Could Trump kickstart new financial policy options? Five key investment themes for 2017

Tilney’s Chief Investment Officer Gareth Lewis reviews the themes likely to dominate investment strategy for the year

2016 was a rollercoaster year beginning with a rout in Chinese equities and commodities and where politics loomed large over the markets in the form of Brexit, the US elections and Italy’s constitutional referendum. 2017 is already set to be an interesting year with yet more elections across Europe, Donald Trump taking office, the UK Government aiming to trigger Article 50 and potential rate hikes in the US.

Speaking at a seminar in London today, Gareth Lewis, Chief Investment Officer at Tilney Investment Management, which oversees over £20 billion of assets, sets out five key themes that he believes will influence investment markets for 2017 and are driving Tilney’s investment strategy.

1. Politics will drive a policy shift from Wall Street to Main Street Equity markets are discounting the positive, but not the negative, impacts of the President-elect Trump’s policies

“While markets have focused on the positive implications of greater fiscal spend along with cuts in both corporate and personal taxes, there are many other potential policy measures, which if delivered, are seen as less beneficial. These include; tighter monetary conditions are likely to follow fiscal expansion, tariffs on trade which could give rise to an increasing use of economic barriers to entry with negative consequences, as well as more restrictive immigration policies. US economic activity was already showing signs of an uptick ahead of the election of Trump as President. US growth is expected to increase modestly as fiscal spending increases. At the same time, Eurozone activity has been resilient despite the shocks of Brexit. On the other side of the world, despite the reformist rhetoric Chinese authorities have favoured further stimulus over structural change.

2. Fiscal expansion and loose monetary policy suggest the Fed (and the market) is currently behind the curve so the Dollar will strengthen further as investors move to discount Fed guidance

“As a result, the Federal Reserve decided to raise rates. The shift in its policy can be attributed to three factors: The FOMCs estimate of the long term productive capacity of the US economy; A reduction in its estimate of natural employment rate; A very large drop in its estimate of the natural rate of interest. None of these will be changed by Trump policy, so rates will tighten but not excessively. However, while Fed guidance may not change much, market expectations can be expected to converge.

3. Rising Treasury yields and strengthening Dollar will reduce global money supply creating a headwind for asset prices

“The change in Federal Reserve policy will have a direct impact on the Emerging Markets, Asia and China. This is due to the global increase in indebtedness, as the significant increase in debt-funded investment leaves many EM and Asian economies exposed to rising rates. An increase in hard currency debt issuance would then create a mismatch between earnings and liabilities if the Dollar continues to strengthen. This is particularly important in China, where over 80% of new debt is used to refinance existing liabilities. Additionally, if bank lending contracts or bond markets shut to new issuance defaults will rise.

4. But…. secular stagnation is not yet dead Chinese capital misallocation requires the three Ds : devaluation, default , dis-inflation

“China is the structural source of deflation. As demand in one country falls, capacity in another country becomes obsolete. However the need to service outstanding debt means that rather than closing capacity, companies are discounting prices and being run for cash flow.

At the end of 2015 China faced three significant issues: the economy was making a loss on its cost of capital; banking sector solvency was deteriorating rapidly; the economy was experiencing severe capital flight. To overcome these issues the Government made three key changes; initiated a debt for equity swap programme; allowed banks to reclassify Non Performing Loans as off balance sheet Wealth Management Products; swapped impaired local government loans for government debt.

“These factors helped accelerate bank lending, temporarily reflating the economy, however unlike the last Chinese banking crisis (1994) these new loans are not going into productive activities. This means that the Chinese economy needs QE and further currency devaluation.

5. Increased UK bank lending suggests the BoE was wrong to re-initiate QE and cuts rates However, expect Sterling to strengthen despite worries over Brexit

“Weak sterling, base effects and increased bank lending all point to a change of direction for the BoE. Sterling has weakened significantly since the Brexit vote. While fear of a “hard” Brexit is one explanation, BoE policy is another – cutting rates and re-introducing QE can be expected to weaken a currency significantly. There has already been a pickup in UK bank lending since Q1, which has turbo charged UK monetary expansion, suggesting the UK has a growing inflation problem requiring BOE action. Language has already changed to reflect the new reality. Therefore we could expect QE to end and possibly a reversal of the August rate cut.

“Change in the political climate across the developed world represents the first significant shift in the post-Global Financial Crisis policy debate. While the efficacy of current fiscal plans are unproven, investors will view this as a move to a pro-growth, pro inflationary environment, which could help sustain the value led equity rally. However, the Fed is likely to be emboldened to deliver rate tightening in accordance with current guidance, leaving market expectations to play catch up, with the likely consequences of higher bond yields and a stronger Dollar. Both of which would cause stresses, as US Dollar money supply contracts and re-financing costs rise. This could create the first real test for US high yield given poor earnings cover and suggest Developed Markets will outperform Emerging Markets. Concurrently, UK bank lending suggests a reversal of recent BOE policy, which could mean that Sterling is a strong currency in 2017.”

- ENDS-

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