Policy risk evident in bond markets
While market commentators sometimes downplay the impact of elections, the reality is that they can lead to policy changes that shape economic fundamentals for years to come. Bond markets are now starting to price in some of these shifts. In the UK, the first Budget from a new government envisages significantly higher borrowing levels, with only a relatively modest pick-up in growth. UK bond markets are not happy, sending long-dated yields towards the highest levels in two years. Meanwhile, US treasuries have also been under pressure in recent weeks as investors started to anticipate Trump’s victory, along with higher levels of borrowing and inflation. Other major bond markets, such as Germany’s, have followed the broader move higher in yields. So far, equities have not been significantly impacted by the bond market moves. However, recent years have shown that bond market volatility can quickly spread to stock markets.
Republicans hoping for a clean sweep
The US election results are not yet final, but it now looks very likely that Donald Trump will become the next US president. The Republicans have won the Senate and have a good chance of winning the House of Representatives, although results for the lower house of Congress may not be clear for a few days. This “clean sweep” would put them in a strong position to enact their policy agenda. While some proposals – such as corporate tax cuts – would be good news for corporate earnings, Trump’s agenda also comes with risk. Tax cuts and tariffs could rekindle inflationary pressures in the US and force the Federal Reserve to keep interest rates “higher for longer.” Bond markets could also take fright at the prospect of higher debt and deficits. For now, major stock markets have focused on the positives and rallied as the election results emerged.
Additional Chinese stimulus
While all eyes are focused on the US, there are also major policy shifts underway in China. The third quarter reporting season included more than a few references to China’s slowdown: LVMH, Apple and Volkswagen were just some of the major Western companies to report weak sales in the country. Investors might have been more concerned if Chinese authorities hadn’t launched a significant monetary stimulus package shortly before quarter end, giving rise to hope that the Chinese economy has bottomed. Economists believe that the government is also preparing targeted fiscal measures to address challenges in the property market. Concrete proposals are expected early this month, but details have been lacking so far. Officials may be waiting for the US election result before finalising their approach.
Positioning
We have become more positive on equities following the US election. There is now greater political certainty in the US, while global growth remains relatively healthy and should be supported by more supportive monetary policy in the US, China and Europe. We are also likely to see fiscal support in the form of tax cuts in the US and support for the property market in China. At the same time, equity valuations remain high relative to other asset classes and, in the case of the US, relative to history. We now have a neutral stance on bonds. Given the recent increase in market interest rate expectations, we are lengthening the average maturity of our bond exposure towards benchmark levels (i.e. neutral duration). We still like some alternative assets and have benefited from this year’s rally in gold and other commodities. However, the relative appeal of alternatives has fallen as interest rates have risen and we are now slightly underweight the asset class at a portfolio level.
