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#PresidentTrump - What now for Markets?

Wednesday, November 09, 2016

GAM investment managers comment on their sectors of expertise following the outcome of the US elections.

Christophe Eggmann

“Trump win could boost healthcare M&A”

Christophe Eggmann – Healthcare stocks

The outcome of the US elections could not have been more positive for drug companies. The clean Republican sweep may spell trouble for Obamacare but democratic proposals to curb drug pricing are off the table. In addition, voters in California rejected a contentious initiative aimed at lowering the price of drugs paid by California state entities. This is another positive for sentiment, and we expect the market to react very positively.

The sector is trading with a 10% discount to the overall market, the highest discount in five years, and biotechnology is trading at record-low multiples. We expect the outcome of the election to help the case for a re-rating of the sector sooner rather than later. Also we expect M&A activity to pick up in the next months helped by the quest for growth, large cash balances and the prospect of corporate tax reform in the US, including a repatriation bill targeted at offshore assets.

Tim Love

“Following the massive Mexican peso sell-off, we reckon it may be just as risky to heavily underweight Mexico as it is to overweight it.”

Tim Love – Emerging markets equities

Emerging market (EM) equities, like a lot of global equity markets, were mostly wrong footed by this election result. By underestimating the potential for a populist backlash on mainstream politics, risk/return on EM assets is being tested for the downside of Trump’s arguments.

On the optimistic side, the corporate environment in the US may benefit from lower taxes, less regulation and a generally more business-friendly sentiment. It is also clearly a plus that the new President has a good chance to end Washington’s gridlock, with both Upper and Lower House majorities. But – and that is the critical question – could the new drive to a “pro-US economy” slip into full-blooded protectionism? Will there be more reciprocal business fines and regulatory hurdles for foreign corporates to overcome? A world of heightened trade and regulatory concerns is not good for EM free trade.

It will crucial to see if Trump downplays his campaign rhetoric on key divisive policy areas. Mexico was one of the main targets, but it is debatable to what extent it will have an actual serious economic impact. Following the massive sell-off (MXN -9%), we reckon it may be just as risky to heavily underweight Mexico as it is to overweight it. The currency weakness may last, and Mexican global exporters are likely to be the beneficiaries relative to domestically focused companies.

If the US withdraws from WTO initiatives and free trade agreements, such as TTIP, losers will include Taiwan and Korea. China would also be another free-trade rollback loser – and if the market there is holding up, it is partly due to the local perception that in geopolitical terms and compared to Clinton Trump may be the lesser evil for China. A potential reduction in the degree of the NATO security blanket for the Western alliance, and for Eastern Europe in particular, is another risk, affecting Poland and the Baltics as well as Romania.

Just like after Brexit, we continue to focus on domestic drivers in EM economies that are shaping this so-called “new world order”, to which Western electoral campaigns are merely responding. Such drivers are huge infrastructure spending (China wants to build 500 new airports by 2020), or fiscal and societal reforms, supported by technological advances (India’s announcement today to abolish large banknotes, fighting corruption and fostering its evolution towards becoming a fintech hub).

1 Brexit

“Best EM prospects are countries not primarily dependent on the US role in globalisation: Brazil, Russia and the European economies.”

Paul McNamara – Emerging markets fixed income

The US election was a surprise, and not what our portfolio was positioned for. We stand by our view that this outcome represents an important move against globalisation and the economic climate underpinned by Washington – IMF and World Bank as well as US Administration that has dominated for the last 30 years. The election represents a major change and we would be wary of underestimating its importance.

That said, initial price action has been substantially less severe than we would have guessed. Apart from Mexico – where the peso is 10% weaker – most EM currencies are doing better than in the aftermath of the UK Brexit referendum. We continue to feel that the best EM prospects are countries not primarily dependent on a significant US role in globalisation – so away from Mexico and Asia, towards Brazil, Russia and the European economies. The key element here is uncertainty and the immediate future will provide more information.

1 Brexit

“US inflation expectations should increase - due to the risk of higher trade tariffs.”

Enzo Puntillo – Fixed income (Zurich)

Increased uncertainty on political and economic policies will increase short-term market volatility. The largest global market risk is likely to come from uncertainty on trade policy. If fully implemented, the increase in trade tariffs would be a large set-back to globalisation and its multi-decade benefits – in the long term, this effect should not be underestimated. Additionally, this could potentially translate into higher inflation, particularly in the US, as the US economy is already almost at full capacity.

When it comes to monetary policy, at least for us it remains unclear if it will turn more restrictive or expansionary. What makes sense is that higher US inflation expectations should put pressure on bond prices due to trade tariff risk, and also US swap spreads should go even further into negative territory due to a substantial increase in fiscal deficits.

Regarding current market risk, we take Brexit as a comparable reference point (election result against the market’s expectation, with lack of details on the policy decisions that will follow). That experience would suggest us that, rather than a long-lasting period of broad-based market turbulence across all asset classes, general market fears could disappear and stay confined within the “epicentre” of the issue, until the dust settles. In this case, Mexican assets are a clear favourite in the EM space. We have not changed our generally positive view on EM based on improving fundamentals, the rebalancing story and valuations, but we are specifically focusing on Mexico, were we already reduced exposure in MXN before the election, and we are currently reconsidering our position in fixed income assets.

