Relief after initial panic

Asset Management - 10/11/2016

After the largely unexpected vote in favour of Brexit last June, Donald Trump’s victory reinforces our view that developed countries have moved into a period of profound political change. The previous such episode goes back to 1979-81 when Margaret Thatcher, Ronald Reagan and François Mitterrand came to power in the aftermath of the 1970s economic crisis. (English version)

The consequences of the spectacular acceleration in globalisation and the after-effects of the 2008 financial crisis have led an increasing number of voters to rebel and demand fresh solutions. The turnaround is probably not over yet and the approaching elections in Europe will need to be closely watched. Whatever the scenario, we can expect the incumbent political class to have got the message: if you want to win an election, you had better acknowledge this malaise even if this means relinquishing tight fiscal deficit controls, all the more so as today's historically low interest rates would seem to suggest that bond investors are not quite the watchdogs they used to be. Our upcoming In the spotlight document will be looking at this transformation in more detail.

The market reaction on the day to this surprising outcome was probably the second shock in as many hours for many: an acceptance speech that was (finally!) presidential in tone from Donald Trump was enough to stop and reverse the initial sell-off as investors started to anticipate the impact of the new President's economic programme. Equity markets, apart from Latin American bourses, rallied. There were some spectacular sector rotations and long bond yields, especially in the US, shot up again. In coming weeks, investors will surely be hanging on every word from their new champion.

Donald Trump's election victory, and the success of the Republican Party in holding onto control of Congress, means the new administration will have more freedom in rolling out his electoral programme.

The programme involves:

  • at the domestic policy level, a massive programme of government spending to stimulate growth. The main focus will be on infrastructure investment. This will be funded with larger fiscal deficits, especially as households and companies are likely to benefit from reductions in marginal tax rates, higher tax deductions and the abolition of death duties. An increase in the minimum wage is also expected to be unveiled. Also tax inversion measures to encourage US companies to repatriate foreign earnings.
  • at the geopolitical, trade and immigration levels, a complete overhaul of free trade treaties like the Alena and bilateral agreements. It also proposes introducing tariff walls which would include increasing duties on imports from China by 45% and by 35% for Mexico. And very strict immigration controls could be introduced to restrict inflows by making it more complicated to obtain visas and possibly repatriating illegal immigrants, a measure that could concern 11 million people.
  • Lastly, the programme also proposes a US disengagement from the geopolitical arena.

Short term caution

Of course, in politics, promises only bind those who believe in them. We can quite justifiably entertain doubts that the programme will be fully implemented as the strict application of the fiscal chapter alone would trigger a sharp increase in the deficit and in government debt levels.

As investors, we will be paying particular attention to two aspects of the programme:

- to what extend will the US be moving towards political protectionism?

- will Trump's policies prove inflationary? There is a greater risk of this happening given his plans to stimulate fiscal policy at a time of full employment, close the borders and deport illegal immigrants, raise the minimum wage and increase import duties.

We can therefore expect to see investor caution for several weeks, pending greater clarity on the likely composition of Donald Trump's administration. Key appointments will be of crucial importance. So far, the market's reaction has been relatively muted, a big contrast with the post-Brexit sell-off. This is partly because markets have been able to discount the risk of a Trump victory in the last two weeks and hedge positions.

We too had hedged portfolios, especially those with exposure to equity markets, but we closed out some of those hedges. Our asset allocation choices are unchanged as fundamentals remain upbeat. December will see the Italian referendum and the rerun of presidential elections in Austria so we will probably have other opportunities for tactical management of political risk.

Greater visibility on healthcare

Despite today's more uncertain environment, a number of investment opportunities are taking shape. Donald Trump's victory means there is now greater visibility on healthcare in the US. Unlike Hillary Clinton, who wanted tighter controls on pharma companies, he has no specific plans for the sector. Fears of a Clinton victory have led to healthcare stocks underperforming this year so we feel this is the right time to get back into the sector.

Trump's victory creates a potentially more inflationary environment in the US and we have factored this into our US bond exposure. The biggest question mark is now whether the Fed will increase benchmark rates in December as expected. If market volatility remains low, it is still likely. But we should remember that market liquidity tends to dry up in December. We can therefore suppose that the Fed will not want to risk adding to volatility if markets are already nervous.

 

  European equities

European markets wiped out falls seen in the previous fortnight after rebounding on news that Donald Trump had won the US Presidential election. Indices initially fell as this was a surprise and his future decisions were unclear but the trend reversed as investors chose to concentrate on potential fiscal reflation and Trump's electoral programme.

