Trump Cards: What Hand Have Investors Been Dealt?

Trump on economic policy

Thursday, November 17, 2016 wecbcast by Caroline Miller, BCA Research. She made following points:

• Infrastructure program and tax cuts will increase budget deficit
• Tax reduction will not give a lot of bang for the buck compared to government spending programs regarding GDP growth
• Fed pressured by Trump policy to increase rates, leads to USD strength
• Europe needs 3 to 4 years to return to growth, Europe will not match rate increase
• Japan has still low inflation
• China is exporting structural deflation (overcapacity)
• Dollar strength, Trump protectionism will hurt emerging Asia most
• High corporate debt level in emerging markets
• US Equity: no visibility of corporate earnings growth, wild card of Trump appointees
• US protectionism and backlash are a threat to growth
• US deficit will steepen yield curve
• Trump tax program will benefit small caps not multinationals

Investment recommendations:

• Underweight of duration in US bonds, preference of TIPS
• Underweight of peripheral european bonds
• Overweight of USD vs. EUR
• Overweight in pharma, staples, utilities (defensive stocks)
• Underweight in tech, industrials and commodities (cyclical stocks)
• Underweight in US vs. European equities: strong USD will hamper US profits. Profit margins are very high in the US historically and compared to Europe. They can't grow on that level

We have entered a new economic environment in the US.

BCA November Forecast

Latest Forecast from BCA:

• The monetary tailwind for global equity prices is strengthening, but the earnings support is weakening.
• It might be necessary to inject more fiscal policy into the mix to rekindle activity.
• Learned behaviors are still supportive of risk assets and more QE in Europe/Japan can be expected.
• Even if the Fed does raise rates in December we doubt more than one or two more will be in the cards.
• Stay neutral on equities, but position defensively and remain long duration in the bond markets.

BCA September Global Market Outlook

Keypoints of BCA Research's latest Report:

• Markets are expecting too much of policymakers who are behind the curve.
• The Fed is unlikely to raise rates in September, given the recent market volatility.
• This is not just a repeat of the 2013 taper tantrum as it reflects very real concerns about global growth.
• Stay neutral on equities, overweight in Japan and Europe and underweight in the emerging markets.
• Further fiscal ease in China and additional exchange rate depreciation would be a game changer for both the emerging market and global view.
• A non-technical recovery, driven by improved perceptions of global growth, could produce a sustainable recovery in high-beta sectors such as Energy, Materials and Industrials.

Outlook Q3 2015 (BCA)

BCA Research has hosted yesterday a webcast and focused on two hot spots of the global economy:

• China: The meltdown of equity prices in the past weeks was dramatic, but stabilized in the last few days and, the market is still up 44% year to date.
  
  Shenzhen Stock Exchange A Shares (ThomsonReuters)
  
  Only a small percentage of the population is invested in the stock market, so the influence on the real economy will be negligible. However, the economy is slowing down because of sinking exports, which is bad for commodity and energy exporters elsewhere. Moreover, commodity exporters are suffering from increased production capacity globally. Thus, stay underweight emerging markets, commodity/energy producers, and other importers to China.
• Greece / Europe: The impact of the Greek economy is of no importance to Europe and much less globally. The real question is: Is Greece an outlier or an omen for bigger problems in the Euro area. So far facts are inconclusive: On the one hand, only Greece suffered a depression and a contraction of nominal GDP of 25% in the last 5 years, which could lead to the conclusion that the tragedy in Greece is an exemption in Europe. On the other hand, one could argue that the high debt in Italy will depress Italy's future growth, because of the austerity measures that will be implemented to bring down debt. With Italy's size this would pose an existential threat to the Euro.

Implication for Asset Allocation:
Small overweight of stocks relative to bonds, and favor developed markets over emerging markets. US equties are expensive relative to European and Japanese stocks. Although Japanese stocks profited from the yen devaluation, the are heavily exposed to China. Furthermore, stay overweight defensives vs. cyclicals because global growth is slowing.

