It is hard to overstate the momentousness of the events that last week led to the election of Washington outsider and business tycoon Donald Trump, as 45th president of the United States.
Keep in mind this is a man who had never run for public office, who spent the entire nine-month campaign with an implacably hostile line towards the Washington establishment and who positioned himself pointedly as a champion of the poor, openly hostile to globalisation and to immigration and alleged publicly that his Democrat rival Hillary Clinton was a criminal and should be in jail.
And yet he won by a comfortable margin in the electoral college by 290 votes to 232.
He promised Brexit x10 and this is what we’ve got.
Students of history have likened it to outsider Andrew Jackson’s win of 1824 or Ronald Reagan’s win of 1980. Others worry over a Hoover like “protectionist” type echo of the 1930’s ahead.
And for UK based investors the Trump win eclipses the UK vote to leave the EU by some margin in terms of importance and is likely to have major ramifications for investors.
Indeed these have already begun.
In the days since Donald Trump was elected, the S&P 500 had its biggest one day rise since 2013, 10 year bonds their biggest fall in three years and benchmark industrial commodities like copper soared on the hope for the stated $1 trillion infrastructure boom.
Meanwhile the US $ has hit a twelve year high and emerging market bond and equities slumped.
All in the space of a week!
As with the case of the vote to leave the EU here in the UK, voters chose to blow a large raspberry at the establishment and vote for change on a seismic scale.
And while it’ s too early to draw definitive conclusions about much of the new administration’s agenda ahead of the new president’s inauguration on 20 January 2017 and while many of the high profile/more extreme policies will be watered down (Mexican wall, scrapping of Obamacare, building 100 new warships) nevertheless the direction of travel is clear and encompasses several key features.
Internationally, the resurgence of the nationalist “right” can be seen as part of a pattern whereby electorates, via the June UK vote to leave the EU, vote for populist parties in Austria, France, Germany and Italy and the appeal of Putin in Russia despite an ongoing and persistent recession, are all manifestations of a deep unease among populations who feel increasingly alienated by out of touch leaders, wealthy corporations and the seemingly unstoppable rise of China.
Our view here at PAM has been stressed repeatedly in 2016 that the investment landscape was turning. The 30-year bull market in bonds was peaking, a decade of deflation was coming to an end, globalisation was running into trouble and threatened by populist forces and we had positioned portfolios accordingly, overweighting infrastructure and real assets to give as much protection against emerging inflationary forces as we practically could.
Much of this we have done already (please see Q3 PAM strategy attached) but given investment is all about constantly challenging assumptions, recognising errors and balancing probabilities to emerge with the most favourable outcome, it’s worth asking several important questions at this juncture to ensure our stance is validated and portfolio positioning correct.
- Is Trump’s win the start of a new wave of protectionism?
Of Trump’s many thousands of statements during the election campaign, among the most consistent have been his strident criticism of the impact of globalisation and its, in his view, damaging impact on the lives of American people.
His “America first” message has been clear, consistent and rammed home over and over again.
He said the word “China” 24,469 times on the ‘stump’ nearly always with negative connotation and it was apparent he was tapping into a deep sense of unease among a workforce worried by jobs “outsourced” to lower cost manufacturing offshore.
First casualty is likely to be the US led initiative Trans Pacific Partnership (TPP) whereby Barrack Obama has spent eight painstaking years stitching a deal with 12 countries in Asia excluding Japan.
This is more likely to be “RIP” as Obama kicks it in to the long grass, victim of the president-elect’s antagonisms towards any Asian mercantilist threat.
The North American Free trade Agreement, NAFTA, will almost certainly be reformed and it will hurt Mexico, if not Canada so much.
Meanwhile the Transatlantic trade agreement (TTIP) between the United States and the European Union will also have to hit the “pause” button at the very least into 2017 and probably beyond.
- What will happen to the US dollar?
We have been bullish at PAM all year in 2016 on the US$.
We have swept any outstanding cash balances (usually up to 20% of portfolios in such a volatile year as this one has been) and ahead of the UK vote on EU membership we had hedged all our sterling in the multi asset portfolios (non-Cautious) at US$1.60.
The threat from “Brexit”, the large quantity of US$ commercial debt in issuance, and the still parlous state of the Eurozone and Japanese financial systems has made it hard to be negative on the US$ and Trump’s win exaggerates this effect.
However, this has gone a long way by now, with trade weighted dollar at a 12 year high and ideas that a Reagan-ite US$ surge to £1:1, € parity and JPY200 should be treated with caution given the still large current account and budget deficits in the US.
- What will happen to interest rates and government bonds?
We continue to be extremely cautious on government bonds.
While we believe strongly that bonds have a place in any diversified portfolio, government bonds had become overbought and overvalued in H1 2016 and we went to zero weight in portfolios wherever we could.
While we don’t buy the apocalyptic slant of the bears that inflationary pressure will force yields to 4% we have become cautious this year.
