The so-called Trump trade is in trouble.
While US Treasury yields and the S&P 500 appear to have responded well to Congress’s passing of Obamacare repeal at the second attempt, specific sub-sectors of the US equity market are now demonstrating palpable scepticism around the Trump administration’s ability to kickstart growth.
For example, financials stocks which fared so well in the aftermath of the November election have underperformed the broader market so far this year while IT stocks – broadly independent of US growth prospects – have raced ahead. Likewise, baskets of high tax-paying, domestic US stocks have underperformed as investors have downgraded the likelihood of significant corporate tax cuts any time soon.
If Republican control of all three houses fails to guarantee the pro-growth agenda a smooth legislative path, where then will this leave markets and investors?
Not all about Trump
While the apparent delay of what were seen as ‘Good Trump’ policies, i.e. tax reform and infrastructure spending, has given many investors cause for concern, it also means that the administration’s worst excesses are held at bay.
Take trade for example.
The White House’s apparent abandonment of efforts to reverse NAFTA reveals the administration’s newly lowered ambitions. Likewise, president Trump’s decision to step back from labelling China a currency manipulator at his recent meeting with president Xi adds to the familiar sense of business as usual in Washington.
While it is probably too early to conclude that the president’s agenda is neutered (tax reform will be attempted again), it makes sense to re-evaluate a market environment less burdened by expectation.
The good news in this regard is that the US and indeed the global economy are in reasonable shape. It is true that some ‘hard’ US data are lagging, with Q1 2017 GDP growth soft.
But US corporate earnings are improving, as shown by the 13% year-on-year growth rate reported so far this earnings season thanks to more stable energy prices, a stronger manufacturing sector and better trading conditions for financial institutions.
And of course jobs are being added apace to the economy, albeit with some seasonal distortions in recent months.
Beyond the US, global reflation was always an independent phenomenon to the Trump trade.
In Europe, economic data and company earnings are improving. The benign outcome of the French election is refocusing investors’ minds on these better fundamentals.
Emerging markets meanwhile, particularly in Asia, remain the epicentre of the global manufacturing revival. China is playing its part, with strong industrial production and retail sales driving growth higher than expected in the first quarter, at nearly 7% on the previous year.
All of this suggests that equities remain fundamentally supported and the fact that they did not melt down following the initial Congressional failure to repeal Obamacare suggested they were never fully reliant on heightened US growth expectations anyway.
While it is true that the global equity rally has endured for over eight years now, history suggests that market cycles don’t die of old age or valuation, but instead of fright.
It is not clear today where the major imbalances lie. Economic growth is not credit-fuelled this time around for example.
If pushed, one might point to expensive US high yield bonds or imbalances in the Chinese economy. And of course there is ever-present geopolitical risk. But these are not especially new developments.
Time for a correction?
While fundamental market support is reassuring, some kind of temporary adjustment would nonetheless be welcome.
The S&P 500’s 30-day trading range is near its lowest since the end of the 1970s and volatility remains low.
The market run-up since November 2016 has been almost unbroken, with moments of doubt translating merely into market pauses rather than outright sell-offs.
Investors naturally dislike turbulence, but its absence for too long is disquieting and might eventually start to speak of complacency. For those of a tactical bent, disillusionment with Trumponomics and its promises to double US GDP growth to 4% raises hopes of a correction.
Warren Buffett famously declared once that 'volatility is a long-term investors’ best friend.'
Secure in the knowledge that fundamentals are reasonable, any sell-off that becomes excessive – and they often do – represents an opportunity to buy stocks at cheap levels with potential upside later. The last real example of such a market move was in the first quarter of 2016. We are probably now overdue another.
A president frustrated at not being able to implement his policies quickly could lash out in order to demonstrate near-term strength. A trade war could be one such outlet, while foreign policy adventures might be another.
Recent airstrikes in Syria and rhetoric around North Korea could fit into the latter mould. However, these are not core risk scenarios from an investment standpoint.
Rather, growing scepticism around the much-vaunted Trump growth agenda should be seen as constructive in that it forces investors to assess the fundamentals as they find them rather than as they imagine they might be.
On this basis, the investment landscape is not found wanting, but equity markets would certainly benefit from some degree of consolidation if only to sweep the top layer of froth away and set a trajectory of modest but sustainable gains over the medium term.
A famous Calvin and Hobbes cartoon saw Calvin declare: “Happiness isn’t good enough for me! I demand euphoria!” From an investment perspective however, mere happiness is preferable.
Julian Howard (above) is head of multi-asset solutions at GAM