MARKET UPDATE 19/11/2024

Market sentiment: Hesitant. The rally on Wall Street, that accompanied the re-election of Trump has paused. This is possibly a response to higher Treasury yields, on fear of resurgence in inflation resulting from some of Trump’s proposed economic policies. It may also be a response to high stock price valuations. The trailing price/earnings ratio on the S&P 500 currently stands at 30 times, a three year high. Investors in non-U.S financial markets are similarly waiting, specifically to find out what a new U.S tariff regime will look like, and their own country’s response.

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The VIX index of implied volatility on the S&P500 is currently at 16.6, slightly higher than the average over the last twelve months, but well below the recent peak of 23 seen on 31st October. This suggests that investors are not expecting volatile trading conditions over the next month. Indeed, many analysts suggest U.S stocks will be rangebound until inauguration day on 20th January, with investors waiting to see what economic policies materialise from the Trump White House.

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Investors should remain diversified, across asset classes and geographies. Financial history demonstrates that, over the medium and long term, the highest risk-adjusted returns go to the portfolios with the greatest number of low, or negatively, correlated assets.

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Where the opposition to Trump’s plans might come from. We broadly know the economic policies that Trump wants to pursue, and there is concern that they are potentially inflationary. In summary, Trump wants to see: higher tariffs on imports (60% on Chinese goods), tax cuts, the deportation of illegal migrants, and an ending of Federal subsidies for green investment projects.

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A wave of deregulation will permit more drilling for oil, an increase in risk-taking by banks, and more M&A activity as anti-trust laws are loosened.

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What we don’t know is the response from inside his support base. Given Republican control of Congress, arguably the Supreme Court, and the increasing irrelevance of mainstream media, it is from within the MAGA community that opposition to the above policies may emerge. Politics, like nature, abhors a vacuum.

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In Congress, small Republican majorities will encourage in-party splits, as opportunists exploit their party’s narrow hold on power (as former U.K prime minister, John Major, found in the early 1990s).

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Trump’s business doners have very different objectives. Eg, oil barons want petrol engines to continue, Elon Musk presumably doesn’t. Private equity backers of Trump will baulk at the prospect of inflation and an upward swing in interest rates, but banks are less concerned given that lending increases in a ‘hot’ economy, and net interest margins increase when interest rates go up.

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And while import tariffs will protect domestic manufacturers, how will the average voter respond to more expensive imported clothes, cars and iPhones?

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Furthermore, the interests of the business doners are far apart from the interests of the many poor Americans that voted for Trump. For all of the superior growth of the U.S economy since 2010, compared to other G7 countries, average health-adjusted life expectancy in 2019 stood at just 65. This is the same as in Blackpool, in the north of England, which is the lowest in the U.K. In West Virgina, it is 62*.

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The Treasury market may also flex its muscle, bullying Trump into modifying those policies that will create still-larger budget deficits and/or inflation. The upward shift along the Treasury yield curve, since Trump’s victory, suggests the bond market is on alert. However, the still-modest positive yield spread between 2yr and 10yr maturities of just 10bps suggests resurgent inflation it is not a widespread fear, and it may be that the risk is priced in. At the Fed, chair Jay Powell last week said he was ‘in no hurry’ to cut interest rates, given the continuing strength of household demand and relatively low unemployment. Markets are pricing in another December 25bp rate cut.

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America’s trading partners, and political allies, may also surprise with their response to the threat of higher tariffs.

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Wall Street winners? Higher-than-otherwise interest rates, together with bank deregulation and increased M&A activity, will benefit financial stocks. Miners and energy benefit from deregulation. Sectors that are relatively immune to import tariffs, such as hospitality and transport service sectors, will benefit more from increased consumption arising from tax cuts than will manufactures reliant on foreign supply chains. Companies whose leaders can curry favour with Trump, and influence policy, may also benefit.

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The large U.S tech stocks, that have driven the S&P500’s rally in recent years, may see no let up in regulatory pressure. Vice president JD Vance is known to be critical of their alleged monopolistic behaviour, while Silicon Valley has traditionally been perceived as left-leaning. However, their lobbying muscle is as strong as that of the banks and energy companies, and they potentially have an ally in Elon Musk.

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Losers? Those manufacturers dependent on foreign supply chains (eg, autos, aerospace and apparel), or on cheap illegal labour. Also, those who export a significant portion of their output to China, since retaliatory may follow any import tariffs instigated by Trump.