Sectors likely to gain from his election posted the steepest rises of the week: mining stocks soared by more than 14%, financials flirted with rises of 10% and pharma and building stocks advanced by close to 8%. In contrast, utilities and autos, especially German car manufacturers with the highest exposure to the US market, fell back as did companies with exposure to Mexico.

In the ongoing earnings seasons, Vivendi unveiled robust third quarter results, featuring upbeat performance in music and better-than-expected revenues from its pay TV Canal +. The only bad news was the decision to cut the dividend in 2017; management thinks its share buyback programme is enough.

Deutsche Telekom's results were in line. AstraZeneca shares fell slightly on lower like-for-like results but the group maintained its annual guidance. Alstom jumped after reporting a 59% jump in first half new orders and reiterating 2020 objectives. In chemicals, Lanxess reported better-than-expected Ebitda and raised its annual guidance. The group's restructuring programme seems to be proceeding well. Arkema's results were in line.

 

  US equities

Donald Trump's victory and the Republican sweep in Congress was a surprise for us. The reaction on Wall St was also a surprise as indices posted strong advances amid very clear sector rotation in favour of cyclicals and financials. This followed developments on credit markets where Trump's potentially pro-business and inflationary programme sent long bond yields higher.

His acceptance speech struck a pragmatic note and was careful to stress national unity, a big contrast with his populist and divisive campaign rhetoric. The market apparently thinks that the President-elect will be able to get the US economy going again with the following key campaign propositions:

-          Fiscal reform involving cuts to personal and company taxes and lower taxation of the USD 2,500bn in multinational profits held abroad if they are repatriated. Tech, pharma companies and industrial conglomerates would be the biggest beneficiaries.

-          Reduced regulatory pressure. That would be especially good for energy (oil exploration/production companies could more easily prospect within the US), healthcare companies (no more risk of regulated drug pricing and proposition 61 which sought to align the prices of drugs used in Medicaid and the Federal veterans programme has been rejected) as well as financials. The big unknown concerns possible customs barriers.

On the day the election results were announced, financials rose 4%, pharma 3.5%, industrials 2.5% and basic materials 2.1%. But utilities, real estate and consumer staples fell by 3.7%, 2.3% and 1.3% respectively.

The NFIB Small Business Economic Trends survey came in at high levels ahead of the election.

It is still too early to know what shape Donald Trump's economic policy will take but the market has clearly decided, at least for the time being, that his election will boost the economy. And that explains the sector rotation into cyclicals and financials.

 

  Japanese equities

The Nikkei index swung sharply this week due to the US presidential race. Following indications that Republican Donald Trump might win, share prices plunged on uncertainties for the future and the stronger yen, which at one stage appreciated to 101 against the US dollar on receding expectations for a US rate hike in December. Global stock markets were facing the biggest loss since Brexit shock. However, on Thursday after the US market rallied, Japanese stocks rapidly bounced back and ended the week 0.6% higher.

This week's top sector was Nonferrous Metals which jumped 5% led by Sumitomo Metal Mining (+8.9%), while the Foods sector shed 4.4%.

Most TSE 1st section shares dived on Thursday. Ajinomoto, Japan's  leading food company, announced disappointing earnings after the market close on Wednesday, and ended 9.9% lower due to the yen's appreciation.

Suzuki Motor's robust earnings growth stood out. Even in this market turmoil, the share price jumped 10% on an upward revision to operating profits for the year ending March 31, 2017 and favourable growth prospects in India.

 

  Emerging markets

Stocks and currencies across emerging markets tumbled after Donald Trump's victory in the US presidential election. The Mexican peso led declines, falling more than 9% against the dollar. Investors were worried that Trump would follow through on some of the protectionist rhetoric he used during the election campaign, possibly raising tariffs and renegotiating trade agreements. Such measures would be very negative especially for emerging-market countries that rely heavily on access to global markets for economic growth.

Nevertheless, Trump's first speech as President elect seemed to be more pragmatic. One of the few emerging markets that gained this week was Russia, investors are hoping that Trump's electoral victory will translate into improved relations with the West and boost the country's flagging economy.

China's services sector grew at the strongest pace in four months in October as new business picked up, along with upbeat official factory and services readings earlier this month. This adds to the view that the world's second-largest economy is stabilising.

