On November 9 the world woke up to a new reality. Donald Trump is set to be the 45th US President. Below is a question and answer session with two investment managers at Calamatta Cuschieri. Kristian Camenzuli (KC) will be tackling questions on the equity market whereas Jordan Portelli (JP) will be tackling the fixed income market.
Equities
Q: How have equities reacted after Trump won the US presidential elections?
KC: Heading towards November 8 our strategy was to increase cash in discretionary equity portfolios. We did not trust the polls, as did many investment managers who were fully invested the day of the election. A win for Hillary Clinton would have theoretically resulted in a market surge, and a win for Trump, a possible repetition of Brexit.
Sure enough, on November 9 the markets did in fact dip, however this time we had to act fast as it only took a few minutes for markets to recover losses.
There are two main reasons to explain the markets’ reaction. The first is that heading towards the election, equity markets sold off; limiting downside risk after the result. The second was that the market started pricing in the pro-growth measures mentioned by Trump, which is positive for the equity markets.
Bottom line: investors were more worried about Donald Trump himself then the policies he plans to put in place once President. Once investors shifted their focus on lower regulation, corporate taxes and expansionary fiscal policies, markets started rallying like there is no tomorrow.
Q: Which sectors are expected to outperform and why?
KC: Sectors which are doing well and should continue doing well once Trump is in office are as follows:
US infrastructure: Trump has said that he will pump $1 trillion over a decade on infrastructure spending. This includes spending on roads, bridges, the rail network, and so forth. PowerShares Dynamic Building & Construction Portfolio ETF (PKB) is a way to get exposure this sector.
US defence: Trump has often talked about increasing spending on defence. At the same time, defence companies have been cutting costs and using cash to buy back stock, both of which contribute towards increasing earnings-per-share. A way to access this sector is via the iShares US Aerospace & Defense ETF (ITA).
US Biotech: Investors worried that a Clinton administration would increase regulations, limit drug approvals and reduce the ability to increase drug prices. By contrast, Trump has talked about limiting regulations and has not made an issue of drug prices. Biotech stocks have rallied, however, uncertainty still surrounds the health-care policy in a Trump administration. A way to access this sector is via the SPDR S&P Biotech ETF (XBI).
US financials: More growth, higher rates, less regulation and lower taxes. Although all the points mentioned are favourable for the US banking sector, I am convinced that Trump’s promise to dismantle the Dodd-Frank banking regulations sparked the rally. An ETF in covering US financials is the SPDR S&P US Financials ETF (SXLF).
European Financials: European banks have criticised the new regulatory standards under Basel IV which have been designed to reduce further the risk of the financial sector. However, now that Trump has been elected, it is highly probable that the reduction in regulation in the US will also happen in Europe. An ETF in covering European Financials is the Lyxor ETF Banks (BNK).
Q: Should investors be exposed to equities at this point in time?
KC: Equities remain attractive from both a fundamental and technical perspective and this applies for both the European and US equities.
Most European equities remain attractive at these levels, still trading below their intrinsic value. We are seeing a rotation out of defensive stocks into cyclicals with higher beta as investors take on more risk. A strengthening dollar against the euro is also contributing positively towards the performance of European stocks as exports become more attractive.
US equities, on the other hand, are pricier than their European counterparts. However, Trump could be a game changer if we see aggressive measures put in place to stimulate growth. This could result in increased profitability for companies and an improvement in margins.
To conclude, if you are thinking about selling right now, I’ll leave you with a quote from ‘Reminiscences of a Stock Operator’ by Edwin Lefevre, which is about as close to a market rulebook as I have ever seen: ‘They say you never go broke taking profits. No you don’t. But neither do you grow rich taking a four-point profit in a bull market.’ And we think this is still a bull market.
Fixed Income
Q: What was the initial reaction to the US Treasury curve following Trump’s victory?
JP: Throughout his campaign President-elect Donald Trump emphasised on fiscal expansion, if he was to be elected. Fiscal expansion means any form of action by a government, such as for instance, infrastructure spending or lower tax rates, that will technically stimulate economic growth. Indeed, Trump throughout the campaign highlighted his pro-infrastructure expansion approach.
Thus the initial market reaction following Trump’s victory was a steepening yield curve, as markets were pricing future inflation expectations, which would imply lower accommodative monetary policies. The 10-year Treasury spiked to 2.26 per cent levels as at Monday, while the 30-year US Treasury breached the three per cent level.
Q: How did emerging market bonds react in relation to a strengthening US dollar?
JP: In line with the aforementioned expectations, we’ve experienced a strengthening dollar primarily against emerging market currencies, with the major loser being the Mexican peso, which plunged by circa 12 per cent, following Trump’s comments of possible trade tariffs. The movement in the peso is justified as circa 25 per cent of Mexico’s GDP are exports to the US. The gains within the dollar triggered a sell-off across emerging market hard currency bonds, which reacted negatively to a stronger dollar due to higher servicing and refinancing costs.
In addition, the sell-off across the fixed income asset class per se was also brought about by the fact that the probability of a December rate hike is now more evident than ever.
My view is that a December rate hike is now imperative, as the continuous overall positive data without a rate hike pace might trigger an overheating US economy. Let’s be realistic, there will be a time lag between the time Trump’s policies are implemented and when we actually see a positive impact on the economy. Thus, in my view, the market might have overreacted to date.
Q: How should a fixed-income investor position his portfolio going forward?
JP: At this stage, portfolio realignment is important. Moving forward we should expect further steepening across the curve. In my view, investors should give importance to key theoretical concepts, mainly the duration effect and the coupon effect. With regard to the former, investors should invest in lower duration bonds, as the impact of a December rate hike and subsequent rate hikes on the bond’s price would be much lower than on long duration bonds. Likewise, higher coupon bonds tend to be less impacted by rate hikes. That said, it is imperative to understand that any rate hike will impact bond prices across the board; it is the magnitude of the impact that differs.
For the more risk-loving investors, following the recent re-pricing, selective emerging market hard currency bonds are now attractive, however bond picking is crucial. Opt for major exporting names which are positively impacted by a weaker domestic currency and hold dollar cash on their balance sheets. The latter will spare them higher servicing costs. Undoubtedly a word of caution: be very selective and diligent in your fixed-income portfolio allocation.
The information, views and opinions provided in this article are solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd is one of Malta’s leading financial services firm. The company offers a wide range of investment services, including independent investment advice, live online trading, savings plans, investment management and fund services. For more information visit www.cc.com.mt.