After an extraordinary week in US politics, let’s take a step back here and try and assess what’s going on. At the recent peak in the S&P 500, the index had risen about 15% from the low point before the US election. So not only were forecasts of looming disaster in the event of a Trump victory proved completely wrong, the equity market has risen in expectation of widespread positive changes to the US economy ranging from deregulation, tax reform and infrastructure spending. After the healthcare debacle, is it time to rethink the efficacy of the Trump reflation trade?
Chart 1 – The S&P 500 Index
We are by no means experts on the US healthcare industry. Our simple view about Obamacare was that; yes, it’s great in that it increased the number of insured, however, this came at a large cost to many US taxpayers. Insurance premiums had risen way too fast in recent years and the out of pocket expenses were prohibitive for many. From our distant, disinterested vantage point, Obamacare needed significant reform.
With the Republicans controlling all branches of Government, and having been fierce critics of Obamacare for years, surely they would be able to cobble together a reasonable plan that would improve Obamacare. The fact that the plan seemed to harm many of the people who probably voted for Trump, and was viewed by so many in the GOP as not worth voting for, leaves us a bit dumbfounded. Frankly it makes the Trump administration look pretty inept in our opinion. Furthermore, with Obamacare as we know it crumbling, what is plan C? If the US healthcare system is at risk of not functioning adequately then it cannot be good for America.
As can be seen in chart 1 above, the S&P 500 Index had been tracking broadly sideways for nearly two years into the US election. This period of no performance coincided with the Fed beginning to normalise policy and the economy was mired in a stop-go period where corporate earnings actually declined (mostly because of the energy sector). Then along comes Trump and the equity market buys into the reflation narrative completely. The bullish narrative is that growth will be energised by a combination of deregulation, tax cuts and infrastructure spending.
In the weeks post the election, we repeatedly talked about how the reflationary Trump narrative could be either elegantly played out or not. We also voiced concerns that he would fail to generate a sustained increase in the growth rate of the US economy. So far, we have seen nothing that is elegant from the Trump administration, and we now wonder whether the healthcare failure is indicative of what may befall all of his main policy proposals.
The optimists out there will say that we should just put this healthcare defeat behind us, and focus on the tax cuts that are coming. Well, surely there is an equally valid opinion that tax reform will be just as difficult to achieve after the healthcare failure. Furthermore, it is our view that financial deregulation will garner a lot of opposition and the infrastructure spending plans, because they look like they will be via tax credits relying on private sector investment, will be less effective in boosting the economy than many believe.
We think that whether you are an optimist or a pessimist on the Trump administration, the events of last week have to bring into question just how successful Trump will be in boosting the US economy. If, after sober analysis, an investor can say that they truly believe that the Trump administration has a high probability of success, then they will be comfortable in owning equities even after the 15% advance since the elections. Anyone who is now questioning whether Trump will be able to make any of the big changes he promised, then surely they will have to look at the recent market rally and the current valuations matching previous bubble peaks (depending which valuation measure) as an opportunity to take profits and move to the side lines.
Will the healthcare debacle have an impact on sentiment in the US? We have all read how the survey (or soft) data was outpacing the hard data since the US election. The question was really whether the survey data was “leading” the hard data or getting ahead of itself. Last week, Markit released their preliminary ISMs for February and the US survey was a disappointment. In fact, the services and composite ISMs are at levels seen in January 2016 at the height of the financial market’s concerns over China. This survey was taken before the political events of last week. We suspect that business and consumer sentiment may deteriorate in the weeks ahead so that we see the soft data fall back to levels consistent with the hard data.
Chart 2 – Markit Composite PMIs for US and Eurozone
If like us, you do not believe that these events simply bring the bullish tax cuts closer, then not only should you be thinking cautiously on US equities but also the US Dollar as well as being constructive on high quality fixed income (owning some gold may not be a bad idea either). In terms of the Dollar, we are detecting that, whereas US economic data may be beginning to miss elevated expectations, European data remains very robust. Chart 2 above shows the composite PMIs for the US and Eurozone, and although it is not right to directly compare the actual levels, it is clear that the US business community is becoming less optimistic in the last two months whereas in Europe, business leaders continue to become more confident.
At the same time, the talk around whether the ECB will change policy later this year only gets louder. The talk is of a potential rise in the deposit rate and a change to the monthly level of QE. We think this may all be a bit premature, but we do expect the Euro to strengthen markedly as and when the ECB properly moves to the exit and if the recent divergence between US and European data continues in the short term, the Euro could be stronger than many believed just a few weeks ago when it was testing 1.0/1.05 to the Dollar.
As for the federal reserve, we and everyone else has noted in recent weeks, that they have tried to become just a shade more hawkish. If Trump’s policies risk getting completely bogged down, then there is every chance that Fed rate rises will be curtailed no matter how bullish Fed speakers are (another busy week ahead on this front). As we have pointed out recently, the Dollar has taken a back seat in recent weeks, and we think that this will continue. This will help high quality bonds.
To sum up, we think that last week’s events in Washington should cause investors in to a reality check. After the majority of investors were wrong footed by Brexit, the Trump election victory and the Italian referendum, making these sorts of market calls is open to failure these days. However, and as pointed out a couple of weeks ago in our report “charts that make you go hmmm”, bubble like valuations coupled with an equity market losing momentum are usually decent indicators that it is right to reduce risk.
Stewart Richardson
RMG Wealth Management