In a surprise move against corruption and unaccounted wealth, India's Prime Minister Narendra Modi has announced the withdrawal of high-denomination bank notes. The ban is intended both to curb the flow of counterfeit money and to help the government clean up a system that has relied on cash to pay bribes and to avoid taxes. For the time being, these anti-corruption reforms are having a negative impact on consumer names but we view them as positive in the long run.

 

  Commodities

Commodity prices, particularly metals and minerals, saw big price shifts in a week dominated by the US elections. Metallurgical coal jumped 13%, breaking above USD 300/t, iron ore rose 9% to above USD 70/t, and copper advanced 8% to USD 5,400/t, a 12-month high. These commodities have seen a marked improvement in conditions this year, mainly due to Chinese property and infrastructure demand and reduced supply after capacity shutdowns in China and limited investment from producers.

The trend acceleration seen in recent days, especially for copper, is a more direct consequence of Donald Trump's election victory. Infrastructure was the only subject both candidates agreed on but the Republican was more emphatic in his canvassing. In his acceptance speech, Trump once again focused on his plans for spending on roads, bridges, tunnels, airports, schools and hospitals. That should have 2 favourable consequences for commodities, improved demand and expectations of higher inflation. Looking beyond the president elect's promise to earmark USD 1,000bn for infrastructure, the real question is how this spending will be funded without causing the national debt to explode.

Note also the first news on China's new 5-year plan. It includes a striking 85% increase in investment on electricity generation. The figures require confirmation but would be excellent news for copper.

Oil prices, meanwhile, were unchanged. The new president is seen as keen to develop shale oil and that could in time mean more supply if prices recover. Over the short term, weekly US output data rose by a sharp 170,000 b/d but this mainly due to the base for comparison being revised higher.

 

  Corporate debt

Credit

After opening on a difficult note, credit markets eventually cheered Donald Trump's victory in the US Presidential elections. The Main and Xover indices ended the session almost unchanged after widening previously by 8bp and 32bp respectively. The billionaire's soothing victory speech reassured investors. Risk premiums returned to pre-election levels the following day. The market preferred to ignore Trump's protectionist bias and concentrated on his generous tax-cutting plans, his infrastructure projects and his determination to deregulate the banking sector. Investors view his programme as inflationary and tended to readjust duration in their portfolios.

S&P has a new rising star after upgrading HeidelbergCement to BBB-/stable. Europcar, the benchmark in car rentals, reported third quarter profits of EUR 96m (-3.3%) and adjusted corporate Ebitda of EUR 159m (+3%). Sales rose 2.1% or 5.1% on a constant currency basis to EUR 707m and represented 22.5% of sector sales, marginally higher than the 22.3% reported in the third quarter of 2015. Constellium's third quarter results rose as expected. Labeyrie Fine Foods announced the resignation of Xavier Govare, its CEO over the last 15 years. This was a surprise and seems to have been caused by disagreements between him and two shareholders over strategy.

Crédit Agricole reported upbeat third quarter results. Attributable earnings at CASA came to EUR 1.86bn a fraction above consensus estimates of 1.81bn. BPCE reported attributable net profits of EUR 955m (-0.5%) but up 2.7% to EUR 929m after restating for non-economic and exceptional items as well as the impact of IFRIC21.

 

Convertibles 

Markets were nervous ahead of the US presidential election on increasing prospects of a Trump win but in the event they retraced all of their losses and more. This was particularly the case in Asia. Names such as Asics, which was down more than 8% following the election, recovered completely by Thursday. The sector most positively impacted by Trump's unexpected victory was US Healthcare as concerns regarding the potential for drug pricing regulation faded: convertible bond names such as Biomarin and Intercept were up 10% and 15% respectively. Elsewhere in the news this week, the Ubisoft saga continued with its 30th birthday celebrations on Tuesday. That was when Vivendi announced that it now owned 24% of the company (and more than 21% of the voting rights).

In Portugal, Sonae revealed improved 9M 2016 revenues (+6.7% compared with the same period last year) thanks to improvements in all divisions except its Real Estate Business. Siemens reported a 3% rise in Q4 revenues but the major news was the announcement that it would spin off its healthcare business. Dish Network reported Q3 revenues slightly above consensus but missed profit expectations owing to a loss in TV subscribers to competing streaming TV services provided by AT&T and Time Warner's Hulu. Weatherford's CEO, Bernard Duroc-Banner, stepped down, to be replaced by the current CFO, and the stock rallied by over 20% on the news.

 

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