Trump’s win – another round but a worse hangover

It’s been an interesting few weeks, during and following the US elections, with Trump surprising most by winning. The volatility of the futures market was something to witness, as Equities sold down and gold rallied, as investors priced in the uncertainty and then, as the win was confirmed, reversed. Not only did they reverse, but Equities have continued to move higher since, whilst Gold has sold down.

The key driver of the positive move in Equities, is the expectation that Trump will reduce taxes and increase fiscal spending, driving growth higher.

The USD has also rallied, a continuation of the USD bull. While the USD had initially benefitted by relative policy tightness, with other central banks in easing mode, it is now benefitting from the expectation of stronger growth. We have been USD bulls for some time and this is working nicely for us. We expect this trade has further to go.

Has Trump’s victory significantly changed our market outlook? 

Not really – we had expected a number of developed market governments to start increasing fiscal spend, but had expected this to come further out, driven by an economic slowdown. So, growth and inflation in the USA are likely to be slightly higher than had been expected. This aside, our expectation of the end game has not really changed. If anything, the eventual and inevitable bust will potentially be that much worse.

Trump’s win and the expectation that the fiscal deficit will widen, has put severe upward pressure on yields. It is thus very likely that he, while knowing that the Fed has created a massive bubble already, will press on their ‘independence’ to return to increased purchases of government debt to keep yields low. Hence, the eventual economic/market event will be that much larger, when the game of confidence is eventually lost by the central bank(s).

In summary this analyst’s market views are: 

• Trump’s policies to positively impact US growth
• Stronger USD – driven now by relative strong growth
• A weaker RMB against the USD – as China’s economy continues to slow. Any trade tariffs imposed by the Trump government will certainly not help.
• Weak/flat commodities – due to the strong USD. While commodities will benefit from US infrastructure build-out, China is still by far the largest driver of commodity prices.
• Weak/flat gold – driven by a stronger USD and a stronger USD/JPY. Furthermore, as rates and yields pick up on the margin, the opportunity cost of holding gold increases. Watch out also for policy decisions coming out of India, regards imports of the precious metal.
• Weak Emerging markets – due to weaker commodities and China and a stronger USD. Trade tariffs will also hurt China and thus spill into EM. Strong USD will negatively impact those economies with USD debt.

How would this analyst invest in the current environment?:

• US equities expensive and overdone – so remain UW. May be opportunities to benefit from sector rotation.
• EU and Japan offer the best opportunity in terms of value – so would look to add to Japan as relatively less well covered market and ability to add alpha is greatest.
• Treasuries – while UW fixed income overall, would look to have a disproportionate allocation to Treasuries. So would look to add on weakness on the expectation that yields may have lower to go, until the bull market in FI is truly over.
• Commodities: prefer to trade these and benefit from any increase in volatility, than hold long term.
• Gold: remain hedged, using a short Yen position, but would look to add on significant weakness.
• Alternatives – preferred to taking exposure to hedge funds than long beta exposure. There are plenty of great managers out there that can generate strong returns, or at least protect capital, in what is likely to be an increasingly volatile environment.

Conclusion:

While the increased fiscal spend in the USA and Japan may extend the current cycle further, the eventual bust will, in this analyst’s opinion, simply be that much greater.

As Central Banks become the only real buyer of gov paper due to financial repression, the markets and the economy will increasingly grow to rely on it fully. If we not there yet, we are certainly close to this point and the ability of the Central Bank’s to pull back from printing, is increasingly diminishing.

The end game is either hyperinflation or deflation. The middle path of normalisation is increasingly narrow. 

Hyperinflation – as the underlying market becomes increasingly reliant on ‘money printing’, it becomes increasingly difficult for the central bank to pull back and tighten money supply. The market and currency may react positively in the initially stages but eventually, as inflation takes hold and confidence in the CBs ability to manage the economy is lost, FX debasement and hyperinflation become increasingly more likely. 

Alternatively, if the CBs do wake up and put a hold on QE policies, the USA and much of the world with it will suffer a 1930s style of deflation. Negative deposit rates may be the catalyst here for the run on the banks, as depositors fear being bailed in and/or paying to hold their cash at the bank.

Gold will do well in either of these outcomes. Hence my view that owning some gold is prudent, adding when there are severe sell offs but similarly hedging the exposure when the trend reverses.