The U.S. elections have delivered a resounding victory for Donald Trump, as well as a Republican sweep of U.S. congress. The real policy impact of a new Trump administration will remain to be seen next year.
We do not expect Trump to implement every idea he floated during the campaign, but there will be a noticeable policy change next year. We will try to determine the potential impact on our investment strategy.
President Trump won the White House with 51% of the popular vote and 312 electoral votes (Associated Press), becoming the first and only president since Democrat Grover Cleveland in 1892 to win a second, non-consecutive term. Trump not only won the southern states but also swept the so-called “Blue Wall” or Rust Belt states of Pennsylvania and Michigan. Trump’s victory brings a popular mandate that will likely lead to deregulation, possibly lower taxes and higher trade tariffs. A higher budget deficit and immigration reform are also in the cards. Foreign policy will become more unilateral, with U.S. assets outperforming initially.
The rally in the U.S. stock market can continue in the coming months but rising bond yields could eventually spoil the party.
- Macro Trend Continues
- U.S. Election – President Trump
- The Fed’s Policy
- Equity Markets
- How is the Euro?
- China’s Problem
- Too Many Chinese Homes
- Fiscal Stimulus to the Rescue?
- Trump’s Deal with China
- The Case for International Equities
- What About Gold?
- Our Portfolio Positioning
Macro Trend Continues
The month of October was another volatile month driven by wild swings in employment data and the run up to the U.S. elections. However, macro-economic trends continue to unfold with inflationary pressures set to slow well into next year. While the labor market is weakening, the Fed has begun to shift policy to prevent unemployment from rising. Some cyclical parts of the global economy seem to be bottoming. It is still too early to tell but there are reasons to believe that Jay Powell might be achieving a soft landing.
Low household debt, a resilient corporate sector, the U.S. housing shortage, and U.S. fiscal policy have acted as a buffer against recession this cycle. For now, household balance sheets and corporate profits remain robust. However, the housing sector, historically the most cyclical part of the economy, has begun to show some cracks. It is possible that consumers and corporates could keep the economy going. However, equities have already priced a soft-landing outcome.
The October U.S. jobs report had mixed signals and was skewed by hurricanes and industrial strikes. Importantly, revisions were substantial, showing 112,000 fewer jobs created than previously reported in August and September.
Stripping out the noise from these numbers, this report extends the “cooling, but not weak yet” labor market trend. Cyclical measures like involuntary part-time workers and discouraged workers were flat, while the share of permanent job losers among the unemployed ticked up.
Trump’s victory could trigger further significant stimulus from China, which could also give a boost to global growth. What China ultimately needs is for the central government to step up to provide liquidity to households, so they can spend to boost domestic consumption.
U.S. Election – President Trump
2024 is not 2016. To start, Trump’s victory is less of a surprise. Moreover, the macro context differs. The 2016 economy was the result of a tepid recovery, while the 2024 economy is cooling down from a period of overheating. The world needed reflation back then, but not now. The Trump victory could actually lead to a higher risk of a recession if bond yields rise significantly or if inflation starts rising again. Higher bond yields tighten financial conditions for an already cooling labor market and weak a global manufacturing sector. Trade tensions will only weaken global economic growth.
The Fed’s Policy
The Federal Reserve cut interest rates by 25 bps as expected yet introduced uncertainty on the timing of its next move. This month’s statement was relatively unchanged, except for the removal of a segment from September highlighting they had gained greater confidence about inflation moving sustainably toward target.
Powell’s comments signal a possible December pause if data keeps surprising positively. The Fed sees reduced downside risks to economic activity, making them less worried than they were in September about staying restrictive for too long. Ultimately, the meeting signalled that the Fed is loosening monetary policy, but it does not know how far and how fast it will cut rates.
In the past weeks Treasury yields have been rising on the outlook of more fiscal spending backed by a Trump administration. U.S. 10-year Treasury yields can go up further in the near-term but will soon meet resistance. The Fed’s latest rate cut, created an upper bound at around 4.6%, since yields should not rise much higher than the federal funds rate.
Equity Markets
Stock markets typically rally after U.S. Presidential elections and the initial market reaction to Trump’s victory was positive for risk assets.
We think equity markets can extend the rally because of the solid corporate earnings, strong consumer spending, cooling inflation and the continued rate cutting cycle.
Markets will continue to be volatile as they will try to guess the impact of the new Trump administration policies next year, but as long as the macro trend remains constructive for equity markets, the upward trend can continue.
How is the Euro?
The Euro area also has a need for lower rates, at least in the weakest parts of the region, which includes the largest economy, Germany. Especially after Germany’s government coalition collapsed last week, adding uncertainty to Germany’s industrial policy.
However, the overall region is not in poor economic shape, after having deleveraged last decade. The foundations under the consumer sector are particularly solid. Households have not spent their excess savings built up earlier this decade and have solid income and employment growth.
Euro area consumer confidence has been steadily improving, after suffering a huge shock in 2022 due to the war in Ukraine and related energy crisis. Still, consumers are hesitant to spend, and while the economy is not especially interest rate sensitive, the ECB is expected to steadily lower rates.
China’s Problem
China’s fundamental problem is that it saves too much. Its national savings rate is close to double that of most other major economies, which means households and companies are not spending enough. Meanwhile, the hole in aggregate demand created by the weakening housing market continues to grow. Historically, China’s elevated savings rate has supported high levels of investment. Unfortunately, that model is breaking down. Over the past 20 years, China’s share of global manufacturing value added has climbed from less than 10% to around 30%. As a share of global GDP, its trade surplus in goods stands near record-high levels. Not surprisingly, many of China’s trading partners are not happy with these developments. Trump has pledged to raise tariffs against Chinese goods from an average of 10% to 60%. Both the US and Canada have already slapped a 100% tariff on Chinese EVs. The EU intends to raise Chinese EV tariffs by as much as 45%.