Morgan Stanley Outlook 2015

Morgan Stanley published couple a days ago an investment strategy outlook for 2015:

• The Cycle Has Further to Go: Improving growth, bottoming inflation and supportive central banks are supportive for risky asset classes. They do not see a problem with high valuation in contrast to James Motier of GMO.
• And consequently, they argue "Equities: It Ain’t a Bubble Yet".
• They prefer developed equities over emerging equities. This is in contrast to other researcher who argue that Asia is cheaper than the US, and hence has to outperform.
• FX: significant USD gains.
• Underperformance of long treasury bonds of developed governments because their yield is on a historic low.

The graph below sums it up nicely:

MS Cross Asset Allocation 

Personally, I would be a bit more carefull. High valuations can cause easily accidents, and be neutral on US stocks!

BCA Webcast: Geopolicy and asset allocation

This is a rather technical piece about geopolitics and asset allocation.
On February 19th, 2013, BCA has held a webcast about "Global Asset Allocation/Geopolitical Strategy Forecast":
USA
Less policy risk due to bipartisan collaboration (although politician still make a lot of noise with extreme positions, behind the scene they are compromising). Normalization of interest rates (i.e. rising interest rates from today's super low levels) is not anticipated by markets today, and could cause problems in the future. Rising yields are bad for bonds, equities and gold.
Europe
France's problem (low productivity) is hiding bhind Italy and Spain. The implementation of structural reforms in Italy in Spain is unsure as their governments are very weak (Monti is gone and Rajoy is weakened by accusation of corruption). But GDP  could grow as austerity policies cease and as exports to growing China and USA rise.

Asset Allocation
We are in a liquidity driven bull market, so don't be underweight equities, especially cyclical stocks (keep your beta high). But liquidity rallies tend to turn around quickly. Hedging with puts on equity indices is prudent. Moreover, we are priced for perfection.
Currencies: Every country is trying to strengthen economic growth by weaken their currency (beggar thy neighbour policy). EPS growth will be influenced as well as the value of respective bond positions.

Goldman Sachs very positive for 2011

On January 7th, they wrote in their Global Opportunity Asset Allocator:

• An improved economic outlook
  Globally we expect 4.7% GDP growth in 2011 and 4.9% in 2012. In the US we recently increased our growth forecast to 3.4% in 2011 and 3.8% in 2012. Policy tightening in China and the sovereign situation in Europe are risks to our positive view and likely to cause volatility, but we believe the strong global growth momentum will continue to dominate asset performance.
  
• Reshuffling risk exposure in the near term (1-3 months) …
  On a 1-3 month horizon, we upgrade our small equity Overweight to a full Overweight, downgrade commodities to Neutral, and investment grade corporate credit to Underweight. We are also Underweight government bonds and, with the strongest conviction, cash. The changes reflect improvement in the global growth outlook, commodity prices which after the strong recent performance are close to our near-term forecasts, and the low yields available in both investment grade credit and government bonds. Within equities, we are Overweight US and Japan and Underweight Europe and Asia ex-Japan on a 1-3 months horizon; we reverse this ranking on a twelve-month horizon.
  
• … and maintaining our strong pro-risk 6 to12-month position
  On a 6-12 month horizon our allocation is unchanged. Our highest conviction Overweight is equities, which we expect to benefit from strong earnings growth and attractive valuations. We are also Overweight commodities, where tightening demand/supply balances should support higher prices at this horizon. We are Neutral on corporate credit where we expect a limited, yet positive return for the year. We are Underweight cash, where the return potential is very low. Our biggest Underweight is government bonds, where we expect zero return over this horizon.

Now, that's much more positive than Morgan Stanley. But the biggest contrast is this "Weekly Market Comment" by John P. Hussman titled "Illusory Prosperity" - Ludwig von Mises on Monetary Policy.

He notes: "the Market Climate for stocks continued to be characterized last week by an overvalued, overbought, overbullish, rising-yields syndrome that has historically been very hostile to stocks."