Wednesday 1 February 2017 5:45 pm Schroders Talk

How Trump’s presidency might affect your investments

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I am an Investment Specialist at Schroders.

While Donald Trump’s presidency is not the only factor that could affect investments in 2017, it is potentially a major one.

Trump’s plans to boost employment, rebuild infrastructure and bring businesses back to the US could have massive repercussions, both positive and negative, for global trade and growth.

His policies have already had an effect. Inflation expectations and stock markets have risen while bond prices have fallen.

But there are risks. What if Trump cannot pass his policies through Congress? And even he if does is there any guarantee that they will have the growth-boosting effect many are now predicting?

There remains the issue of debt too, with both government and consumer borrowing still historically high in many Western nations. This may slow the speed at which rates may rise and inhibit economic growth.

Below, we look at the potential implications of a Trump presidency on financial markets and provide an outlook for stocks, bonds and currencies in 2017.


How has Trump affected the bond market?

Trump’s election has had a substantial impact already.

Inflation expectations have risen in anticipation of Trump’s employment and spending policies, driving bond yields higher and prices lower (the two move inversely of one another).

Government bond yields for most developed countries have risen since Trump won the US election.

US 10-year Treasury yields have risen to 2.35%. UK 10-year gilts now yield 1.3%, while 10-year German Bunds and Japanese government bonds, both of which had negative yields through the middle period of the year, are yielding 0.3% and 0.045%, respectively.

Could this be the beginning of the end of the financial repression that has driven yields ever lower?

Chart illustrating how Trump's election caused bond yields to spike

How do bond yields compare historically?

Taking a long-term view, yields remain comparatively low, both in absolute terms and in real terms, taking account of inflation.

The 10-year Treasury still remains comfortably below its 10-year average of 2.8% and well below the 4.8% it offered a decade ago.

UK, German and Japanese government bonds also yield well below their 10-year averages of 2.9%, 2.19% and 0.91%, respectively.

Table illustrating how bond yields have been falling consistently over the last few decades

Where next for bonds?

David Harris, senior investment director for fixed income at Schroders, said: "The market is pricing in the risk of higher interest rates in the future due to uncertainty surrounding government spending policies worldwide, many of which have potentially inflationary consequences.

"The economic impact of a Trump presidency will not be known for a long time. The pricing of higher risk assets (equities for example or bonds with a higher risk of default) will ultimately depend on the evolution of Trump’s policies.

"In the very near term a cautious investment strategy remains appropriate. The possibility of either a move away from radical polices toward a more balanced approach as well as the risk of further antagonistic comments on foreign policy are both large and warrant a cautious and nimble approach to global markets.

“Investors should have an eye on taking advantage of selective opportunities, particularly where the bond issuer is strong and dislocations occur in the market.”

Stock markets

How has Trump affected stock markets?

Stock markets have rallied with some hitting all-time highs. Strong gains have come since Mr Trump won the presidential race with investors expecting his policies to reinvigorate the US economy and for this to spread out further.

The US market’s gain (6.2%) is dwarfed by those in Europe and Japan with the Eurostoxx 50 and the Nikkei 225 up 9.4% 10.9%, respectively (figures were taken on 25 Jan 2017).

Chart illustrating how stockmarkets spiked following Trump's election

How expensive are stock markets?

Stock markets have been spurred on by hopes that Trump’s policies will help break us out of the slow growth cycle we have been stuck in since 2008.

Despite most stock markets experiencing substantial gains, some of the main valuation metrics do not appear out of control.

Valuations on the FTSE 100 and Eurostoxx 50 are roughly in line with their long-term (10-year) CAPE (cyclically adjusted price-to-earnings) ratio averages at 13.7 times and 13.4 times, respectively.

The CAPE ratio compares a share price with the earnings of the company concerned over 10 years, to smooth distortions created by the business cycle. It can also be applied to indices, with lower figures suggesting better value.

Japan’s Nikkei 225 is below its long-term average at 24.4 times, but US stocks are trading higher than their 10-year average at 23.4 times.

Table illustrating how stockmarket valuations remain relatively under control despite soaring indexes

Where next for stock markets?

Alex Tedder, Schroders' Global Equities Fund Manager, said: “2017 is all about Trump. Will he execute, or not? He has made a lot of promises and the market has reacted to that very positively already.

“Now he needs to deliver, and he needs to deliver on multiple fronts. If he does, the US is likely to do well, and continue to lead global markets higher.

“However, risks remain ever present and if macro shocks occur, valuations will come under pressure.

“In emerging markets, rising protectionist policies could be a headwind, but improving domestic economies and stronger fundamentals are still not fully reflected within expectations.”

“Irrespective of the market environment there are always opportunities at a stock level, in companies that can prosper despite such uncertainty.

“In IT, the disruptive impact from technology enablers and new platforms should not only change the competitive environment but drive growth opportunities and operating efficiencies across industries.

“The outlook is improving for banks too. A better revenue environment is emerging as loan growth improves. Lenders will also be helped as rates move from historic lows supplementing the positive impact from cost-cutting and diminishing regulatory risk.”


How has Trump affected foreign exchange markets?

Trump’s potentially inflationary policies have lifted the outlook for interest rates, particularly in the US. The Federal Reserve (Fed) raised rates in December 2016 and is expected to do so several times in 2017.

As a result the US dollar has strengthened against a basket of currencies as the prospect of higher rates attracts investors.

The Japanese yen has weakened too providing a boost to its exporters, while the British pound has struggled since the vote for Brexit and continues to do so in the face of uncertainty over its trading position with Europe and the rest of the world.

Chart illustrating how currencies reacted following Trump's election win

Where next for currencies in 2017?

Marcus Brookes, Head of Multi-Manager at Schroders, said: “It is pretty rare these days that anybody has anything bad to say about the US dollar. When investors become extremely optimistic about anything, we consider it prudent to proceed with increased caution.

“Since mid-2014, the US dollar has moved 30% higher against a basket of world currencies. This move has been underpinned by economic outperformance versus its global peers and the prospect of the US Fed being the only central bank in town raising rates. While that narrative may prove correct over the course of the next year or so, we believe it’s now largely in the price.

“Indeed, were the dollar to continue strengthening, we would expect it to have a negative effect on the economy and therefore undermine the argument for higher rates in the first place! It’s a bit of a circular argument.”

“Sterling looks good value here in our view, having fallen close to 18% against a basket of world currencies from its nearby peak in early January to multi-decade lows. Although one can’t rule out an overshoot on the downside over coming months, we think the currency is close to bottoming.

“The outlook for the euro and yen is less clear given negative interest rates in both Europe and Japan. However, should the interest rate policy in the US be called into question then both currencies could benefit over the next year.”

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