Sunday 17 December 2017

Trump is casting a shadow over world markets

Donald Trump. Photo: AP
Donald Trump. Photo: AP

Tom McCabe

Just as Trump Tower looms over the Manhattan skyline, the recent election of Donald Trump as US president also threatens to overshadow everything else on the horizon for investors. His victory poses big questions for investors, especially coming hot on the heels of the Brexit vote.

In the immediate aftermath of the election, investors drove equities and cyclical stocks higher in anticipation of a massive US stimulus package, which also pushed global bond yields sharply higher by accelerating inflation.

Even in the absence of any stimulus policy from Mr Trump, the trajectory for the global economy looked to be improving as we approached year end. US economic growth, which weakened in the first half of 2016, should improve as business investment bottoms out following the collapse in oil-related spending.

Growth in Europe could slow slightly as businesses and consumers digest the implications of Brexit, although generally we believe the creeping recovery over the past few years should continue.

Elsewhere, we expect the structural slowdown in China to continue, but a hard landing seems unlikely.

Conditions in emerging markets are stabilising, helped by firming commodity prices.

How much extra Mr Trump's stimulus policies add to US growth in 2017 and 2018 really depends on the size of any tax cut and spending package announced.

We think his original stimulus package could be watered down by the time it happens, not least because the US budget deficit is already forecast at 3.1pc for 2017, according to the Congressional budget office in the US.

In the near term, Mr Trump's stimulus package should help US growth. His global impact depends on how much he then follows through on his protectionist rhetoric, a key theme of his election campaign.

In our view, a shift towards protectionism is a negative for long-term global economic growth and could possibly even outweigh the impact of stronger shorter-term US growth, particularly when one considers how increasingly dependent the global economy is on the emerging economies.

Government bond investors have been some of the most notable losers so far from Mr Trump's election. However, we struggle with the notion his election marks a seismic turning point for inflation.

US inflation data in October indicated only three of the 10 broad categories of items saw their prices rise by more than 2pc over the past year. Pricing pressures don't appear widespread in the developed economies.

However, the base effects from the collapse in oil prices will fall out of inflation calculations in early 2017, so the headline inflation rate should accelerate.

This, combined with expansionary budget policies in 2017, could harden the resolve of the US Fed to raise interest rates at least twice.

Taken altogether, these factors point to an uncertain year for government bond investors, one where returns could be very low or slightly negative depending on the see-sawing of fiscal and monetary policy.

In the stock markets, the slowly improving world economy should help profits, firmer oil prices and steeper yield curves will boost the energy and financial sectors.

In our view, this resumption of profit growth should be the catalyst for mid to high single digit stock market returns.

Although currencies are notoriously difficult to forecast, we think the dollar may creep closer to parity versus the euro over the next 12 months. Sterling will likely remain mired in Brexit uncertainty, making short-term forecasts even more difficult. In our view, sterling is more likely to weaken versus the euro. However, we think it is unlikely to reach parity versus the euro.

Oil prices will benefit from Opec's proposed production cut, assuming producers comply with it, while uncertainty around US foreign policy under Mr Trump could also push prices higher.

Investor uncertainty also helps the case for gold, though this could be countered if US inflation surprises to the upside or if the Fed turns more hawkish on interest rates.

As with 2016, 2017 promises to be a year where risk assets like equities, corporate bonds and commercial property can grind higher, outperforming cash deposits or government bonds.

However, markets also experienced some significant episodes of volatility in 2016 and the arrival of president Trump adds yet another layer of complexity to an already confusing environment for investors.

The next few months will also see a French presidential election and other votes that will create pockets of uncertainty in the eurozone.

So while portfolio diversification is always important for any long-term investor, its benefits could be even more tangible in 2017.

Tom McCabe is global investment strategist at Bank of Ireland Private Banking.

Irish Independent

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