In a post-Brexit landscape, were markets more priced-in than anticipated?
To say Donald Trump’s U.S. Presidential win was a surprise to most political pundits would be an understatement.
Some of the most popular prognosticators were predicting as high as 80-90% chance of a Clinton win with most around 65-70% immediately prior to Tuesday’s vote.
That said, there were several signs over the past few months that markets were pricing in higher odds of a Trump victory than the prognosticators expected such as the persistent rise in interest rates and underperformance of rate-sensitive assets.
The question now is what can we glean from Trump’s policy proposals over the past year to get a sense of the impact on markets?
A Backdrop of Improving Economic Fundamentals
Although Trump’s upset brings uncertainty, it’s important to make note of an improving macro picture in the last few months that has gotten little recognition amid the recent political din.
Overall, global growth is being revised upward, paced by better activity in China, gains in the manufacturing Purchasing Managers' Indices (PMIs), improvements in global trade and an end to the mini-industrial recession that gripped results a year ago.
Global interest rates appear to have bottomed, and yield curves are steepening as policymakers acknowledge inflationary pressures and begin to shift from pure bond buying toward interest rate targeting, a stance that reintroduces two-way risk into sovereign markets.
Credit spreads are reasonably well behaved, given the move in underlying rates, and earnings revisions continue to trend positive after a decent third-quarter reporting season in which beat rates were solid. We would emphasize that if bond markets really thought growth was faltering, and that a Fed hike was a policy mistake, then the 10-year Treasury would be closer to 1.35% than to 1.75%. Importantly, with earnings estimates moving up and stock prices down roughly 3%, price-to-earnings multiples are lower, and the yield on the S&P 500 remains an attractive 2.1%, versus 1.8% on the 10-year Treasury.
In many ways, our call for a cyclical upturn this year based on easy comparisons, more fiscal spending/stimulus and a weaker U.S. dollar and yuan is now stronger as Trump’s policies are more pro-growth for the deep cyclicals and financials. In other words, we do not see a reversal in the now well-established cyclical upturn and we have more confidence in our bullish 6-12 month view.
Potential Sector Reactions
In terms of sector performance, the full picture may take time to develop as we learn more about Trump’s intentions and who he will choose to help him pursue those goals. In other words, uncertainty may remain high in the near term.
From what Trump has spoken about in his policy proposals we are likely to see an increase in infrastructure spending. He has repeatedly cited the need to improve roads, bridges and other infrastructure in the U.S., calling for a “trillion dollar rebuilding plan.” This should bode well for Capital Goods and Materials stocks levered to infrastructure. His anti-terrorism stance will also have positive implications for Defense stocks.
Another centerpiece of his campaign was a call for rollbacks on regulations. Pharmaceutical and biotech stocks may see some benefit here if we see reduced regulation on drug price inflation. Financials may also see some benefit here with declining regulatory scrutiny under a Trump Presidency, and the potential for a repeal of Dodd-Frank and limitation on additional financial market obstacles.
Trump’s America First energy plan will likely boost energy stocks as his administration expands domestic drilling efforts. Coal companies may also benefit from reduced environmental regulation. However, if natural gas exports to Mexico are banned, gas exporters could face headwinds.
With regards to trade, here there may be cause for concern. Trump’s anti-trade rhetoric may weigh on foreign trade partners and stocks that are levered to trade with the U.S. as well as U.S. multinationals. The poster child for this concern has been the Mexican Peso which has been exceptionally weak since Trump first won the Republican primaries.
In particular, Mexico, Eastern Europe and potentially China and Japan could see some fallout if Trump follows through on his threats to nix the North American Free Trade Agreement and the Trans Pacific Partnership.
Considerations for Investors
For investors, this is not the time to be over-trading. For at least the next week after the election, we are likely to experience fast markets on exceptionally high volume. Volatility will be elevated as risk is taken down and hedges are removed. Beyond that, focus should return to both company and macro fundamentals, which are improving. And as we mentioned, investors should keep an eye on Pharma/Biotech, Financials, Materials, Energy and Industrials in particular for buying opportunities
International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.
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Investing in currency involves additional special risks such as credit, interest rate fluctuations, derivative investment risk, and domestic and foreign inflation rates, which can be volatile and may be less liquid than other securities and more sensitive to the effect of varied economic conditions. In addition, international investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.
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