Don’t Be Trumped In The Year Of The Rooster

The Year of the Rooster signified a wake-up call to investors.  Fresh off the back of major political manoeuvrings, the economic landscape now looks very different.  With such a drastic paradigm shift we asked Dave Agar, head of our in-house Investment Research Team, to give us his take on what investors should expect over the remainder of the Lunar Year: Will Trump lay a golden nest egg in the US, will Theresa May hatch a cunning Brexit plan, and how quickly will inflation and interest rates get off the ground?

The Trump Effect?

Q1) One of the first questions on people’s minds when it comes to investing this year will be the effect of Donald Trump’s presidential election victory on financial markets. What implications do you think his election will have for investors?

The immediate reaction to Mr. Trump’s election win – a huge upswing in financial markets founded on the belief that Trump equals growth – took a lot of observers by surprise.  His expansionist policies led many to expect tax cuts and significant government spending, and this was well-received by the investment markets.

The big issues now are firstly whether Mr. Trump will be allowed to turn on the taps as quickly as he would like and secondly what impact this will have on the trajectory of the US economy.

That said, a corporate tax cut is undoubtedly going to be a good thing for stocks over the short-run.  For investors, it is important to understand which industries are most likely to benefit from these proposed tax cuts.    It is worth noting that a lot of companies already pay considerably less than full US corporation tax, whereas others come pretty close, and therefore probably stand a better chance of benefitting from any tax cut.

Q2) Janet Yellen, chair of the US Federal Reserve, has spoken a lot about her optimistic view on the US economy and we have already seen US interest rates rise in December last year. Should we expect further rate hikes this year?

The low (or even negative) interest-rate regimes we have seen across developed markets recently were motivated by a need to boost economic growth and inflation, although have demonstrated limited success.  Mr. Trump’s answer appears reflect a growing consensus that the solution is to throw cash at the problem.  Old fashioned Keynesian economics!

The US economy under Mr. Trump’s stewardship continues to grow, as deflationary pressures ease. Further tightening of interest rates should go hand-in-hand with his expansionism, but that is not to say it is necessarily going to work.  One important factor in determining how the US grows under Trump will be how his belligerent trade policy fares and whether we see escalations of trade-related rhetoric.

Q3) Overall, then, how does the US market look as an investment opportunity? Are US equities expensive and will the US dollar continue to rise?

By some measures, US equity markets look expensive compared to historical norms.  By other measures, stocks are not particularly expensive, and leading indicators as well as the economy in general are looking healthy.  Corporate earnings expectations and surprises will likely determine US equity returns, rather than any further multiple expansion.  The key for the Investment Research Team at AAM is to identify fund managers who are well-placed to take advantage of further upside in US markets.  However, at the same time we would be looking for signals that prices were inflating above their intrinsic values and at that point we will look to take profits.

As well as room for growth in equity markets, there appears room for USD appreciation, owing to interest rate differentials between the US and other developed markets.  Nevertheless, it will be important to monitor USD concurrently with US interest rates, as we have historically observed the USD strengthening on the expectation of rate rises, though it has typically stabilised or even fallen on the event.

Chart: New York Board of Trade US Dollar Spot Index (Value of USD versus a basket of currencies), Aug 2015 – Date, Two lines on indicate two interest rate rises 16th December 2015 and 14th December 2016), Source: Yahoo Finance

Brexit

Q) Aside from Trump’s election, the biggest area of uncertainty for investors this year must surely be Brexit and the long-term implications it will have. What toll will the decision to leave the EU take on the UK economy?

Putting aside the political discussions, and concentrating purely on the investment implications it is difficult to position Brexit as a positive.  Even if you take the view that the UK economy will benefit from an eventually reduction in import tariffs, or that the dominant service sector will flourish without the regulatory bureaucracy from Brussels, getting from here to there is likely to be extremely disruptive.  UK stock markets have performed reasonably well since the vote, although much of this is due to the collapse in GBP, which helps boost earnings for companies that report in Sterling and operate internationally.  In fact, it is the value of Sterling that is showing the market’s lack of confidence in the economic outlook for the UK.