1 Brexit

“We are looking for opportunities to increase back risk levels, for instance in Mexican or Brazilian bonds”

Jack Flaherty – Fixed income (New York)

Markets do not like uncertainty, so following the news of a Trump victory there was a knee jerk move to sell risk assets, with the Dow Jones Average down over 800 points at one point. Those losses were curbed dramatically as the prospect of a Republican House, Senate and Presidency could be seen as more pro-business than the previous administration. Trump has promised to roll back regulations and make it easier for business to prosper. On the other hand, his protectionist rhetoric is worrisome and also symptomatic of the bigger populism we are seeing worldwide. Right now we are looking for the dust to settle a bit and opportunities in order for us to increase back risk levels.

Credit markets in the US also showed early weakness but are rebounding. Treasury markets, which would be seen as a beneficiary of a flight to quality assets, are instead focusing on some of the economic ramifications of a one-party US government. On the surface, Trump’s plans would be stimulative and add to the deficit.

Worries over Trump’s stance on Mexico has led to weakness in the peso but it has rebounded from the worst. Our portfolios had recently pared back risk ahead of this event. Our credit exposures have decreased and any spread widening should not have a material impact. We would see serious weakness as a buying opportunity. Defaults have actually already peaked over the short term. Our outright foreign exchange exposure to Mexico is our smallest this year (compared to other FX risk such as AUD, NZD and KRW) and it is partially hedged with MXN put options and JPY call options. The Trump victory should encourage the recent steepening of core yield curves to continue (more fiscal easing and reduced term premium), a theme we favour. It may also allow the rates outright sell-off to continue a little while further. The USD faces a number of cross currents and, for the time being, we don’t have a strong directional view on it versus the EUR and the JPY.

In emerging markets (EM), Mexican assets are likely to experience some continued volatility but we would view any material sell-off in Mexican bonds in particular as an opportunity. The recent monetary tightening and likely hit to sentiment is expected to cause the Mexican economy to slow over the coming 12-18 months, and should mean any inflationary shock arising from currency weakness will not feed on itself. Any contagion from the Mexican peso to the Brazilian real may slow the recently started easing cycle but will not prevent it, in our opinion. We continue to favour long-dated Brazilian bonds, and would again view weakness over the coming weeks as an opportunity to play for a deeper easing cycle than the market is currently pricing.

“Trump win could boost healthcare M&A”

Christophe Eggmann – Healthcare stocks

Christophe Eggmann

The outcome of the US elections could not have been more positive for drug companies. The clean Republican sweep may spell trouble for Obamacare but democratic proposals to curb drug pricing are off the table. In addition, voters in California rejected a contentious initiative aimed at lowering the price of drugs paid by California state entities. This is another positive for sentiment, and we expect the market to react very positively.

The sector is trading with a 10% discount to the overall market, the highest discount in five years, and biotechnology is trading at record-low multiples. We expect the outcome of the election to help the case for a re-rating of the sector sooner rather than later. Also we expect M&A activity to pick up in the next months helped by the quest for growth, large cash balances and the prospect of corporate tax reform in the US, including a repatriation bill targeted at offshore assets.

“Following the massive Mexican peso sell-off, we reckon it may be just as risky to heavily underweight Mexico as it is to overweight it.”

Tim Love – Emerging markets equities

Tim Love

Emerging market (EM) equities, like a lot of global equity markets, were mostly wrong footed by this election result. By underestimating the potential for a populist backlash on mainstream politics, risk/return on EM assets is being tested for the downside of Trump’s arguments.

On the optimistic side, the corporate environment in the US may benefit from lower taxes, less regulation and a generally more business-friendly sentiment. It is also clearly a plus that the new President has a good chance to end Washington’s gridlock, with both Upper and Lower House majorities. But – and that is the critical question – could the new drive to a “pro-US economy” slip into full-blooded protectionism? Will there be more reciprocal business fines and regulatory hurdles for foreign corporates to overcome? A world of heightened trade and regulatory concerns is not good for EM free trade.

It will crucial to see if Trump downplays his campaign rhetoric on key divisive policy areas. Mexico was one of the main targets, but it is debatable to what extent it will have an actual serious economic impact. Following the massive sell-off (MXN -9%), we reckon it may be just as risky to heavily underweight Mexico as it is to overweight it. The currency weakness may last, and Mexican global exporters are likely to be the beneficiaries relative to domestically focused companies.

If the US withdraws from WTO initiatives and free trade agreements, such as TTIP, losers will include Taiwan and Korea. China would also be another free-trade rollback loser – and if the market there is holding up, it is partly due to the local perception that in geopolitical terms and compared to Clinton Trump may be the lesser evil for China. A potential reduction in the degree of the NATO security blanket for the Western alliance, and for Eastern Europe in particular, is another risk, affecting Poland and the Baltics as well as Romania.

