US Markets: at last the great rotation?

Asset Management - 16/11/2016

Investors are keeping their cool and suppressing their dismay. Donald Trump’s victory in the US Presidential Elections has failed to disrupt markets, sparing investors a strong surge in volatility. After the initial shock, it is now time to look at positioning.

1/ Will the election results create a new market dynamic?

For more than two years, investors had ignored valuations and preferred to buy stocks with long term growth potential. The focus was on companies with little exposure to the cycle and economic rupture plays. This strong aversion to risk penalised our investment team’s value approach. Cautious scenarios on US growth and concerns over earnings trajectories were bad news for many stocks.



 

But Donald Trump’s accession to the White House has changed the situation. His victory will accelerate the return to normal long bond yields and reflationary pressures. Both trends kicked off during the summer months and they have been reinforced by the prospects that the Republican candidate's programme will be implemented. Changing perceptions on inflation represent a power catalyst for a new market dynamic while the expected shift in the yield curve has triggered an investment style rotation.

This transition marks the end of a two-speed market and will probably cause the valuation gap to narrow in the next 6 months. Donald Trump's first statements as President-elect contrast sharply with the populist rhetoric of his campaign and will put cyclical stocks back where they belong.

2/ What investment style will manage to perform well?

Sector rotation began on the day following Donald Trump's success. Now that the uncertainty has lifted, markets can once again focus on valuation levels and fundamentals. Certain value segments will benefit from this new accent on deregulation.

First and foremost is healthcare, a non-cyclical sector which enjoys strong visibility, especially as concerns earnings growth. Healthcare stocks like Allergan, which makes Botox, also offer attractive valuations and risk/return profiles. With Hillary Clinton’s defeat, the risk of increased pressure on drug pricing has abated and there should now be fewer curbs on mergers and acquisitions.  

The halt to regulatory projects will be good for bank stocks like Bank of America and life assurance plays like MetLife.

Investors are effectively betting on Trump following through on his campaign pledge to water down the Dodd-Frank regulations that were introduced after the 2008 crisis. And financials should also benefit from rising interest rates as the new president's economic policy is resolutely pro-growth and inflationary.

Elsewhere, we can expect companies with a domestic focus, which will gain from reduced taxes, and infrastructure plays to do well. This new environment should also favour makers of industrial and energy equipment like oil pipelines and construction companies like Caterpillar.

3/ Isn't it already too late to adopt a value strategy?

After a particularly difficult 2015 and an equally tricky start to 2016, EdR Fund US Value & Yield and EdR Fund Global Value have partly offset underperformance in recent months, mainly thanks to rising commodity prices. But it is not too late to take positions. Some of the leading sectors we are overweight in like financials and healthcare have still not made up for lost ground.

Some leading sectors have still not made up for lost ground



 

 

In the next six months, a pro-cyclical environment and higher interest rates should mean a relatively smooth ride for our portfolios. The Fed will probably raise interest rates in December but markets have been factoring this in for weeks. And no major decision will be taken before the 45th US President is officially sworn in on January 20, 2016 which leaves time for investors to take positions. Note that over the medium term, we will be watching to see if there are any signs of risks like trade protectionism, rapidly rising inflation and geopolitical isolationism and any indications that the economic stimulus programme is failing to produce results.

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