Chart is GBP/USD, Jan-16 – Date, Source: IMF

Inflation

Q) One upshot of the recent political overhaul and the investment promises made in the US and the UK is higher inflation is widely being forecast for 2017. What impact will this have on investors?

Indeed, we would expect additional inflationary pressures to result from Mr. Trump’s plan to stimulate the economy fiscally and the OPEC agreement to cut production will also feed into higher inflation this year.  This trend has started to emerge in US inflation figures and there was a sharp increase in UK inflation at the start of 2017.  High inflation can quickly erode the value of cash savings and therefore investors have to look at alternative ways of holding assets.

Chart: US & UK CPI Change, Sources: BLS & ONS

For investors in periods of rising inflation some kinds of investment tend to do quite well, like gold or certain types of bond that are inflation-linked.  Most obviously, equities tend to perform well in such environments and remain one of the best ways to generate capital growth above inflation. Risks appear focused on the bond markets, I would highlight bond-focused exchange traded funds.  As such, we recommend clients review their portfolios with their advisors to ensure they are fully prepared for the arising risks and opportunities.

Opportunities in Emerging Markets

Q) And finally, what do you think of emerging markets as an investment opportunity over 2017?

Over recent years, one trend among a number of emerging economies like India, Indonesia and Brazil, has been the significant fall in current account deficits.  Owing to this fact, plus waning fears over commodity prices and the so-called ‘hard-landing’ in China, emerging market assets are looking reasonably priced.

However, the US still has an important role to play in determining the fortunes of emerging markets.  Should Mr. Trump conspire to dampen domestic demand, this would place great strain on those economies that are economically tied to the US.  There is still room for further strengthening of the dollar, which could be damaging to commodity markets and as such, exposure to emerging markets that rely on commodities should be monitored carefully.

How AAM Can Help?

Q) Overall then, how are AAM placed to guide investors through this year?

I think the overall tone of this discussion reflects that while the shifting economic landscape has thrown up some challenges for investors, it has also presented a number of opportunities.  Unfortunately, investing is never without risk but at AAM we believe by understanding the risks involved we can help our clients navigate the difficult terrain in order to reach their financial goals.

We also believe in the danger of the consensus.  In times following significant market movements, it can be easy to get swept up in the view that markets are going to correct or reverse back to a previous norm.  We are conscious of placing too much faith in what the rest of the market is thinking and we recommend evaluating every investment on its own merits.

There are time-tested principles that successful investors follow, and we believe strongly in ensuring investors are aware of them when they make their decisions.

In this unpredictable climate, we look to build all-weather portfolios for our clients that are globally diversified and robust to the many challenges facing investors this year.  At the same time, our in-house Investment Research Team is committed to ensuring our portfolios also capture the opportunities that are available in financial markets.

In saying that, not every portfolio is the same because everyone we work with is different.  If any of our existing clients have any questions about their portfolios, I would suggest they contact their financial planner so they can help identify the best strategy.  And anyone not yet working with us should feel free to get in touch to arrange a free consultation.

Disclaimer: 

The views expressed in this article are those of the author and do not necessarily reflect the views of AAM Advisory Pte Ltd. This document/article should not be construed as an offer, solicitation of an offer, or a recommendation to transact in any securities/products mentioned herein. The information does not take into account the specific investment objectives, financial situation or particular needs of any person. Advice should be sought from a licensed financial adviser regarding the suitability of the investment product before making a commitment to purchase the investment product. Past performance is not necessarily indicative of future performance. Any prediction, projection, or forecast on the economy, securities markets or the economic trends of the markets is not necessarily indicative of the future performance. Whilst we have taken all reasonable care to ensure that the information contained in this document is not untrue or misleading at the time of publication, we cannot guarantee its accuracy or completeness.