Asset Allocation

Investment Outlook: 1Q-2017

All Change – Trump Triggers Inflections

Just when Developed Market (DM) equities were looking tired, along came Trump. And then everything changed.

Inflection points, long in the making, were triggered, sometimes with counter-intuitive consequences. The debate over fiscal expansion versus austerity has been resolved – Donald Trump has emerged as the world’s most powerful proponent of Keynesianism. US Treasuries – which almost everybody agreed were overpriced but nobody quite sure when to sell – collapsed on the victory of Republican presidential candidate Donald Trump. The 10-year yield, which was at a historical low only a few months before, spiked up.

After a brief struggle, risk asset markets decided:

  1. Republican control of both houses of Congress made America more governable;
  2. Trump’s promised increased infrastructure spending and tax cuts would lift US economic growth;
  3. But it would also bring already simmering inflation to a boil;
  4. Fed rates would have to rise by more than previously expected; and
  5. “Make America Great Again” was protectionism by another name, with negative implications for Emerging Markets (EM) and Asia ex-Japan (AXJ).

And that triggered market dynamics that reverberated around the world. The US Dollar, which until then also appeared tired, got a new lease of life, sending gold plunging. The consequent weakening of the Yen against the greenback boosted Japanese stocks. But it spooked EM and AXJ on fears of a repeat of the 2013 Taper Tantrum and the normalisation of US inflation expectations in 2015, when these markets were hammered on weakening domestic currencies and fears of Dollar funding stress.

The “Trump Trade”, as we have called this – bullish Dollar and DM equities but bearish bonds and EM/AXJ equities and currencies – will likely pause until the inauguration of President Donald Trump late January. Much then depends on whether he makes good on his election promises/threats. Our best guess is he will carry through much of what he promised. Unlike Obama, the new President will control both houses of Congress. And if he doesn’t deliver on a good portion of his mandate, the anger he has stoked in his supporters will likely rebound on him.

So the “Trump Trade” will likely resume, taking US equities even higher. European equities will join the DM stock rally, helped by continued quantitative easing by the European Central Bank (ECB) and a stronger Dollar. Japanese stocks will likely continue higher, along with a stronger USD/JPY. But EM and AXJ equities will tread water until there is greater clarity on how the Trump Administration proceeds with its protectionist agenda.

But this is not a “brave new world”. Donald Trump is the latest disruption in already disrupted markets. Markets may now want to believe that Keynesianism is the panacea where monetary stimulus failed. But it would add to the global mountain of debt. And there will come a point when the consequent higher rates will kill the market for already expensive risk assets. Stay invested but be nimble – this is a market where investors may have to shift positions quickly.

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