Three asset classes and the ‘Trump trade’: Part 1
It’s now six months since Donald Trump was elected US President and four months since he was inaugurated.
In many ways the situation has been better than initially feared by investors. Trump has not withdrawn the US into isolationism and there has been no trade war with China. He also appears focused on pro-business policies such as deregulation and tax reform and is more supportive of the US Federal Reserve under Janet Yellen than feared.
But recent events including firing FBI director James Comey have cast a shadow on the US administration.
This is the first in a two-part article series in which we explore the effect of the US administration’s policies on three asset classes: equities, bonds and fixed interest, to help self-managed super fund (SMSF) investors when thinking about their investment strategies. In this article, we look at equities.
In terms of investment markets, a common view seems to be the “Trump trade” has driven the surge in global share markets since the US election, but that this could reverse because of the political situation that surrounds Trump. This perspective is too simplistic.
The main reason for the rally in shares since last November has been the improvement in economic conditions and surging profits globally. Second, the political environment is likely to speed up Trump’s pro-business reform agenda.
Correction risks and seasonality
Share markets have had a great run and are arguably due a decent (5% or so) correction as a degree of investor complacency has set in. The scandals around Trump along with risks like North Korea and future US interest rate hikes could be the trigger for a downturn in markets.
It's well known the best time for shares is from November to May and the worst time is from May to November. Most major share market crashes occur in the May to October period, including 1929, 1987 and the worst of GFC.
The seasonal pattern partly reflects tax loss selling by US mutual funds around the end of their tax year that sees them sell losing stocks around September to reduce capital gains tax bills. They buy shares back in November and this, as well as investment of year-end bonuses, New Year optimism and the absence of capital raising over Christmas and New Year, drive shares higher from around October/November.
In Australia in July markets get a boost as investors buy back after tax loss selling due to our financial year ending in June, but otherwise we follow the US pattern.
Five reasons for optimism
Beyond current short term risks and threats there are several reasons for optimism around equities. First, valuations for most share markets are not onerous. While price-to-earnings multiples for some markets are a bit above long-term averages that is not unusual in an environment of low inflation. Valuation measures that allow for low bond yields show shares to no longer be as cheap as a year ago, but they are still not expensive.
Second, while US share markets appear relatively over-valued on some measures, other global share markets are not. Third, global monetary conditions remain easy and in the absence of broad based excess (in growth, debt or inflation) look likely to remain so.
The US is likely to hike rates two more times this year and start allowing its balance sheet to run down later this year. But this is from a benign base and other central banks are on hold or easing. So a shift to tight money bringing an end to the economic cycle looks a fair way off.
Fourth, global economic growth is looking healthier. Global business indicators are strong, the OECD’s leading economic indicators have turned up, jobs markets are tightening and for the first time in years the IMF has been revised estimates of global growth upwards.
US growth looks to be trending up again after a seasonal soft spot early this year, Chinese economic growth appears to be stabilising at around 6.5% after an earlier upswing, Japanese growth is the best in years and the Eurozone looks strong. Australia continues to muddle along.
Fifth, profits are strong: US profits are up 14% year on year, Japanese profits are up 15%, Eurozone profits are up 24% and Australian profits look set to rise 20% this financial year.
Nevertheless, after gains over the last year and a strong start to this year, shares are vulnerable to a short-term correction as we go through seasonally weaker months. The political scandal around Trump, North Korea and interest rate worries could trigger a retraction in equities markets.
However, with most share markets offering reasonable value, global monetary conditions remaining easy and global growth and profits looking good, the trend in shares is likely to remain up.
In part two of this series we look at the US administration’s effect on bonds and property.