‘Trumponomics’ continue to support markets

Risk assets are exhibiting an exceptional degree of resilience and equity markets are clearly saying that President Trump is good for corporate profits.

Markets are expecting a fiscal boost from the new President, which will drive an increase in corporate profitability and earnings – a positive for equity markets, all other things being equal. That is likely to lead to a tightening in interest rates given where we are in the employment cycle. The consequent rise in bond yields would normally act as some sort of brake on the economy, but because of global quantitative easing it is likely there will be an international bid for yield that will keep a lid on the Treasury market. So while corporate profits are picking up, bond yields are unlikely to back up because global investors simply won’t let them.

We inch closer to elections in Europe, with the electorate in Holland and France first to take to the polls, and these events will shine a spotlight on the tensions and differences of opinion that abound – if not place pressure on the financial system depending on the outcome. Yet markets are highly complacent, despite the strong presence of far-right parties in both countries. Should we get a surprise in either country, we can expect a spike in volatility for risk assets due to the uncertainty of what will follow.

The European economy looks reasonably healthy, but there is a growing acceptance that monetary policy and QE specifically in Europe is no longer working, despite growth in Europe in 2016 being stronger than in the US. It is likely that higher growth and inflation will make the central bank think it can take its foot off the accelerator, and QE tapering will be critically important as we move through 2017 and into 2018.

The potential impacts of President Trump’s policies are also occupying our thoughts. We have been looking at what the outcome will be from expected fiscal easing and a more hawkish Fed, as well as Trump’s migration policies and trade barriers. Taking all the above into account, Trump in the round is likely to be neutral to negative for GDP growth, which means the market is clearly giving Trump the benefit of the doubt at this point.

But ongoing policy uncertainty raises a lot of questions that the market doesn’t have all the answers to. Are we still expecting business-friendly policies to come from the US government? Is the market right to be optimistic about what it’s seeing and what it’s hearing? Will the Fed hike rates by three or four times rather than a couple, and what does this mean for bond yields? We are also concerned at the potential impact of interest tax deductibility, should Trump go down this route. Even after taking into account cuts to the headline tax rate, treatment of interest expense could be a net negative. Although companies’ profitability may increase, the proposed policy tax shifts suggest that either equity or debt holders are likely to be negatively impacted.

As for the Fed, while there are inflationary pressures picking up in North America, there is a view that says that global deflationary forces and a stronger dollar will help to mitigate that, meaning aggressive interest rate rises are not necessarily on the table.

Against this backdrop, we are trying not to overthink things. As investors at the more cautious end of the spectrum we are mindful that the shift towards more growth-friendly policies is supportive for equities and risk assets more widely, but not so positive for bonds.

Portfolio positioning
Given valuations and fundamentals we have taken a look at emerging markets and Japan (where we have a meaningful overweight position) in recent weeks, but have opted not to change our positioning. Broadly, macroeconomic and policy backdrops are improving across EM, with improving current account deficits, firmer economic growth and a positive domestic consumption trend, particularly in India and Indonesia. Unlike in Europe and the US, domestic politics in emerging market countries appear to be pulling away from populism.

However, China remains a concern. The factors that have boosted recent growth (such as Chinese property sales) are slowing down and exports are unlikely to rise sufficiently to offset this slowdown. As key sectors of the economy weaken, domestic consumption seems insufficiently strong to prop up the economy. In Japan, equities have re-rated against a weaker yen and firmer global growth, and corporate earnings upgrades are likely to follow – as a result we expect high single-digit earnings growth and enhanced shareholder returns from Japanese companies.

Mark Burgess – CIO EMEA and Global Head of Equities – Columbia Threadneedle Investments