Too Many Chinese Homes
This brings us to capital investment which is the bigger problem. In China’s case, it is useful to distinguish between investment linked to the housing market and other forms of investment. With respect to residential investment, the IMF reckons that housing accounts for as much as 20% of total economic activity in China. The problem is that China does not need more homes, so construction activity is bound to slow down in the coming years.
Considering that export-linked investment will come under pressure, this only leaves non-residential investment geared towards meeting domestic demand as the main channel by which China can recycle its flow of savings. And here we come to the main problem, which is that China already has enough industrial capacity to meet domestic demand. What China really needs is more domestic consumption.
Most of China’s current problems are a result of past policy choices. Beijing should have used counter-cyclical stimulus measures earlier when the property market started to fall to avoid the current deflationary environment. And some of its policy flip-flops have damaged business confidence, leading to a crisis of confidence among consumers.
Fiscal Stimulus to the Rescue?
In theory, it should not be difficult to boost consumption. People like to shop, after all, and if they are not spending enough, the government could just give them more money. Just like the U.S. & Europe did after COVID.
In China’s case, however, both practical and philosophical considerations limit the extent to which fiscal policy can spur consumption.
Can the threat of higher tariffs lead to a bigger Chinese stimulus package, and create an opportunity for Chinese equities? Not necessarily, as the Trump victory is not a surprise, and China’s stimulus plan was designed with this scenario in mind.
While stimulus is coming, it is unlikely to create a meaningful recovery in the near term.
Longer-term, with Trump in the White House it is now more likely that U.S. and China will reach a trade deal, but getting there will generate volatility. For the U.S. to get its desired deal, it needs to threaten credible pain.
Trump’s Deal with China
President Trump intends to use tariffs in his second term, but with the aim of making a grand bargain in China, and other trading partners. Such a bargain would include inducing Beijing to increase Foreign Direct Investment (FDI) into the U.S. Investors should expect lots of hemming and hawing as the newly elected President Trump engages in brinkmanship with China but should fade the hysteria as Trump intends to resolve the trade dispute, not perpetuate it. For Trump, national security and economics are not directly linked. At least not in the simplistic ways that many Washington DC insiders think.
The Case for International Equities
Goldman Sachs recently published it long-term return expectations and is forecasting a 10-year return of just 3% per annum for the S&P 500.
The last few years have been exceptional for stocks, with valuations far from cheap and concentration at all-time highs. This suggests lower returns going forward and Goldman agrees, publishing a paper to that effect. Their estimate is 3% a year for the next 10 years, with a range of -1% to +7%. But just because we agree with the above facts, does not mean investors should rush to sell stocks. In fact, the opportunity beyond the top 10-20 U.S. stocks as well as in international equity markets is pretty good.
First, let us cover the facts. Valuations are indeed elevated. Most measures point to all-time highs in valuation, on par with 1999 if not higher. Valuations are without doubt the most important driver of long-term returns – a high starting point leads to bad subsequent returns. But the key word is long-term, as valuation is a useless short-term indicator.
Though the average stock is not unreasonably priced, the drag in valuation comes from the top, which increasingly drives the index. The top ten stocks make up 36% of the S&P 500, higher than all previous peaks going back to 1925. The record of top stocks remaining at the top a decade later is sobering. Companies with disproportionate profits inevitably see competition and margin erosion, which is usually poorly anticipated by markets. Today’s high concentration means the inevitable fall from grace will hurt index returns more than in past episodes. In fact, Goldman’s analysis suggests that without such concentration, their long-term estimate would be 7% a year instead of 3% a year.
The last key driver worth mentioning is simple: bonds matter again. After multiple years of outsize returns, investors may want to lock in gains and park them in ~5% yielding bonds. Goldman’s estimates on this front are more aggressive than ours, but they see a 72% chance that stocks underperform bonds over 10 years.
What to make of these facts? 10 years is a long time and none of the above suggests an imminent correction. It might come next year, or in 2029. Timing it is next to impossible and thus liquidating stock positions is ill-advised. We believe investors should explore equal weight or large/mid-cap strategies instead of the top ten stocks that dominate retail accounts. Go global and own the cheaper European and Asian stocks alongside U.S. ones. Diversify into fixed income while rates are high so that your portfolios are more balanced.
What About Gold?
Gold has been on a tear, rising to new all-time highs this year. It has not only risen in U.S. dollar terms, but against all currencies.
Following the freezing of Russia’s FX reserves, strong demand from central banks has pushed gold to record highs. With all of Russia’s G10 FX reserves frozen, diversifying from the U.S. dollar to other major currencies is futile. Strained relations between the West and the Global South, particularly China, should continue to support central banks’ demand for gold.
Our Portfolio Positioning
We did not make changes to the portfolio strategy in the run up to the U.S. elections. The core portfolio has a balanced approach to risk with overweight positions to NASDAQ, China, and the healthcare sector.
We are currently neutral on duration in the fixed income part of the portfolio. If Treasury yields would rise further, we would potentially increase duration in the portfolio.
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
The Standard & Poor’s 500 (S&P 500) Index is a free-float weighted index that tracks the 500 most widely held stocks on the NYSE or NASDAQ and is representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.
The Nasdaq Composite Index is a market-capitalization weighted index of the more than 3,000 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks. The index includes all Nasdaq listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debentures.
