In a year of shock surprises and experts getting it wrong on big issues like Brexit, Trump and the market reactions to those outcomes it has been difficult to make reasoned logical analysis of the investment markets and their trajectories.
I have waited till now to offer a more considered position in this newsletter once all the outcomes have been “delivered” for 2016.
There is now an emerging “trend theme” for the USA as well as the obvious risk of an interventionist Trump, with one Tweet too many causing a major fallout.
The Theme Overview: Trumpenomics
The key theme is that the Trump presidency will generate domestic growth that pushes up inflation, the US dollar and interest rates. The US growth will trigger growth globally as well.
- Trump will significantly lower corporate tax and that will spur investment activity by the large corporates and also repatriate funds held offshore. This will fire up the US share market – and funds have and will continue to flow into the US market as a result – over the short – medium term.
- He also plans to create jobs and economic activity with infrastructure spending.
The US does have a number of projects which could be fired up – as a catch up exercise with China.
- He also is not afraid of creating debt – as a generator of growth and jobs.
However, Trump sees a poor America needing to be fired up, while Janet Yellen of the US Fed sees a stretched America that is getting close to full capacity, with low unemployment at 5% and inflation starting to rise but currently 2%. Further economic stimulus could fire inflation and trigger significant interest rate rises over the next 12-18 months. There have already been suggestions that the next US rate rise could occur in March.
[ In Bond markets as rates rise the capital value of existing bonds on issue fall since they were issued previously with a lower payment rate and are less valuable on the secondary market – compared to new issues. Hence in the short term money tends to seeks “safety” in the equity markets which may be rising.]
The effects of “Trumponomics” on the markets are that Initially this could cause a significant inflow of funds into the US share market – from fixed interest funds and also raise the US dollar. That could continue for about 6-12 months, but at some point a sharply rising US dollar with rising interest rates could cause either a mini recession or flatling of growth and market correction. If and when is unknown, but probably more likely to be in 12 months.
However, the pressure of money “looking for a home” is likely to be on the equities markets for a period.
The bigger risk of interest rates rising more quickly is the flow on effect to mortgage interest rates in Australia at a time when the property market is “overvalued” in a number of areas. Brisbane, Melbourne and Sydney.
The major Australian banks source a large portion of their funding for mortgage debt from low cost overseas sources. If the rates rise significantly there then the lenders will seek an effective margin on the new cost base. Mortgages could rise at a slightly faster rate to provide a buffer and a degree of certainty that the lender will be suitable compensated for future rate rises.
The pressure for this is more likely to occur once the next 6 months has passed, but this may coincide with the expected surplus of apartments, mostly in Brisbane and Melbourne – but also parts of Sydney.
While the U.S. investment markets could sail onward and upwards the Australian property market may well sag. A rising U.S. dollar and a falling Australian dollar will assist the Australian share market.
BUT – Of course the Tweeting and Executive Orders from the President could also trigger a backlash along the way – independent of the economic or investment situation.
Trump Tweets & Executive Orders: Trump Diplomatics
The Trump management style is to berate companies and industries into submission and achieve economic policy by intimidation.
This was last done successfully by FDR (Roosevelt) in the 1930’s, during the depths of the Great Depression, when he forced through new legislation and the “New Deal” for impoverished Americans.
Trump’s style has had a significant effect since the election win in November. At some point it will wear thin and more than one company will call his bluff.
Additionally, actually getting legislation through Congress has a track record of being more difficult than many expect. There is a long history of Presidents failing to achieve more than 5%-10% of their stated legislative targets and objectives. This will probably include Trump as well – although it will take time to show through.
Internationally however, this may trigger a more serious fallout that impacts the current growth story. Just as I write – the ban on Muslims entering the USA has been executed as an Executive Order by the President – and the fallout has yet to be fully assessed.
Now there is the attack on the EU, nominating Germany as using the Euro to undercut the U.S. dollar – a negotiation tactic. But quite blunt.
It is not hard to imagine that something else or a series of issues may knock the investment markets down as a cautionary reaction.
It will be a volatile couple of years – and despite the trend theme outlined above – the uncertainly will continue and at times seem overwhelming and may trigger a market reaction.
Based purely on economic probability about 12 months out – but when you add in politics maybe sooner.
However, we were told Brexit wouldn’t happen and a Trump Presidency wouldn’t happen.
I am happy to say that even if the case above has a 70% probability of occurring the other 30% could still surprise.
So, in bullet point form the following expectations for 2017 are the most likely outcomes:
- The USA will continue to grow and generate some welcomed inflation – so that deflation becomes a non issue. The interest rates will probably rise at a faster rate than was expected 12 months ago.
- The investment markets will also improve and rise in line with positive news and sentiment. This will last between 6-12 months before a slump arises when the markets overshoot. Unrealistic over expectation will become more obvious and reality set in at some stage within that 6 – 12 months, once interest rate rises are seen as a bit more than desired in the circumstances.
Some form of correction would then seem inevitable within that time frame.
- Of course it would only take a serious mini crises triggered by a Trump tweet to start a series of negative sentiments to pervade the investment markets at an earlier stage as well.
- Rising interest rates in the USA could well have a knock on effect through the world, and in Australia housing interest rates will also rise at a faster rate than initially expected. Since most major banks have offshore borrowing as a key element in their home loan funding. Reshuffling their source of funding can take time – and their profits are more important.
Although some forecasters think the RBA will cut rates – this seems unlikely to affect mortgage rates if U.S. rates are rising as well. In any case the RBA will be very reluctant to cut any further since any further cuts will have a negligible effect.
This will also probably start to flatten the property market mostly everywhere, particularly in Brisbane and Melbourne in 2017 and have stronger effect in 2018 – but it will be interesting to see how it affects Sydney. Infrastructure spending, Air B’nB investors buying, and overseas interest, as well as no clear overbuilding except in some pockets may keep the Sydney market afloat to some degree.
- Europe is facing more issues again – which seem to be insurmountable, with pressure to within Italy to exit the Euro and political pressure in France from the hard right.Fortunately, much of the Euro zone issues are localised since the economic impact of the Euro zone is still steadily shrinking as a percentage of world GDP. So if there were to be more ructions and there most likely will be – they will be both anticipated and also discounted.
- China seems to have been caught out with some provinces admitting to fudging their past GDP growth rates – to meet targets. If the real (lower) growth rate unravels further then there could be some significant knock on effect for Australia.They have just recently suspended their monthly domestic property pricing reports – so as not to spook the market with falling price figures. Who knows what else they may manipulate – and what the effect will be.
It will be a fascinating year to watch…….
From an investor’s perspective this is a key time when strong active investment management by the funds that PSK and I view as having solid track records come into their own. Picking a path through the minefield – so that longer term investment potential is retained while minimising short term – high volatility.
If you have friends or family – who have doubts about their investments or their superannuation – get them to have a conversation with me about options available to them - and how they can be better off in the longer term with good financial management.
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