Trump Win Sends US Market to Record Levels – North American equities ended 2016 on a high note. Donald Trump’s Presidential win, a rate hike and a pickup in global economic activity were catalysts for risky assets. The US election sent US stocks (especially small-capitalization companies) surging while a strengthening US dollar pressured emerging markets. The trend of low volatility sectors such as Utilities, Telecoms and Consumer Defensive names outperforming reversed. Industrials, Financials, Energy, Materials and Consumer Discretionary are now leading the rally.
OPEC reached a deal with non-OPEC members to cut production by 1.8 million barrels per day in 2017. Thus, oil prices reached an 18-month high and Canada’s S&P/TSX gained more than 4.5%.
On the back of a recovery from a global industrial recession, rising bond yields and inflation expectations accelerated after the U.S. election results. Trump’s win boosted hopes for a pro-growth change in U.S. economic policy while the US Federal Reserve raised rates for the second time in 10-years.
Slightly More Positive On Bonds, Still Neutral on Equities – In a complete reversal from the previous year, 2016 posted solid gains across most major asset classes despite the negative tone to begin the year.
At the outset of 2016, the focus was on diverging monetary policies geographically. This year’s spotlight is on the divergence of fiscal policy and monetary policy in the US, complicated by the Trump factor.
The optimist can identify the benefits that may be derived from Trump’s fiscal platform, specifically improved competitiveness for US companies via lower tax rates and a less stringent regulatory regime. Further, infrastructure spending should support multiple sectors, including construction and engineering companies.
Meanwhile, more cautious investors will find discomfort in the powerful US dollar. Bolstered by interest rate increases, the swelling greenback can limit the international competitiveness of domestic firms. Globally, trade tariffs and protectionism will not only hurt foreign firms who export to the US but also impose an indirect tax on US consumers.
Given the wide distribution of potential policy outcomes, markets are anticipating an injection of volatility in 2017. Nevertheless, the setting is positive to start the year on account of solid US and global expansion. Ultimately, global equity performance is likely to hinge on the prospects for a broad earnings recovery from the currency and commodity-related downturn of the past two years.
The unpredictability of the Trump administration is likely a large contributor to the wide range in earnings forecasts. Analysts expect S&P500 earnings to range between $124-$134. On average, and all else being equal, the forecast is for an 11% appreciation in the S&P 500 over the next 12-months. However, this is contingent on the multiple holding at 17.2x versus a 10-year average at 15.8x.
As the uncertainty premium rises, gold may become a solid insurance policy. The allure of gold stems from the over crowded US dollar trade and the tripling of the US Federal Debt since 2001, which now stands at $19 trillion. As a result, a 1% increase in interest rates adds $190 billion to the federal deficit, approximately 1% of GDP. Therefore, the path to rate normalization when combined with infrastructure spending means the event risk on interest rates is significant.
After posting an 8% loss in 2015, the Canadian stock market was the top performing developed market in 2016. The outlook for the Canadian economy is not as promising as last year’s return suggests. OPEC’s deal to cut production and raise prices hinges on cooperation from member countries as well as non-OPEC nations. Both sides have incentives to cheat the system and historical data coincides with this. Further pressure may come from the Trump administration’s push to reopen the North American Free Trade Agreement.
US government bond yields bottomed in July and moved rapidly higher on Trump-inspired growth prospects. Thus, GMG elected to add higher yielding, short-term securities. In addition to a steady income stream, government bonds should provide downside protection in the event the implementation of Trump’s plan is impaired. However, in keeping with our bias for a continued, albeit slow, cycle of rate increases, bond duration remains short.Download PDF Version