Whatever one thinks of the claims and counter-claims surrounding Donald Trump following his recent firing of the FBI's head, markets have been rattled. But arguably, equities are due for a correction and there is no reason for panic.
Equities in the US and to some extent the rest of the world have been hit by fears that controversy around US Donald Trump’s alleged attempts to influence probes into possible Russian manipulation of the November elections.
Regardless of what one thinks of such allegations (this publication is not inclined to speculate), talk, however wild, that the president could be impeached, or be prevented from doing his job because of endless investigations, have spooked markets. The days of the “Trump trade”, as the rally since November 9 has been called, may be drawing to a close - for now.
But how much of what is going on has anything to do with political theatrics, and how much of what has happened is an overdue correction? As economists like to point out, the US equity market is now more than nine years’ old, and history tells us that such a period is long in the tooth. With possible further US interest rate hikes in the pipeline, the “normalization” process could take a toll. Markets, as traders should know, usually price in expected or hoped-for changes; a key issue will be the ability of the Trump administration to deliver on promised cuts to America’s high corporate tax rates, and deliver on deregulation in areas such as banking. Policy stasis could take more shine off markets.
The general view of wealth managers appears to be that Trump’s problems were the catalyst for a pullback in markets that is arguably overdue. For example, this is the stance of Lim Say Boon, chief investment officer at DBS, the Singapore-listed banking group. “US politics may be a convenient trigger and driver. But the bigger and simpler story is that equities are richly valued, lack new drivers, and carry the burden of some pretty big expectations.”
“And a lot of those expectations have to do with the ability of Donald Trump to justify yet higher valuations - through tax cuts, fiscal stimulus, faster economic growth, and yet higher earnings. But the Trump has been piling up the markets’ doubts over his ability to deliver more than a new controversy every month. Or should that be a new one every day? And there are also policy uncertainties with regards to quantitative easing. The Japanese will probably continue into the foreseeable future. But the limits are discernible in the euro area. Meanwhile, the US faces the risk of a Big Shrink in the Federal Reserve’s balance sheet,” Lim Say Boon continues.
The market correction may ostensibly have been caused by the furore surrounding FBI director James Comey earlier in May and subsequent claims - not yet substantiated - that the president has sought to interfere with investigations into claims that Russia sought to swing the US national elections last year. Pioneer Investments, the US firm, has pegged impeachment risk at 10 per cent. BlueBay Asset Management, an investment firm, has branded the furore around Trump, and market movements associated with it, as “overhyped hysteria”.
That there has been a rise in market alarm is not in doubt. The VIX measure of S&P 500 volatility spiked over 50 per cent at one point, and Treasuries rallied as investors pushed back the prospect of a rise in higher US interest rates.
Mark Dowding, partner and co-head of investment grade debt at BlueBay Asset Management, argues for more of a focus on legislative agendas, and less on the shenanigans of the White House. “Our focus is primarily on whether this latest storm and the recent data releases have changed our fundamental view on the US economy. Here the answer is that it has not,” Mark Dowding, partner and co-head of investment grade debt at BlueBay Asset Management, said in a note late last week.
“This [last] week’s labour market data (claims at historic lows) and a strong Philly Fed survey reinforce our confidence that the underlying structural economy is robust and that as long as the S&P does not experience a much more severe down move, we see nothing to suggest that the Fed will deviate from their normalisation of rates. At the March meeting, the Federal Open Market Committee dots suggested five more hikes until the end of 2018 and we believe that this path will remain unchanged in June, with the FOMC hiking at this meeting and signalling a gradual path. This will take the Fed Funds rate back towards a neutral rate above 2 per cent in the year ahead, with the economy close to full employment and with inflation close to its target. In this context, we believe that the pricing at the front end of the US curve is more asymmetric than ever, with market prices discounting no more than two hikes between now and the end of next year,” Dowding wrote.
“As we look ahead, we continue to voice the view that Capitol Hill remains more important with respect to the US legislative agenda than the White House. Trump appears to be a bit of a circus - but even were he to exit the stage, the prospect of Pence would probably be viewed even more bullishly by business and financial markets. In the short term, we see the announcement of a Special Counsel to take control of the investigation into potential collusion with Russia is a constructive step. Robert Mueller [new FBI head] is a hugely respected figure by both Democrats and Republicans and will have free reign to provide a decisive ruling on whether there is a case to answer on collaboration between the executive branch and the Russian state. This will not be a quick process, but it’s our expectation that it will calm the overhyped hysteria,” he added.
What does seem clear, from Family Wealth Report’s conversations with the industry, is that political views of investors are leading to some very different asset allocation decisions. Atlantic Trust (an interview item is forthcoming) has told this publication that there is a yawning gulf between the risk appetite of a pro-Trump investor confident of certain changes taking shape, and a worried anti-Trump individual fearful about the direction of financial markets. These political differences are having significant effects on asset allocations, Atlantic Trust says.
Perhaps what all these issues suggest is that for high net worth and ultra-high net worth individuals, now more than ever it is important to stand back from the political fray and think about what are the medium- and long-term drivers of return, while having the tactical nimbleness to move when required. A certain stoicism in the face of all this drama isn’t always common. Wealth managers can really prove their value by trying to instil a measure of calm.