Given the euphoric reaction to a Trump victory that saw equity markets and bond yields soar, then it could be said that his presidency so far has been a rather damp squib. Markets had focused on the twin promises of fiscal stimulus through tax cuts and infrastructure investment, concluding that such policies would pour fire on an already robust US economy, leading to much faster economic growth and higher inflation, resulting in a steeper rise in interest rates.
Equity markets rallied about 15 per cent in the months after the vote, driven mainly by the financial sector and domestic cyclicals that were perceived to be best placed to benefit from this fiscal stimulus and higher rates. The banking sector for example rallied nearly 40 per cent in the aftermath of the election. 10 year bond yields also rose from 1.8 per cent to over 2.6 per cent in just a few months as inflation expectations were reset higher.
The “Trump trade” was in full swing and investors were rapidly rotating from the safe havens that had served so well over the years of sluggish economic growth into cyclicals that had been largely ignored since before the financial crisis. Given the historically high valuation spreads that had developed between the defensives (expensive) and cyclicals (relatively cheap), this rotation was entirely understandable and probably somewhat overdue.
Unfortunately for the bulls and the rotation trade, while there have been multiple executive orders covering immigration, healthcare, trade agreements, and the environment amongst others, none seem to have actually resulted in any actionable legislation. In fact, despite having a Republican-controlled senate and congress, it seems that President Trump, contrary to some expectations, cannot pass through his policies without opposition. His failure to repeal so-called Obamacare has been the most public and humiliating, but his much vaunted tax reform also seems to have become bogged down in details before it has even been announced. While Trump continues to tweet and bluster, the impact on financial markets of his opinions has already seemed to have diminished.
In the meantime, markets have focused on a perception of heightened political risk around the world. These have included US military action in Syria and Afghanistan, tensions with North Korea, a public falling out with Russia, French elections, Brexit, German elections and the list goes on. In reaction, markets have reversed some of their initial enthusiasm, seeing 10 year yields drop from over 2.6 per cent in March to less than 2.2 per cent by mid-April. Given that the Federal Reserve has raised interest rates by 50 basis points since the election then the rise in bond yields has actually been pretty underwhelming. The rotation trade has firmly gone into reverse as the perceived safe havens such as consumer staples have recovered lost ground to achieve new highs (and valuations), and bond yields have begun to price in low growth and inflation once again.
The question markets have to answer now is this: if Trump cannot pursue his inflationary policy goals, then is the global economy doomed to another five years of economic torpor? The evidence seems to suggest that this is not the case. While the market’s attention has been firmly focused on political tensions and risks, the global economy has meanwhile been showing the first coordinated acceleration in growth since the financial crisis.
Whilst stronger economies such as the US, UK, and Germany have been doing well for some time, recently more troubled areas such as France and Italy have seen a marked improvement in economic data. Chinese economic growth accelerated in the first quarter of the year, assuaging some of the fears over a hard landing in the world’s second largest economy. Even the likes of Japan have seen export growth jump as their industrial-based economy benefits from this improvement in global trade.
At a stock level it is clear that those sectors most exposed to the economy are finally seeing a pick-up in sales and earnings. The US financials have mostly reported strong earnings yet again as the US economy continues to perform well. Industrials around the world are reporting growing earnings and more importantly for future growth, strong order books. Even areas that have been struggling under the weight of weak demand and over capacity such as steel have seen prices rise as demand has returned and capacity reduced. The world economy has been improving steadily since last summer, but with all the noise around Brexit, Trump, and the rest it seems that markets have barely noticed.
If Trump fails to embark on policies designed to inflate the US economy does it matter? Arguably with relative valuations still favouring cyclicals over defensives coupled with an improving global economy that will benefit those cyclicals the most, then probably not.
All data sourced from Bloomberg, as at 25 April 2017.
Jake Robbins is manager of the Premier Global Alpha Growth fund