Trump's surprise election flipped the equity markets upside down. Sectors which had outperformed became a source of funds as investors sold them to invest in maligned financial and energy stocks. This volatility has created no shortage of opportunities in 2017, but investors need to pay attention to these five factors over all else:
- Will we finally get inflation? For eight years now global central banks have been working to create inflation via quantitative easing – with little success in the U.S. and outright deflation in Europe and Japan. Trump’s election has rekindled “animal spirits” amongst market participants due to multiple inflationary prospects: billions in infrastructure spending, cash repatriation, tax cuts and immigration reform. However, the market appears too sanguine on the chances of full passage given typical government gridlock. With many stocks fully pricing in reflation, investors need to be wary of heightened expectations heading into first quarter earnings.
- Macro or micro? It seems the baton has finally been passed from monetary stimulus to fiscal stimulus as the Fed fades into the background. The central bank era – whether truly over or not – has been terrible for stock pickers as highly-correlated markets move in a “risk-on, risk-off” fashion. Will 2017's best trades be macro-based or should investors focus primarily on individual company analysis? Year-end 2016 showed that sector rotation was the theme as investors moved out of high-yielding consumer staples, REITs and utility stocks into basic materials and industrials. This will likely continue and investors need to analyze beyond daily index performance (S&P 500/Dow) as there is plenty of movement “under the surface.”
- The revival of active management? Fundamental analysis has not always been rewarded in said highly-correlated markets. However, equity correlations have collapsed to five-year lows following Trump’s election and the industry is hopeful that stock picking will pay off rather than attempting to front-run Fed rate decisions. 2017 could finally be a bright year for the struggling asset management industry which has performed poorly and witnessed constant pressure from outflows and redemptions. Ultimately, it may take a crash or a recession for hedge funds to remind investors why they are worth the fees.
- King dollar – friend or foe? Ironically, the dollar’s recent strength - now trading at fourteen year highs - is serving as a headwind to Trump’s policy goals. Even if American manufacturing experiences a revival, currency pressure will weigh on exports and consolidated S&P 500 multinational earnings. Furthermore, this makes it difficult for the Fed to hike two or three times in 2017 as the market has already sold the short end of the Treasury curve in anticipation. With consensus leaning towards a 100% chance of multiple Fed hikes, be wary of ‘black swan’ type events similar to Brexit and Trump’s win in 2016.
- What happens to European credit? Out of all global asset classes, none seem more disconnected from fundamentals than European sovereigns. While most 10-year yields have backed up out of negative territory, many remain at historic extremes: German 10-year bunds yield 32 bps, France’s 10-year yields 77 bps, and even Greece – previously thought to be insolvent! – can borrow for 10 years at 6.75%. Political risk in the European Union will be a key talking point heading into Italy’s elections this month as populism continues to spread around the globe.
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