Like many people, my knowledge of US politics is driven somewhat by the excellent TV series The West Wing. While watching Donald Trump’s victory speech, it certainly felt like another Netflix blockbuster coming to a climactic end. Unfortunately, we need to pinch ourselves as the new series is just beginning.
When Trump states he wants to “make America great again”, he needs to add “at the expense of the rest of the world”. By stealing growth via trade barriers, for example, he is trying to undertake reshoring, or import substitution, to the benefit of US citizens. Understandably, emerging market currencies and equities have sold off.
I am not convinced the world will grow faster under Trump. More likely, it will grow less fast but heavily skewed towards the US and away from both Europe and Asia.
The markets are discounting the future but some of the moves seem quite heroic to an old sceptic like me. Longer-maturity bonds have sold over‑aggressively into this “regime change” as term premiums and inflation expectations are built back into curves. The popular expensive defensive equities have been sold in favour of banks and “wall building” cement makers.
We have had huge sympathy for many years with the lower-for-longer thesis. However, after February’s China growth shock and oil price slump, it had become somewhat consensual. The deflationists leapt on the lower oil price and “headline” consumer price index, ignoring core CPI, which was not doing much. Post-oil price rally of late summer, it was the turn of reflationists, who also leapt on the oil price and headline inflation number, again ignoring core CPI.
For a month or so pre-Trump, the equity market was rotating to value, cyclical and financial stocks at the expense of bonds. We were fairly dismissive but Trump changed this. Nobody can tell whether this is a regime change or not but, for now, the market has bought the regime change, so we are not fighting it.
A good manager accepts the situation and recuts his cloth. We have reduced interest rate sensitivity materially as the outlook for bonds looks worse, with the possibility of stagflation. The outlook for US equities looks better but arguably worse for emerging markets and Europe.
In six months or so, we should have a better idea. We may be living in some Trump-utopian dream, or be back to secular stagnation with extra stagflation on the top. Additionally, European growth and political instability is a constant worry. This axis has worsened post-Trump.
A good, bad or maverick Trump?
We seem to be heading towards a sub-optimal place for bond investors. We expect a little more growth and inflation for the US, and higher bond yields in the short term. We have been both amazed and appalled at the extra growth forecasts most economists and strategists have presented. Most suggest extra growth of 0.3 per cent to 0.5 per cent for a year or two, whether under good, bad or maverick Trump. All expect a similar pick-up in inflation.
We find these forecasts underwhelming. Why? The fiscal/infrastructure gain may be hard to implement and may be overemphasised. Fiscal multipliers tend to be high in recessions but not with low unemployment. The US has structural unemployment in Republican Rust Belt states, not mass deficient unemployment. In addition, tax cuts are leakages on the system and have low multiplier effects.
It is debatable how much the Republican Congress will allow Trump to do. The bond sell‑off and the strength of the dollar will tighten financial conditions as well. In addition, the illegal alien repatriation proposal, and, most importantly , his trade policies, could be hugely counterproductive. This will put up import prices, which will act as a tax on consumers and raise prices: the wrong sort of inflation.
Going forward we like loans, being senior secured and floating rate, as well as large‑cap, non‑cyclical domestic-facing US high yield bonds with short durations. We like “reason to exist” large franchise banks in the US and the UK and dislike emerging markets, the periphery of Europe and European investment grade corporate bonds.
Do not be a hero and let the carry do the hard work. In six months’ time bond yields could well be higher, which may present an opportunity to extend duration, assuming the Apprentice’s honeymoon period has faded.
John Pattullo is co-head of strategic fixed income at Henderson Global Investors