Asset Allocation

Investment Outlook: 2Q-2017

Trump Truncated?

Global equities will likely correct in 2Q17 as doubts over Donald Trump’s ability to steer the world’s largest economy boil over.

Risk appetites will pull back in coming months because US President Donald Trump has not delivered on the most economically significant parts of his agenda – that is, tax cuts and infrastructure spending/fiscal stimulus. Nor should markets have been expecting anything quite so soon. Yet stock prices have moved ahead of reality. More significantly, Trump has blown his first months in office politicking rather than building. The noise of the tweets, the apparently pointless political confrontations, and the controversy over Team Trump’s dealings with the Russians have dominated the narrative of the early months of his presidency. Donald Trump has been behaving less the President of the most powerful nation on earth than an angry politician still in the midst of a campaign. And his erratic policy outbursts have created international uncertainties on the trade and geopolitical fronts. These are a lot of policy negatives for global equities, which have on average rallied 11% off the lows from when Trump won the election.

But a new bear market in global equities is unlikely. Markets do not typically go into bear mode in the absence of recession or geopolitical shocks. We cannot rule out the latter but the former is highly unlikely. Indeed, the global economy is gathering growth momentum, with the US at the forefront. Even the European economy – which the market expects to post flat economic growth this year – should surprise on the upside this year. The Eurozone Composite Purchasing Managers’ Index (PMI) – often seen as a forward indicator of economic activity – has been surging since September last year. Meanwhile, China will likely still put in a creditable 6.5% GDP growth performance this year.

US equities are vulnerable to a significant correction because valuations are pricing in a “Trump bump” for the economy. But so far, all they have gotten is a “bum steer”. Yet the economy is doing well, the Treasury yield curve is still very much positive, and equities earnings yields are still above the 10-year US Treasury yield. These are not conditions for an equities bear market. But a sideways slog is a distinct possibility until Donald Trump tweets aggressively a little less and does for the economy a little more.

But parts of the Trump Trade – the US dollar and Japanese equities – will likely do better than US equities over coming months. US inflation has been and will likely continue rising, notwithstanding inaction on the fiscal front from the White House. And the US Federal Reserve will continue hiking rates in a world where there is little likelihood of any significant rate rises anywhere else. If the European Central Bank is at least hinting at an easing in negative rates, the Bank of Japan is likely to maintain its negative policy rate. The yield differential between the 10-year US Treasury over the 10-year Japanese Government Bond will continue widening, taking the USD/JPY higher, that is weakening the yen. And with that, there should be better prospects for Japanese equities.

So is this Trump Truncated? Not necessarily. We remain bullish on the US dollar and Japanese equities. And given rising US inflation and Fed rates, there is little reason to change our generally bearish view of bonds, particularly Developed Market sovereigns. However, we are more qualified with US equities. Valuations are stretched. And stocks have already priced in, in some measure, tax cuts, deregulation, and fiscal stimulus. We are downgrading US equities from Overweight to Neutral on a 3-month view. Given President Trump’s failure to even repeal “Obamacare”, there will be growing doubts on his political ability to deliver on yet more controversial measures on the economic and trade front. The political disruptor is now being disrupted. Before US equities can push higher – and that is important for global risk appetites – the President of the United States has to show he can lead and not just tweet.

Those old enough may remember the words of Elvis Presley’s 1968 hit: “A little less conversation, a little more action”. Yes, please, Mr President.

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