Trump Trade takes a turn

4 min read

So much for the “Trump Trade” – the simultaneous surge in US stocks, Treasury yields and the US dollar that followed the surprise win by Donald Trump in November’s presidential election.

With the Republicans not only winning the White House but taking majorities in both houses of Congress, investors piled aboard an agenda that included promises to cut corporate taxes, loosen tomes of regulations and spend US$1 trillion ($1.3 billion) on infrastructure, generating economic growth and inflation, and creating the conditions for the Federal Reserve to lift rates at an accelerated pace.

After some nervous moments after the Trump win, the stock market took off on a spree that has boosted the S&P 500 index by almost 17%, in nine months. The US 10-year yield shot from just under 1.8% to 2.2%: five weeks after the election, the yield was above 2.6%.

The more globally oriented called it the “reflation trade.” This thesis propounded that the Trump legislative agenda would bring the US economy a helpful pick-up in inflation, and that a rebound in global inflation would push up bond yields, while boosting stocks and commodities.

Investors who were looking for rapid enactment of tax cuts and other fiscal stimulus measures have largely been disappointed as expectations of quick action in 2017 have faded, with the Trump agenda becoming bogged down in Washington realities. Also, the realisation has set in that reflating the world economy is not only a US task.

Chinese economic growth is also a strong driver of global reflation: or more precisely, China’s “credit pulse,” a term coined by PIMCO global strategist Gene Frieda. The credit pulse is the growth rate of aggregate Chinese credit relative to the country's gross domestic product (GDP).

China’s massive credit stimulus starting in 2014 initially put a floor under commodity prices and emerging market (EM) growth. The subsequent unexpected acceleration in Chinese real estate investment drove both commodity prices and volume demand higher: EM growth rates picked up, and sent global trade volumes surging.

In fact, this may be an even larger contributor to global reflation than the promise of fiscal stimulus and deregulation in the US could promise to be – and one that’s actually been doing the job since well before Donald Trump was elected US president.

But what has saved investors in the reflation trade – at least, on the stock market – is improving economic data, and on that back of that, increasing optimism on corporate profits. According to Thomson Reuters I/B/E/S, S&P 500 earnings are expected on average to have grown by 10.8% in the second quarter. In Europe, for the STOXX 600 companies, second quarter earnings are expected to increase 14.2% from the previous year. In Japan, the recovery in corporate profits since mid-2016 has been spectacular: in the January-March quarter of 2017, profits were up 26.6% year-on-year, with profits from manufacturers up by an extraordinary 70.3% in annual terms.

Overall net profit at Japanese companies for the March 2017 year-end climbed to a record high, with nearly 30% of firms reporting their highest-ever profit. Analyst forecasts are heading even higher. In the last week of July, the Daiwa Securities revision index – which tracks the proportion of analyst upgrades minus downgrades – jumped to 26.2%, from 6.5%. To put that in context, Daiwa says the average figure for the revision index since 2000 stands at about minus 10%. According to Nikkei, listed Japanese companies expect total net profit to jump 13.6% in the current financial year (ending March 2018.)

Ironically, in a scenario to which US investors can relate, a swelling political crisis in Tokyo has Japanese PM Shinzo Abe fighting to save his government, raising questions over the completion of the long-awaited “third arrow” of the “Abenomics” structural reforms.

The first “arrow” of the Abe agenda was unprecedented monetary easing, the second was massive government spending, and the third arrow was aimed at structural reforms. The strategy was supposed to rescue the economy from decades of stagnation – it hasn’t. But domestic demand – including private consumption – has emerged as the key driver for Japan's growth, replacing exports.

Doubts over whether a scandal-plagued administration can prosecute its agenda are only too familiar to US investors – yet the three main US indices have now risen in eight of the past nine months, and are regularly recording record closes. While the idea that President Trump’s tax cut and infrastructure spending plans would light a fire under US economic growth and inflation, triggering a global rally in cyclical stocks and banks, while bonds and yield-sensitive stocks were dumped in anticipation of a faster rise in official interest rates, now seems a very strange one, the stock market is still rewarding investors who piled into the Trump trade.

That is despite the Administration’s first major legislative push – the American Health Care Act – failing to garner enough support among Republicans, and being withdrawn from the House of Representatives floor minutes before a vote.

The President’s campaign goal was to lower the company rate from 35% to 15%, but no legislation has been seen. The White House has spoken of enacting the most sweeping tax overhaul since the Reagan era before year-end, with legislation to be unveiled in September and voted on in the House of Representatives and Senate before the end of November. A Deloitte survey released earlier this month showed that the great majority of tax, finance and business professionals did not believe it would happen: just 5.3% of the survey respondents believed that Trump’s proposed 15% rate would become law.

Of all the market reactions this year, the one that tells you most emphatically that the “Trump trade” is a bust is the rise of the Euro against the US dollar: so far in 2017, the Euro has gained 12.6% against the greenback, to reach its highest level in two and a half years.

In short, very few investors still have faith in the Trump effect on the markets. But in improving global economic growth and company profits they do have faith; granted, that is, that geo-political concerns (exemplified by North Korea), domestic US political concerns (an Administration that could spend a week governing without scandal) and China’s ability to rein in credit growth while keeping economic growth on track don’t ruin the outlook. 

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This information is current as at 23 August 2017.

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