was hit hard when FBI director James Comey announced in a letter to Congress that additional emails had come to light, which appeared to be pertinent to the Hilary Clinton investigation. Clinton’s lead melted as fast as equity markets sold-off in the days to follow. European equity indices, for example, lost about 4% between 28 October and 6 November. On 6 November Mr. James Comey wrote another letter to Congress, and confirmed the result of the first FBI investigation that Mrs. Clinton’s email usage would not warrant an indictment. As a result, markets recovered most of their losses in a matter of days and the polls swung back in favor of Mrs. Clinton.
On Election Day, markets were extremely volatile with risky assets, the USD, and the MXN (Mexican Peso) selling off significantly. When the result became clear markets calmed and most markets recovered the majority of their prior losses.
Until 28 October, equity markets diverged somewhat with European equity markets up by 2.6% (EuroStoxx50), the Japanese Nikkei225 up by 6.1% and the Chinese CSI 300 up by 2.7%. The US S&P500 was, however, down by 1.9%. Gold prices fell 3.1% and the price for Brent oil was almost unchanged. Then, on 28 October, when FBI director James Comey shocked the US public and – as it appeared – global market participants, market volatility increased significantly and calmed only after the election.
The major post-election beneficiaries were global bank stocks, on the back of expected deregulation, pharma stocks, since it was feared that Clinton would introduce more stringent rules on drug pricing, and industrial metals, on the back of an expected major US infrastructure program.
The US elections clouded a significant rebound of growth indicators. The growth path for the US, Europe, Japan and China (see page 5) has clearly improved and seems to be stabilizing on a solid footing.
In October we observed another round of strong growth indicators. The US ISM manufacturing index climbed to 51.9 after 51.5. Also, the European manufacturing PMI rose to 53.5 after 52.6. US labor costs rose more strongly than in previous months. Average hourly earnings increased by 2.8% year-on-year. US non-farm payrolls rose by 161,000, which is a decline vs. the previous month but nevertheless a confirmation that the US economy is still creating new jobs.
Inflation expectations continued to rise. The US 10-year break-even inflation rate rose by almost 0.1%-points after the US elections to 1.91%. This was probably also the result of expected aggressive reflationary policy measures by the Trump administration.
Another underappreciated development was that the US reporting season turned out to be quiet positive. A majority of about 70% of the S&P500 companies managed to beat their EPS estimates.
At its meeting on 2 November the Fed came out broadly in line with expectations. It stated, though, that the case for a hike “has continued to strengthen”. The market-implied probability of a December hike currently stands at 85%.
Unlike the Fed, the Bank of England (BoE) surprised us with more hawkish comments. While the BoE has indicated a higher likelihood of a rate cut, in its recent announcement it told the public that the next rate move could be either up or down.
IMT Risk Monitor
On 5 November, when markets were very concerned about the uncertain outcome of the US elections, we observed a spike of implied volatilities, especially in equity and fixed income markets. Currency and commodities markets remained well behaved. Other than that, our risk indicators did not move much compared to last month. The equity valuation risk declined slightly, due to the market correction. Also the market became somewhat more relaxed about systemic, i.e. banking, risks.
We see the recent policy-induced market volatility as only temporary, and when looking through the policy induced clouds we observe increasingly encouraging signs of better economic growth. This does not mean that we can be relaxed about the risk environment. There is still a fragile European Union in general and the uncertain Brexit situation in particular. The US elections have revealed a deeply divided political landscape with severe tensions within the US population. There are also potential risks related to Russia, the Middle East, and the Far East. We also see risks for bond and equity markets, if central banks should become less accommodative.
Nevertheless, we continue to be cautiously optimistic since our base case remains a slow-growth scenario and a very gradual tightening path for the US Fed.
Considering Trump’s announcements during the campaign, we expect positive economic impulses from lower taxes, infrastructure spending, and deregulation. However, a more protectionist US would potentially also reduce international trade and the associated economic benefits for all involved trading partners.
Industrial commodities could benefit from increased infrastructure spending, while the impact on oil prices is not so clear. Trump wants to support the domestic oil industry, which would lead to higher production and lower oil prices. At the same time, the US may impose additional sanctions on Iran, which could limit Iran’s ability to supply world oil markets.
The outlook for the gold market is not clear-cut to us either. On the one hand, gold would be supported by further political uncertainties – not least related to the new Trump presidency. On the other hand, stronger growth and rising interest rates are clearly negative for gold prices. On balance, we continue to see larger downside risks for gold.
We remain positive for the USD and continue to see downside risks for the GBP, sine a hard Brexit scenario remains our base case.