Just like after Brexit, we continue to focus on domestic drivers in EM economies that are shaping this so-called “new world order”, to which Western electoral campaigns are merely responding. Such drivers are huge infrastructure spending (China wants to build 500 new airports by 2020), or fiscal and societal reforms, supported by technological advances (India’s announcement today to abolish large banknotes, fighting corruption and fostering its evolution towards becoming a fintech hub).

“Best EM prospects are countries not primarily dependent on the US role in globalisation: Brazil, Russia and the European economies.”

Paul McNamara – Emerging markets fixed income

1 Brexit

The US election was a surprise, and not what our portfolio was positioned for. We stand by our view that this outcome represents an important move against globalisation and the economic climate underpinned by Washington – IMF and World Bank as well as US Administration that has dominated for the last 30 years. The election represents a major change and we would be wary of underestimating its importance.

That said, initial price action has been substantially less severe than we would have guessed. Apart from Mexico – where the peso is 10% weaker – most EM currencies are doing better than in the aftermath of the UK Brexit referendum. We continue to feel that the best EM prospects are countries not primarily dependent on a significant US role in globalisation – so away from Mexico and Asia, towards Brazil, Russia and the European economies. The key element here is uncertainty and the immediate future will provide more information.

“US inflation expectations should increase - due to the risk of higher trade tariffs.”

Enzo Puntillo – Fixed income (Zurich)

1 Brexit

Increased uncertainty on political and economic policies will increase short-term market volatility. The largest global market risk is likely to come from uncertainty on trade policy. If fully implemented, the increase in trade tariffs would be a large set-back to globalisation and its multi-decade benefits – in the long term, this effect should not be underestimated. Additionally, this could potentially translate into higher inflation, particularly in the US, as the US economy is already almost at full capacity.

When it comes to monetary policy, at least for us it remains unclear if it will turn more restrictive or expansionary. What makes sense is that higher US inflation expectations should put pressure on bond prices due to trade tariff risk, and also US swap spreads should go even further into negative territory due to a substantial increase in fiscal deficits.

Regarding current market risk, we take Brexit as a comparable reference point (election result against the market’s expectation, with lack of details on the policy decisions that will follow). That experience would suggest us that, rather than a long-lasting period of broad-based market turbulence across all asset classes, general market fears could disappear and stay confined within the “epicentre” of the issue, until the dust settles. In this case, Mexican assets are a clear favourite in the EM space. We have not changed our generally positive view on EM based on improving fundamentals, the rebalancing story and valuations, but we are specifically focusing on Mexico, were we already reduced exposure in MXN before the election, and we are currently reconsidering our position in fixed income assets.

“We are looking for opportunities to increase back risk levels, for instance in Mexican or Brazilian bonds”

Jack Flaherty – Fixed income (New York)

1 Brexit

Markets do not like uncertainty, so following the news of a Trump victory there was a knee jerk move to sell risk assets, with the Dow Jones Average down over 800 points at one point. Those losses were curbed dramatically as the prospect of a Republican House, Senate and Presidency could be seen as more pro-business than the previous administration. Trump has promised to roll back regulations and make it easier for business to prosper. On the other hand, his protectionist rhetoric is worrisome and also symptomatic of the bigger populism we are seeing worldwide. Right now we are looking for the dust to settle a bit and opportunities in order for us to increase back risk levels.

Credit markets in the US also showed early weakness but are rebounding. Treasury markets, which would be seen as a beneficiary of a flight to quality assets, are instead focusing on some of the economic ramifications of a one-party US government. On the surface, Trump’s plans would be stimulative and add to the deficit.

Worries over Trump’s stance on Mexico has led to weakness in the peso but it has rebounded from the worst. Our portfolios had recently pared back risk ahead of this event. Our credit exposures have decreased and any spread widening should not have a material impact. We would see serious weakness as a buying opportunity. Defaults have actually already peaked over the short term. Our outright foreign exchange exposure to Mexico is our smallest this year (compared to other FX risk such as AUD, NZD and KRW) and it is partially hedged with MXN put options and JPY call options. The Trump victory should encourage the recent steepening of core yield curves to continue (more fiscal easing and reduced term premium), a theme we favour. It may also allow the rates outright sell-off to continue a little while further. The USD faces a number of cross currents and, for the time being, we don’t have a strong directional view on it versus the EUR and the JPY.

In emerging markets (EM), Mexican assets are likely to experience some continued volatility but we would view any material sell-off in Mexican bonds in particular as an opportunity. The recent monetary tightening and likely hit to sentiment is expected to cause the Mexican economy to slow over the coming 12-18 months, and should mean any inflationary shock arising from currency weakness will not feed on itself. Any contagion from the Mexican peso to the Brazilian real may slow the recently started easing cycle but will not prevent it, in our opinion. We continue to favour long-dated Brazilian bonds, and would again view weakness over the coming weeks as an opportunity to play for a deeper easing cycle than the market is currently pricing.

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