CIO Viewpoint: Examining our US views under President Trump
Head of Investments, Lombard Odier Private Bank
As Mr Trump settles into the Oval Office, investor expectations are meeting reality, and the policy priorities of the 45th US president are becoming clearer. Mr Trump’s inauguration speech focused largely on his ‘market negative’ trade protectionism agenda, rather than his ‘market positive’ promises to stimulate the economy via tax cuts, deregulation and infrastructure spending. Early actions on tightening immigration controls, building a wall along the Mexican border and moving to quit the Trans-Pacific Partnership and renegotiate the North American Free Trade Agreement speak to the same strongly protectionist agenda, but markets took heart at his moves to revive two oil pipeline projects, and ease regulations on infrastructure projects and American manufacturing.
Market reactions to Mr Trump’s early days in office have been cautiously positive. As of 24 January, the S&P500 was at record highs, 10-Year Treasury yields rose by 3 basis points (bps) on the previous day, and the US dollar (USD) firmed against other major currencies. Pre-inauguration, we note that markets had priced in a lot of positive news on Mr Trump’s pro-business agenda and promises to Make America Great Again, opening the door to potential disappointments in coming weeks. Between US election day on 8 November 2016 and Mr Trump’s inauguration on 20 January 2017, the S&P500 had risen 6% – the most of any president’s first-term election since John F Kennedy – while the USD was around 15% overvalued against the euro (EUR) on a purchasing power parity basis (PPP), according to our estimates.
We note that positive market reactions reflect solid US economic fundamentals, and that Mr Trump’s proposed fiscal stimulus and deregulation are also poised to give a late-stage ‘vitamin boost’ to the economy this year. US December industrial production, housing data, jobless claims, and inflation figures were all strong. US banks have made a solid start to the fourth-quarter earnings season, while 2017 S&P 500 earnings growth has been revised upwards in recent weeks. For 2017, we forecast US GDP growth of 2.5%, aided by Mr Trump’s fiscal stimulus. This is above 2.2% Bloomberg consensus estimates, and our estimated 1.8% long-term growth potential for the US economy.
We note that US stock dispersion is close to its highest level since the global financial crisis, and huge sectoral rotations have taken place in recent weeks. We believe US smallcap stocks, stand to gain more from tax cuts and a strong domestic economy, and that technology stocks should benefit most from a promised repatriation of US cash parked overseas. We also believe healthcare stocks have suffered unduly in recent months. However, we note that US stocks have seen spectacular gains in recent years (a 166% rise for the S&P500 under President Barack Obama), and now trade at historically stretched valuations (2016 price/earnings ratios are roughly one standard deviation above historic averages, according to our calculations), even as pressure on domestic wages is rising.
As the US economy moves from a deflationary to a reflationary environment, buoyed by Mr Trump’s fiscal splurge, we note that a reversal in the long-term US bond market bull run may lie ahead. We believe rate hikes in 2017 should bring the Fed Funds rate from its current 0.75% to 1.25-1.50%, putting the bond market under pressure. Our forecast for the 10-Year Treasury yield by end-2017 is 2.25%.
In credit, higher financing costs from rising US interest rates are likely to be at least partially offset by a corporate tax cut. We believe recent gains in commodity markets should boost the energy and materials sectors in particular.
There are many factors which we note should justify an underweight USD view: the dollar looks expensive on a PPP basis, the US current account deficit is large versus other major economies, the real interest rate differential is neutral for the greenback, and Mr Trump himself has made comments against a strong dollar. However, in the short term, this is weighed against a bullish US growth and monetary policy outlook, fiscal stimulus, threatened tariffs on US imports, pledges to boost domestic manufacturing, and proposals for US companies to repatriate between USD 1-4 trillion of cash parked overseas. For now, we believe dollar strengthening will pause for breath, having now priced in many of Mr Trump’s campaign promises.
Given considerable uncertainty surrounding Mr Trump’s policies, we note that risks to our views loom large. Mr Trump enters power with the lowest approval rating of any US President and an unconventional policy approach that leads us to expect significant market volatility ahead. Our central scenario is that Mr Trump’s policies could prove growth-friendly in 2017, but risk endangering both the US economy and global trade beyond this year.
We remain particularly vigilant on risks surrounding trade protectionism, US dollar strength, and market valuations. Protectionism could easily gather pace, with the imposition of trade barriers, tariffs, and the possibility of a US trade war with China, endangering the global economy’s single most important bilateral relationship. Meanwhile, a rapid further strengthening in USD could result in an aggressive global tightening in monetary conditions, damaging growth, triggering a global dollar shortfall, and leaving emerging markets struggling under the weight of USD-denominated debts.
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