Markets can be expected to respond positively to US policy changes on the horizon, according to investment director at a boutique investment business
Markets can be expected to respond positively to US policy changes on the horizon, according to Michael Stanes, investment director at Heartwood Investment Management, a boutique investment business.
Reaction to Donald Trump’s tax proposal has been mixed, with some praising the opportunities for economic growth and others contending that the sweeping tax cuts will balloon the deficit. Currently, the tax reform’s fate hangs in the balance – having effectively no support from Democrats and splintered support within the Republican party. Deficit hawks, such as Senate majority leader Mitch McConnell, favour a revenue-neutral proposal and are sceptical of Secretary of the Treasury Steve Mnuchin’s claim that the cuts would pay for themselves by causing economic growth at 3% annually.
Notable propositions include slashing corporate tax from 35% to 15% and an opportunity for tax relief on overseas cash repatriation. Stanes welcomed these proposals, commenting that if the Trump administration was able to progress these, it would likely have a “positive impact on US capital expenditure and broader economic activity.” He added that this would be supported by “growth that is durable, liquidity stimulated by ongoing central bank accommodation, and corporate earnings improvements.”
Stanes expressed short term optimism but long term cautiousness due to a changing political and economic landscape. He said: “In particular, we would highlight the potential headwinds of higher US interest rates and tighter financial conditions in China. Furthermore, one of the key elements to a stable financial environment over the last few years has been central bank support, which has been reflected in rising valuations across asset classes. We expect this comfort blanket to be tested more by investors in the second half of the year, particularly as we pass through the electoral cycle in Europe. Overall, we are maintaining our positive view in the shorter term but expect to be more cautious as the year progresses.”
Focusing on a range of sectors, Stanes made the following key points:
The international backdrop for equity, such as in the US, Europe and Japan, has been generally supportive. However there is a need to be “mindful of potential event risk and the later stage of the market cycle.”
With regards to UK equity, Stanes expressed more cautiousness, but said that the “resilience of emerging market equities has been impressive and suggests a more positive outlook in the absence of a trade shock out of the US.”
Bonds have recently benefitted from “elevated geopolitical tensions and softer inflation expectations”. While there has been a downward trend in bayields, Stanes does not believe this is due to a “deteriorating growth backdrop”, so it is not expected to be a long term pattern.
The US Federal Reserve’s “more hawkish tone” and “more focus on a [European Central Bank] exit strategy” further supports the notion that this is a transient trend.
Furthermore, “credit spreads – both US corporate credit and emerging market sovereign debt (hard and local currency) – continue to tighten given the solid growth backdrop.”
Following a fall in UK gilt yields, and “better than expected” results in the fourth quarter, UK property developers are “performing well”.
However, Brexit uncertainty remains a factor, causing some investors to primarily put money into cities outside of London, which are considered “less exposed” to Brexit uncertainty.
Despite the recent slide in the oil price, Stanes expects that “an improving global economic environment and a tighter supply/demand balance will ultimately be supportive to commodity prices later this year.”
Heartwood considers gold to be a “vital diversifier”. Meanwhile, industrial/base metals have been weak “despite positive data surprises from China”.
A “greater likelihood of increased stock dispersion (i.e. between winners and losers)” is expected, which could mean a more “positive view on equity hedge strategies” While “increasing interest rate divergence should create more opportunities going forward”.
Market volatility remains low – but Stanes believes this “is unlikely to persist as we move into the second half of the year.”
Along with sweeping tax reform, just last month Trump signed presidential memoranda to review Dodd-Frank.