Yields had turned negative by mid-year in $12 trillion worth of government bonds with Germany and Japanese investors penalised most and this has become an unsustainable situation. Yields are now higher than at start of the year with US 10 year yields touching 2.5% on the expansionary Trump plans.
We remain selectively very positive on corporate bonds.
You can still get 6% on BB rated bonds issued by large corporates with strong businesses like French glass packaging group VERALLIA, French paints manufacturer or CROMOLOGY and UK builder BALFOUR BEATTY, so just under investment grade, which we believe is good value.
- What is the outlook for equity markets?
We are cautious on quoted equities in the short term and medium term, more positive longer term.
We have sold all our UK equity positions that performed well post Brexit with average profit taken 30% in BAE, BP, BHP, BURBERRY, FRESNILLO, HSBC, ROLLS and SMITHS.
We believe Trump’s actions will penalise multi-nationals, large technology companies and global consumer companies that have been beneficiaries of globalisation and whose threat to their profitability if not their business models is real and non-trivial.
We are particularly negative on the FANGS (FACEBOOK, AMAZON, NETFLIX and GOOGLE) as well as global consumer companies, whose supra normal profit margins will come under pressure in the next few years in our view and whose valuations are extremely high on a historical basis.
We continue to be bullish however on certain targeted sectors such as defence and aerospace- ex US, Trump’s threat to cut the US contribution to NATO is real and logical. The US contributes 70% of NATO spend currently-Industrials-investment in fixed assets at a 25 year low in the west-Infrastructure-related to this the infrastructure is poor both in the US and the UK.
We were already overweight these asset classes (please see Q3 strategy attached) but we have further boosted allocations as a result of the president elect’s clear commitment to driving infrastructure programmes revitalising US industry and replenishing capital stock.
Valuations remain at generational highs in the important US equity market (54% of MSCI World) Cyclically adjusted price earnings (CAPE) ratios are at 21x which seems high to us.
*Source: Bank Credit Analyst (BCA)
They provide little in the way of jobs for Americans, they hide large amounts of money offshore so no good to the US treasury and manufacture mostly in countries like China and Vietnam.
Far better in our view to be invested in specialty engineering, value adding building materials, specialty chemicals and other niches where the national push to create jobs will be most pronounced and where the most money will be invested.
- What will happen to commodities?
We remain extremely positive on the outlook for commodities.
The CRB index is turning up from a ten-year low, quality stocks of good quality deposits are getting harder to replace and quality crop acreage harder to harvest in scale.
Coal, zinc and nickel are all in confirmed bull markets and copper has joined them this week rising 12 days in a row on the Trump infrastructure pledges.
Commodity equity is significantly undervalued in our view. For example some of the highest quality gold assets in the world are generally available for a price not much greater than 50% of book (KINROSS, YAMANA) while China’s second largest coal producer with all in costs of $100 a ton and life of mine of 50 years (SHOUGANG FUSHAN) can be bought for $3bn or less than the value of its assets. Finally, THARISA, the world’s leading supplier of chrome and major producer of platinum can be bought for a price earnings ratio of 3x.
Broadening this theme out wider, shipping and rig building stocks known well to us, PRECIOUS SHIPPING in container shipping in Asean and SEMBCORP MARINE in Singapore. Managements of both we have met several times, SEMBCORP most recently in July and
Donald Trump has been a cheerleader for the coal industry and has furthermore questioned the value of the large scale shift in power generation from hydrocarbons to renewable forms of energy production.
His pledge to back out of international agreements to limit carbon emissions we believe is significant and America is likely to join China, India and Russia in a more relaxed attitude to investment in coal and nuclear energy which even today still account for over 50% of global generation baseload.
- Should investors increase their exposure to infrastructure?
Allied to this we believe the message to rebuild America infrastructure is not only credible but both broadly deliverable and because it us very much needed (try getting through O’Hare or taking the Amtrak service from Boston to NY?) this policy will be accepted with open arms by Congress when proposed by the new President in 2017.
Shovel ready projects to build new airports, bridges, hospitals, schools roads and tunnels are all part of a mooted $1 trillion plan over the four-year life of the new administration and will add alone up to 1% a year of GDP.
And it’s not just in the UK that creaking infrastructure need to be replaced. Amid all the brouhaha over Brexit, PM Theresa May’s new slogan “We’re all builders now” means the stocks of companies like BALFOUR BEATTY and BREEDON AGGREGATES are likely to be at the forefront of a new civil engineering boom nuclear power plants.
US spending on fixed assets at 2.9% of GDP is at its lowest for 50 years and the infrastructure is by general agreement not adequate to meet the demands of a modern day first world economy.
Funding will also almost certainly be found via the deep rooted municipality bond markets and if necessary a Fannie Mae Freddie Mac arrangement similar to that in private sector housing since the 1970’s. (though with safeguards to avoid the conclusion that befell them in 2008).
