It is only a few weeks since Donald Trump became president-elect, but the period before the US election almost feels like another era. With Trump’s election, political and economic orthodoxy appear to have been turned on their heads. A combination of tax reform, fiscal stimulus and de-regulation are a heady cocktail when combined with a Federal Reserve policy stance geared to ‘running the economy hot’.
Going into the election we took the view that should Trump win there would be a short term re-pricing of risk assets, reflecting the higher risk premia required by uncertainty over his views on protectionism and international trade, but after that we would see a strong performance from US equities. What surprised us was this process took only a few short hours, with Trump’s reflationary policies garnering centre stage.
Easier fiscal policy combined with plentiful credit is a powerful combination and US equities have responded strongly. The rally in the dollar has caused the more domestically-focused US companies to outperform and the rise in bond yields has been a catalyst for cyclicals to outperform defensives (bond proxies), reversing the trend of recent years.
Elsewhere, emerging market and Asian equities have put in a mixed performance, reflecting better fundamentals on the one hand and dollar strength on the other. Japanese equities have performed well, reflecting yen weakness which has significantly boosted corporate earnings estimates and prompted investors to focus on the region’s relatively attractive valuations.
Given the shift in policy emphasis, bonds in all regions and sectors have, understandably been on the back foot. However, inflation-protected securities have significantly outperformed their nominal counterparts, as much of the rise in yields has reflected rising inflation expectations.
Looking into 2017, we expect the rise in developed economy inflation to exceed policy rates. This should provide support for inflation-protected bonds and ensure they continue to do well versus nominals. Elsewhere, we still expect corporate bonds to outperform, though we need to keep an eye on whether we are entering a stage of the cycle where corporates feel emboldened to releverage to support M&A activity.
The current environment has generally been positive for relative value absolute return strategies and we retain a core holding in funds which can add value in a relatively market-neutral framework.
We have not seen fit to change our already well-diversified asset allocation. We feel it stands to benefit from the theme of asset price reflation, with the Anglo-Saxon economies leading the way.
We may increase our US equity exposure further, but markets feel extended at current levels. Asia and EM have been a source of volatility for us, but we feel the dollar rally has so far been a benign adjustment and we have capacity to add to this position.
Jon Cunliffe is CIO at Charles Stanley.