US elections: Strong stomachs needed
Amid the market’s Wall of Worry surrounding Trump and Brexit, strong stomachs and close attention to market developments are key to successful strategic positioning.
We start the working week in a new world of Trump. At best, investors are complacent, at worst, they are suicidal, with not many shades of grey in between. Which way do we turn, tin hats on or raise your head above the parapet? We need to think very carefully but also be careful not to overthink the various scenarios into Armageddon.
The key to successful forecasting and investment strategic positioning is not so much arriving at the outcome, but much more the anticipated travelling along the way. For example, it is impossible for us to forecast the true implications of Brexit and what the final deal will look like. At the moment, markets are sanguine but a little nervous which is introducing a discount into potentially affected businesses. This will evolve over time and if a hard Brexit becomes more likely, then this discount will get bigger and so on. The skill is in working out how the markets will interpret the developments, rather than the final outcome itself.
Communications between ourselves and the EU have not been especially cordial since the Brexit vote and Theresa May is taking a tough stance, almost as if she had been a Brexit supporter in the first place. This is most likely because she views this as the mood of the majority of UK voters and is therefore positioning for the best possible outcome by demanding the impossible, from which point, concessions and compromise will evolve into the final deal. Unfortunately this approach isn’t cutting much ice in Brussels and is being met with a frosty response from Messrs. Junker and Tusk as well as some acerbic comments from French and German ministers. The outcome of the US election and the glory basking weekend snaps from Nigel Farage in Trump Tower has probably annoyed the Eurocrats in Brussels significantly more after his MEP outbursts in the European Parliament. He is single-handedly stoking up global political turmoil – you have to admire the tenacity even if his politics turn your stomach.
Let’s park Brexit and the Supreme Court issue to one side for now, as it is unlikely that the UK Parliament will vote down Brexit, even if they are given the chance and we won’t know any more until well into 2017. What are the key global risks that we should focus on to determine whether we want equities, bonds, alternatives, cash or Gold for the foreseeable future?
The main reason the markets took last week in their stride was the conciliatory speech that Trump made on his victory – the populist rhetoric and barnstorming was gone and he has engaged reverse gear with his foot to the floor. However, he can only go so far before he hits the wall of his supporters who will rampage against him if he goes much further. There is the potential for civil unrest here which should not be underestimated due to the strength of feeling and the degree of polarisation. His political naivety and lack of experience may trip him up via an ill-judged tweet but hopefully his advisers are taking over to prevent revolution.
Of far more importance than the personality traits are the anticipated policy changes and what he will still proceed with. It looks like Hillary Clinton will remain a free woman and the Mexican wall will be an upgrade to the existing fence – these are minor issues for UK based investors looking from afar. He has pledged to return jobs to the US that have gone to China and that can only be achieved through protectionist policies which will start a trade war. We would therefore view this key pre-election pledge as sacrosanct and therefore any businesses and countries that are connected to this are vulnerable. That said, how much does the US export to China for the Chinese to retaliate to any significant degree? He will still have to convince a Republican Congress that free international markets have gone too far and it is time to look after Uncle Sam.
This is in effect the same issue that drove the Brexit vote. UK jobs for UK citizens and a cessation in the growth in foreign outsourcing and immigration, so-called looking after John Bull. This mood must also be waiting to make its voice heard in the EU as the voters have a lot more to rebel against having endured significantly weaker economic growth since 2008 with persistently high unemployment and a lot more immigration. So whilst Trump unleashing a trade war is one risk which will inevitably lead to lower global growth and inflation, as tariffs are imposed or higher cost US labour reintroduced, the bigger risk could be a populist revolution in Europe along similar lines. At stake is the future of the Eurozone which has echoes of that which occurred in Greece in 2015 which is still unresolved and limping along.
Thinking this through leads one to focus on the Italian Referendum on 4 December 2016 and what that could mean for the EU should Prime Minister Renzi lose the vote. He threatened to resign earlier in his premiership when he was riding a wave of popularity if he lost. He would now appear to be regretting this pledge as the vote is looking neck-and-neck. If he does lose, it is now debatable whether he would resign due to the implications as this would plunge Italy into constitutional crisis with the EU. The leader of the opposition recently met with Donald Trump and is stoking up the populist vote.
This would be a major market event but we need to be careful before hitting the panic button. The markets know all this not forgetting the fact that most Europeans want the Euro, including the Greeks, as to revert back to their national currency would be disastrous in terms of economic status and relative wealth. The UK has just become approximately 20% poorer on a purchasing power parity basis relative to the rest of the world following Brexit and the fall in Sterling. If Italy readopted the Lira, it would collapse relative to the Euro. Those that call for the end of the Eurozone really don’t understand what they are wishing for. There is no going back from here. What needs to happen is reform from the centre but the incumbent unelected bureaucrats aren’t listening and appear steadfastly stubborn in their statements, which only serves to harden the resolve of the objectors.
Quite where this will end and what will transpire is difficult to determine. Even if Renzi wins his vote, there are more elections next year in France, Holland and Germany giving ample opportunity for the populist vote to disturb the status quo. Sitting in cash until then is not an option for most investors and certainly not for ourselves. The most attractive asset classes are looking like infrastructure and anything construction related as we anticipate a tilt towards fiscal expansion and away from monetary policy from the Autumn Statement. This is similar in the US and will create jobs and economic growth, one key reason to remain invested in equities. Bonds are looking vulnerable as inflation inevitably picks up but many have been underweight for some time, including us, so no need to adjust there. The ruling Europeans are worried and will have to shift their position but are unlikely to even consider doing so until there is a crisis.
We often talk about the Wall of Worry being good for progress in markets. At the moment the wall feels very high indeed and only the lack of viable alternatives is sustaining equity market support. Strong stomachs are required over the next few weeks and months as the world goes through this populist revolution.
Guy Stephens, managing director at Rowan Dartington Signature