While the outcome of the US election is now clear, uncertainty will not subside during president-elect Donald Trump’s transition to power. He is the first president in history not to have prior government or military experience, and his speeches have left ambiguity on the policies he will pursue.
Mr Trump’s proposals include increased infrastructure spending, lower corporate and individual income taxes and less government regulation. While this seems like a pro-growth agenda, the question is whether he will be able to implement these changes and what the broader implications will be.
While the details and scope of Mr Trump’s plan will remain unclear for some time, the move from monetary policy support to fiscal stimulus seems apparent. The pro-growth agenda also opens up a move from deflation to reflation and a path towards higher interest rates.
Implementation of significant fiscal stimulus and tax reforms is quite complex, so we’ll have to wait for medium to longer-term outcomes. In the immediate aftermath, markets globally have reacted very differently on the equity and fixed-income side.
Yields on 10-year US Treasuries rose significantly following the election on the prospects of a boost to economic growth and reflation expectations, and bond markets have been selling off globally. Whereas developed equity markets reacted positively to the result on the prospects for a potential uplift to GDP growth, showing little concern for potential inflation and increases in US debt levels.
These opposite reactions in debt and equity markets have led the US equity volatility Vix index and US Treasury volatility index to diverge significantly as an outcome of the election in strong contrast to their close correlation over the past decade.
The challenge for investors will be to understand what the implications will be over time as the initial market reaction may not reflect how markets trade in the medium term.
On the fixed-income side, following the election, bond markets have changed tone with the US 10-year rallying and credit markets selling off. The probability assigned by the market to the Fed increasing rates in December is quite certain. While this is just the initial reaction, being selective in fixed income positioning and duration exposure will be key.
Within equities, short to medium-term prospects for US equities are likely to improve following a boost to fiscal spending and its subsequent effect on growth. Mr Trump’s win could increase the following of anti-establishment parties across Europe. Uncertainty deriving from the rise of populist parties, an upcoming referendum in Italy and elections in France and Germany next year, will probably affect European equities making US equities even more attractive on a relative basis.
At a sector level, in the immediate post-election, financial stocks surged as the sector should experience positive impacts from fiscal stimulus, higher yields and regulatory easing. Moreover, healthcare companies should benefit as the result of the election having removed uncertainty around drug pricing, which had lately weighed on stock prices. Immediately following the election the sector started outperforming the broad market.
However, valuations are still compelling. Historically the sector has traded at a premium while now valuations are in line with the broad market. Although there could be some pressure from a reform of Obamacare, prospects for pharma and biotech companies look very attractive.
More broadly within global equity markets, in the immediate post-election period emerging markets (EM) sold off sharply as the US dollar and rates reacted to forecasted stronger global growth and fears grew about the protectionist rhetoric of the campaign. Importantly, longer term, the case for emerging markets remains intact; valuations are still attractive versus EM’s own history and versus developed markets.
From a fundamentals standpoint, most EM countries have improving earnings and current accounts, falling inflation and currencies that have already depreciated significantly over the past few years. In addition, EM countries have space to step up stimulus and reforms to support growth to mitigate the impacts of increased uncertainty around US policy.
EM stocks seem to have over reacted. The US dollar had already strengthened significantly leading into this year and concerns regarding large further dollar appreciation from here seem overdone and far too consensus (although this is a risk to be monitored). Over the past few days EM stocks have already started rebounding.
As investors start understanding the impacts of the new presidency, it will take time for things to play out. Several market rotations could take place before clear winners and losers emerge. As uncertainty will continue for some time, a flexible approach to investing will be key.
Ilaria Calabresi is a vice president at JP Morgan Private Bank
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