The Global Investment Committee met this morning to gauge the effect of the US election outcome on financial markets. The committee believes that market volatility will return to more normal levels and that economic fundamentals and expected policies remain favourable for risky assets, such as stocks and commodities.
Beginning of a new era
We expect Donald Trump’s election to define a new era in US politics. After a campaign filled with exaggerations, we now expect the reality of policy definition to dominate headlines in the coming months leading to the State of the Union Speech, at the end of January.
Risks and also opportunities
A Trump administration may increase market risks in the short term, but opportunities will also arise, as the relationship between the US and the world is redefined more in favour of the US. We believe that international risks will increase the most, related, for example, to trade and foreign policy issues. Nonetheless, after the initial market reaction has faded, investor focus should return to the fundamentals driving the economy.
Fundamentals to stabilize market volatility
Market volatility, which had been rising, should abate, as the market adjusts to the news of a Trump presidency. Our view is for a return to more normal market conditions during the last months of the year. Even during the campaign, market focus had begun to return to fundamentals. And fundamentals are in good shape, in terms of both macroeconomic expectations and company earnings inside and outside the US. Manufacturing is also showing signs of picking up around the world, supporting a modest but sustained economic recovery. The strong fundamentals should provide stability while the election results are digested by market participants.
A new set of policies to support growth
While the day after an election is too early to predict the course of a presidency and its impact on markets, there are already a few broad indicators regarding the direction of the new administration. Trump’s key policies focus on immigration, taxes and trade. Economic growth and a pro-business agenda are also expected to be emphasized, with increased fiscal stimulus, focusing on infrastructure and energy, and lower taxes. We expect policies in these areas may provide additional momentum for corporate earnings growth in 2017.
Eventual stabilisation in markets
World equity markets reacted strongly to the Trump victory with higher than usual volatility. We expect volatility to continue for a few days, with spillover to other markets around the world. But as soon as clarity emerges on effective policies, and the underlying economic fundamentals and mitigating factors are evaluated, the market volatility should stabilize close to historical levels.
Equities to regain poise
In the days and weeks to come, the US stock market will likely lead the direction of global markets, given that the impetus for change is emanating from the US. Another point of attention in the coming days and weeks will be emerging markets, which are the target of possible trade negotiations. Large sector rotation within the equity markets can be expected. For example, the industrials sector may come into favour if infrastructure spending is increased. It will not be immediate, however, and must first be defined by concrete policy measures.
In reaction to market volatility, stabilising measures from policymakers and central bankers can be expected. Once volatility subsides, equity markets could represent an opportunity for clients who are underexposed to stocks.
The sectors that we are most positive toward are information technology and health care, where medium-term innovation and demographic trends remain supportive. The recent correction in health care stocks has also made them more attractive.
US Treasuries at risk
Policy uncertainty under President Trump will continue to create upside pressure on US Treasury yields, also considering that the risk is inside the US and that a strong emphasis on public spending and lower taxes can lead to large fiscal deficits in the years to come and a large issuance of government bonds. In addition, an isolationist stance may reduce the willingness to finance the US by large creditor countries. A higher risk premium is to be expected for US Treasuries versus German, Japanese and other core government bonds, together with a steeper yield curve in the US. Persistence in financial market volatility could restrain the Federal Reserve from raising rates in December.
Higher volatility in currency markets in the short term
The redefinition of the role of the US in the economic and political world order could lead to higher currency volatility at times of regional tensions, as the balance of economic and political power between the big blocks will be less stable. But the policy differences between the big economic blocks will remain a strong driver of currency markets with the growing influence of fiscal policy differences and monetary policies to stabilise markets.