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Outside of the U.S. Elsewhere, European, Latin American and Asian stock markets are trying to price in the impact of higher U.S import tariffs, and a more unpredictable White House. Trump’s victory has spurred the E.U to take seriously the report it commissioned on European competitiveness by Mario Draghi. Released in September, he called for ‘more Europe’. Specifically, Euro 800bn investment in innovative industries, and the consolidation of the region’s telecoms, energy and finance industries to create global players. He wants a deeper debt market, and more joint issuance of debt by member states. Northern member countries abhor the prospect of being jointly liable for the debts of southern countries, while few member states are willing to see corporate national champions taken over by regional rivals (as the German government’s response to UniCredit’s creeping bid for Commerzbank has shown).

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The U.K. Having left the E.U, Britain has no great power behind it to negotiate down any increase in U.S tariffs. The new Labour government is faced with a stark choice. It can choose to tie the country more to the U.S, through a trade deal that will be unpopular at home. Congress has already made clear that it must include higher pharmaceutical prices for the NHS, and imports of American foods such as chlorinated chicken. Or the U.K can look to re-join elements of the E.U, such as the customs union, and so benefit from Brussel’s negotiating strength, and being inside the world’s largest trading bloc. But this is politically risky, the government will be taunted as a ‘betrayer’ of Brexit, not only by the right wing press, but also by the many Labour supporters who voted to leave the E.U.

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U.K gilt yields did not fall in response to a 25bp interest rate cut from the Bank of England last week, to 4.75%. In part, because it was expected. Also, they have been driven higher over the last month by the recent budget, that projected more borrowing than previously planned by the government, and by rising yields on U.S Treasuries. Two themes that look likely to persist.

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Non-U.S stock markets. U.S stock markets may well rally again once Trump begins putting in place his economic policies, and stronger demand lifts corporate earnings growth The country is home to global tech leaders, a position it is unlikely to relinquish soon. However, given the current high valuations on Wall Street, the cost of any disappointment to this theme could be high. Especially if it does come from a bond market sell-off.?

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Non-U.S stock markets look better placed to withstand a negative shock in the U.S. Economic growth is certainly slower elsewhere in the G7, but stock valuations are much lower, particularly in the U.K. The FTSE 100 is dominated by defensive sectors (eg, pharma, insurance, utilities energy), whose cash-generating predictability perhaps deserves more global investor attention than it currently gets.

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China’s bail out of local governments and new dollar debt issuance. Ten days ago Beijing announced a $1.4 trillion (Rmb 10 tr) stimulus package, aimed at restoring the balance sheets of local governments (allowing them to issue bonds, to help write off property-related debts, and to start investing again in the local economy). While welcome, investors are still waiting for a stimulus package aimed directly at raising household spending, and economic reforms that will reduce the perceived need felt by many Chinese to build precautionary savings.

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Last week China returned to the dollar bond market for the first time in three years, issuing $2bn of debt of varying maturities. Rather than Hong Kong, the traditional financial market for such sales, the sale was done in Saudi Arabia. It was twenty times oversubscribed, and the debt was sold with yields only a few basis points over U.S Treasury equivalents. Much of the demand reportedly came from Chinese investors, looking for a home for dollars held offshore. The size of the issue makes it relatively insignificant, coming from the world’s second largest economy. But the use of Saudi Arabia, a country China has been building up relations with, was symbolic. And the narrow spread over Treasuries is indicative of investor confidence in Chinese debt.

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Gold and Bitcoin have both reached fresh highs in the last three weeks. Gold peaked at $2,787 an ounce on 30th October, it then lost 7% of its value until yesterday when a strong rally lifted it to $2,620. While fear of inflation is good for gold, the rise in Treasury yields is not since the opportunity cost of holding a non-income producing asset, such as gold, increases. Bitcoin has reach $91 during several recent trading sessions. Trump has become a supporter of crypto currencies, and has spoken of creating a national reserve of crypto. This may have led to some front-running by investors.

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The Democrat party. Much has been written on where the Democrat party went wrong. One argument being made is that it remains condescending to those who are not within its tent.

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The party had numerous opportunities in recent years to demonstrate empathy for those outside its coalition of interest groups (eg, unions and gender/race groups). It could have used the ‘defund the police’ issue to separate itself from some of the stranger parts of progressive politics. It should have been as interested in protecting free speech on university campuses, during recent protests over the Middle East, as the Republicans. These were missed opportunities to speak to non-college white males, catholic Hispanics, etc, and to show it is a party that goes beyond the narrow interests of its constituent member groups.

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Instead, Joe Biden let slip his scorn for Trump supporters just before the vote, in a similar manner to Hilary Clinton in 2016.

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Rangebound sterling. Sterling stands at $1.26, having lost four cents since the U.S election. Higher than previously expected U.S interest rates and Treasury yields should help the dollar, but since a loose fiscal/ tight monetary policy combination is also happening in the U.K, the result may be a continuation of what has been range bound trading, of between $1.20 and $1.30, over the last two years.?