We believe Trump’s win is extremely positive for the engineering sector both in America and globally.
Investment in plant and equipment is at a generational low and high quality engineers are trading at a fraction of their intrinsic worth in our view.
As countries and western societies move to repair clapped out stock like GKN, PARKER HANNIFIN, MORGAN ADVANCED MATERIALS.
*Source: Bank Credit Analyst (BCA)
- Should investors increase their exposure to defence?
A key perception of Donald Trump’s programme has been to increase defence spending to counter a perceived threat from enemies such as Russia, ISIS and North Korea.
However contrary to media consensus, his proclamations on defence have been more nuanced. While it’s true he has complained about the cuts in the Obama administration’s defence budget to below 3% of GDP and while it’s also true building warships is a major source of jobs his attitude to the situation in tbe middle east and Russia has been more placatory and we believe realpolitik will encourage the new Trump administration towards common interests at least for now. So we would not overweight the big defence stocks in the States.
The picture in Europe and Asia is more pointed however. In Europe’s case The Trump pledge to reduce America’s funding to NATO (currently 70%) has teeth we believe, while in the case of Asia we do believe also defence spending is on the rise.
But we have sold BAE and bought FINMECCANICA…
The management of FINMECCANICA is known well to us…it is Italy’s largest defence company (a key supplier to the UK MOD via its ownership of global helicopter group. We would also look at Asian defence and engineering stocks COMEC.
- What is the likely impact on the financial services industry stocks
We remain cautious on financial services of both equities and bonds.
The market has become more positive, or at least less negative, since Trump’s win, but the Dodd Frank act of 2010 was particularly draconian in terms of imposing conditions on banks and insurers and their profitability targets and capital requirement. It’s true that nim (net interest margin) will benefit potentially from improved spreads via higher bond yields
And it means in our view that banks especially will continue to struggle to hit their return on equity targets of higher than their cost of funding for many years. A ceiling of 10% ROE, a cap on dividends and further balance sheet, capital raising does not make for great business in our view.
- What is the likely impact on healthcare
The introduction of what has become known as “Obamacare” the sweeping move to universal healthcare as advocated by the new Democratic administration in 2008 has been successful but extremely costly.
American healthcare spending is now a staggering 16% of GDP or double the global average. Even allowing for the fact that America is a wealthy first world country we believe the country will have no choice but to rein in its spend on healthcare.
Despite the bounce post Hillary Clinton’s defeat we would fade this and are significantly underweight the sector.
- What are the likely longer term consequences for financial markets?
Perhaps the most interesting observation about the liberal western media’s commentary on a Trump presidency is how vacuous much of it is. It ranges from ill-informed criticism of his policies to cynicism that he won’t be able to get his programme through Congress to generalised hysteria that he’s unhinged and could plunge us into World War 3.
It would behove many of these so called experts and amateur scribblers to read what he writes and listen to what he says before embarking on their bouts of outraged panic.
At PAM so far in 2016 we believe we have grappled with the seismic events of Brexit and now Trump.
We have not been dogmatic in our stance but have needed to be pragmatic in such a difficult year by hedging our sterling and buying a decent portion of UK exporters and dollar earners that would benefit from Brexit.
When UK voters voted to leave the European Union on 23 June 2016 it was seen as a snub to the establishment in Europe but within the context of the global economy a mini tremor on the Geiger scale and was generally brushed off outside the UK.
However Donald Trump’s election as 45th President of the United States is a seminal moment for global financial markets we believe. It raises profound challenges to policy makers worldwide throwing down a gauntlet to the established interests that have run western governments since the collapse of communism in the late 1980s.
Indeed it can be argued with some justification that communism’s collapse then, forced at least partially by the policies of a political outsider conservative Republican Ronald Reagan, bears striking similarities to the circumstances of the global polity at that time, except potentially in reverse.
A backlash against the forces of globalisation, a widening and persistent gap between its winners and losers and desire to put “America” first look to have been among the key factors behind Trump’s win.
An anti-Washington message, a consistent line of bringing US jobs back to America and to end offshoring, to rebuild US infrastructure as well as a “pro-growth” and mercantilist economic policy.
The election of Trump, following hard on the heels of the success of the Brexiteers whose stunning defeat of the pro EU UK government in June, is in our view emblematic of the growing disconnect between the establishment and its supporters, indeed it is our view at PAM that it would be no exaggeration to say that the entire post WW2 set of international treaties and institutions painfully negotiated in the wake of the peace between the Treaty of Rome through to Bretton Woods to the IMF and WTO is under threat and may not survive in their current forms.
The sea change will have important consequences for investors globally in their asset allocation and the way investors assess risk and their investments.
It will be important in coming months to analyse developments particularly in France, Germany and Italy where difficult elections and referenda loom, that will also have potentially tricky ramifications for investors ahead.