by Harbour Asset Management
Without doubt, Trump's victory has been a surprise for markets and the pollsters. However, in the wake of the Brexit vote, and a closing in the US poll gap, investors had generally been hedging their bets and markets had already sold off significantly in the last 6-7 weeks coming up to this election.
There is evidence of a significant cash build-up in global portfolios, investor fear indices have been elevated and high (if not record volume) of US equity futures, and put to call ratios have set the scene for conservative biases going into this US election.
After an initial sharp sell-off, the local and Asian market reaction has recovered, with broad European and US equity markets actually rising last night. Some specific risk indicators, such as the US dollar versus the Yen and Swiss Franc and the Mexican peso, have understandably taken a more brutal price shock.
We would be surprised to see the New Zealand equity market weaken significantly in the near term, given the peak to trough fall of 13% in the last 6-7 weeks.
The global bond market's initial reaction of driving yields lower as equity markets fell has also reversed sharply, with US 10 year bond yields above 2% for the first time since January. Focus has quickly moved to the pro-growth and protectionist policies that Trump has suggested, which would be expected to deliver higher inflation.
We still broadly think that bond yields have formed a bottom and will trend higher, even though cash rates in New Zealand are likely to be anchored at low rates for some time. In the US, stronger longer term growth and higher inflation could drive a more pronounced tightening cycle. This is probably a more significant risk for financial markets.
Drawing specific conclusions is difficult at this time. However, if we take Trump at his word thus far, it is possible to consider some sectoral perspectives. Healthcare stocks could rally, and even Australian and New Zealand healthcare companies may be positively impacted as Clinton's proposed healthcare reforms were seen as negatively impacting the broader sector. In contrast, companies and countries benefiting from international trade could be negatively impacted.
Although again, much will depend on the Republican Party (which is split down the middle on free trade polices). In the medium term, Trump is eyeing up stronger infrastructure spending, which could support cyclical companies and commodity prices. In turn, we should also eventually expect a steeper US yield curve as expectations turn to Trump's replacement for Yellen.
Much of the media focus on Trump's policy platform has been on the social aspects. Economic aspects have barely surfaced in this somewhat negative campaign. On balance you could argue that Trump and the Republican Party together are somewhat business and investor friendly, especially if you are a US investor. Tax cuts, infrastructure expenditure, opening up healthcare reforms, and resetting monetary policy could all be viewed as equity friendly in the near term. Trump has talked about a fiscal stimulus of 2-3% of GDP. This could change the global storybook on achieving growth moving forward.
However, from a global perspective, the potential for reversing some free trade agreements, and a US first backdrop creates risks and uncertainty for non-US companies. Just how much Trump can get done on the trade front is open for question despite the Republicans holding the Congress and Senate. Trump has the scope to argue that he has won the election and is obliged to deliver on promises he has made.
In our view this divisive election, between minorities and the core middle aged white vote, between millennials and the older generations, and between liberals and conservatives, sets the scene for conflict going forward. Conflict can increase policy uncertainty. From a European perspective there seems to be unanimous dismay, except in the case of Dutch, French and Italian far right parties. Markets are likely now to line up the next election cycle, starting with Italy on 4 December.
How might investors react?
With caution, but we think constructively with respect to equities and cautiously with respect to bonds. Look through the emotion, and consider the likely medium term economic scenarios.
Harbour had generally built significant cash and defensive positions in equity portfolios during September and October. Rather than take a further defensive step we are considering over sold investment opportunities. In a disrupted market, equity prices often over-react. Moreover many New Zealand and Australian companies are delivering solid profit results; most recently A2 Milk and Mainfreight guided the market to stronger earnings outlooks. We think the Australasian investment universe contains many uncorrelated investment opportunities with solid prospects. We are still relatively cautious many pure yield equity exposures, although value is emerging as global investors continue to pull back investments in New Zealand. In credit markets, we are wary of governments and businesses with high debt levels, as higher interest rates put pressure on debt serviceability. Some will fare better than others.
The shock of Trump's election is felt through our emotions, and as individuals we react relative to our beliefs in how society ought to behave. It is not possible to totally disentangle the emotion from the economic and business facts because consumer and business confidence can be impacted at heightened times of uncertainty.
It is true that one period of great uncertainty (the US election) is now replaced with another; investors might be asking:
For New Zealand, we can assume that the TPP trade deal is off the cards, this was looking increasingly unlikely under either Clinton or Trump. On trade, New Zealand faces Asia more than the US, as does Australia.
Several reports suggest global trade growth is likely to fade under a protectionist Trump presidency. This is perhaps the case, however, politically New Zealand is increasingly linking up with greater Asia; the latest trade delegation to India emphasises the opportunity.
Moreover, it is hard to see migration trends softening. Population growth for New Zealand remains both a challenge and an opportunity. We wouldn't bet yet on New Zealand being negatively impacted in a shifting world order.
Implementing effective global climate change policies is now a heightened concern. To us it seems more likely that little will be done to politically stem carbon emissions in the US, and the real economic effects of climate change on the New Zealand economy and businesses is possibly a stronger medium term concern.
Finally, what about our own political and economic institutions? Is our society at risk of matching US and European unease?
New Zealand has experienced an unprecedented period of political stability. This stability has led to relatively strong business investment and employment. In our view, our ageing society, together with low real income growth for some of the population, growing wealth inequality (Auckland house owners versus the rest?), could potentially set the scene for change in New Zealand as well. However most indicators of "wellbeing" and income equality are significantly more aligned with a progressive society, than one falling back to divisive conservative politics. Rather than shaking our heads and asking ‘America what have you done?’, New Zealand would do better to ask: ‘what could we be doing better?’
Andrew Bascand
Managing Director, Harbour Asset Management
Christian Hawkesby, Executive Director
This column does not constitute advice to any person.
www.harbourasset.co.nz/disclaimer/
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