Overview
Disquiet and volatility are back, on a global scale. Whether they stay remains to be seen, as early post-election reactions are often reversed.
Our president-elect has articulated a verbal track record on a range of economic and geopolitical issues that could unsettle markets.
The former includes his comments on trade (a bias toward protectionism) and higher budget deficits (via very large tax cuts and infrastructure spending), for example. The latter captures his positions on immigration (much less), Muslim visitors (none), our allies in NATO and in the UN (reduced support), and nuclear weapons (more countries should have them), to name a few.
Although we haven’t believed in election promises since we enjoyed reading “Where The Wild Things Are,” it’s fair to say that there is heightened uncertainty. Perhaps it was all campaign rhetoric, and policy will turn out to be OK. We’d be fine with that. For now, seeking to be good fiduciaries, we’ll take the Missouri approach on this (“show me”) and continue to exercise caution.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
Our readers know that our analytical time horizon is 5+ years, and our portfolio construction horizon is 18–24 months. We also feel that, on shorter time frames, markets will “bounce off the guardrails” in unpredictable ways, driven by un-forecastable, random events.
The Trump win could be one such unpredictable trigger. In the coming days, markets could bounce from the right to the left guardrail, with no apparent rhyme or reason. However, we’re not trying to predict these “noise” events. Rather, we seek to ascertain whether the financial markets road is aimed at Boston or Beijing, Billings or Bogota. That, we feel, will primarily be driven by valuation and, in the longer term, by public policy. The latter is too early to discern. But the former (asset prices) looks elevated for some risk assets, like stocks, and for Treasury bonds. To generate robust future equity returns from here, we feel that it would take very innovative policies that materially drive earnings upward. Further, Mr. Trump’s policy statements, even discounted for election hyperbole, suggest higher fiscal deficits and higher inflation – seldom a good thing for bonds.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
As we write this, the oft-considered safe-haven Japanese yen has remained flat to slightly weaker to the U.S. dollar in the wake of unexpected results in the U.S. election. With roughly three-quarters of the companies in the Japanese Topix stock index reporting, corporate earnings appear to be headed for a slight drop from the previous quarter. This is likely due at least partially to a stronger currency in 2016, as the yen’s higher value hurts exporters’ overseas earnings upon translation. Economically, Japan continues to improve only slightly in 2016, with various indicators all holding steady at modest levels. Valuation remains attractive, especially if higher U.S. interest rates weaken the yen and possibly boost Japanese earnings in the near future.
Europe
Srinath Sampath, CFA®, PhD
Managing Director, Portfolio Management
Through all the political drama in the U.S., the European Union (EU) has experienced gradually improving economic health. Indeed, the EU has weathered the surprise Brexit vote well and actually gained on several macroeconomic fronts: industrial production is strong relative to the US, retail and auto sales are robust, and the trade balance continues to strengthen. Importantly, core inflation is running at 1.1% – a sign that the Quantitative Easing program introduced by the central bank (ECB) is having the desired effect. While its Quantitative Easing stimulus is currently slated to draw to a close in March 2017, the expectation is that the ECB will extend the program, adhering to its stated mantra of doing “whatever it takes” to get continental Europe back on track.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
It looks increasingly like the UK economy will not fall into recession in 2016, as many market pundits predicted after the Brexit vote. Recent surveys show that GDP started the final quarter on a strong footing, and that manufacturing’s post-referendum contraction will be short-lived. Looking ahead, a lower pound should help to support the economy, primarily by boosting exports. On the other side of the coin, the sharply weaker currency is also raising inflation, now running between 1.5% (headline) and 2% (for core). Higher prices could eat into real wages and dampen household spending. The upbeat economic news and inflation concerns led the central bank to leave rates on hold earlier this month and shift its bias away from further easing.
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The macro story in emerging markets (EM) continues to improve: stabilizing fiscal balances, improving trade, reduced external pressures and mild inflation. Measures of the manufacturing and service sectors have reached two-year highs for China and India, and a four-year high for Russia. Elsewhere we are observing improvement from earlier this year. However, caution is still in the air. The recovery in China has been driven by earlier policy stimulus, which could soon start to fade, and its high corporate debt level and bubbling housing market are concerns. Further, EM corporate earnings are still lackluster. At this moment it’s much too early to tell what the Trump administration will or will not do. However, if tariffs on China were to rise to anywhere near the promised 45%, and trade agreements materially altered, EM equities and fixed income could be negatively impacted.