The repositioning of investor portfolios has been dubbed the ‘great rotation’, with money gushing out of bonds and flowing into stocks. But will it last?
Since the upset victory of Donald Trump on November 8, the S&P 500 has risen a further 5.5pc while the Dow Jones has surged more than 8pc. But are ‘Trumponomic’ policies sustainable?
Exactly a year ago, global equity markets were plunging.
On the first day of trading of 2016, the Dow Jones Industrial Average, one of the main US stock market indices, suffered its worst start to a year since 2008.
The benchmark S&P 500 index, meanwhile, experienced its sixth-worst start since 1927, according to data from Bloomberg, while European stocks suffered their worst start ever.
The main trigger for the sell-off was a resurgence of fears about the health of China’s economy.
What a difference a year makes.
On Tuesday, the first day of trading of 2017, global stock markets resumed their year-end rally, buoyed by the publication of a survey showing that China’s manufacturing sector grew at a faster-than-expected pace last month, providing a further fillip to the nearly year-old recovery in commodity prices.
Equity markets were also lifted by the publication of a separate report showing that the US manufacturing sector grew at its quickest clip last month in two years.
Since the upset victory of Donald Trump in the US presidential election on November 8, the S&P 500 has risen a further 5.5 per cent while the Dow Jones has surged more than 8 per cent, fuelled by expectations that the next administration, which takes office on January 20, will win congressional approval for a hefty fiscal stimulus package consisting of tax cuts and infrastructure spending.
European and Japanese shares have also enjoyed strong gains.
On Tuesday, the Stoxx Europe 600, Europe’s benchmark equity index, entered bull market territory, having surged more than 20 per cent since a low last February. The Nikkei 225, meanwhile, Japan’s main equity index, has shot up nearly 18 per cent since the election, driven by the 12 per cent decline in the yen versus the dollar.
According to Deutsche Bank, the value of global equity markets has increased by a staggering $3 trillion since Trump’s victory.
This is roughly the same amount that has been wiped off the value of the Bloomberg Barclays Global Aggregate bond index, one of the leading developed and emerging market (EM) bond indices.
This is because the flip side of the “Trump rally” has been a sharp sell-off in bonds as investors fret about a faster pace of monetary tightening to counter a rise in inflation.
The yield on the benchmark 10-year US Treasury bond has risen 60 basis points since the election to 2.4 per cent, its highest level since mid-2015.
This repositioning of investors’ portfolios has been dubbed the “great rotation”, with money gushing out of bonds and flowing into stocks.
Yet as Convergex, a US brokerage, rightly noted in its morning note on Wednesday: “Since US stocks were clearly early fans of president-elect Trump and the Republican[-controlled] Congress, it is fair to ask how much more influence they really have in the New Year.”
In other words, is the Trump rally sustainable?
This is the million dollar question in financial markets as 2017 gets under way.
While few investment strategists expect the equity rally to come to a shuddering halt any time soon, there is an inescapable feeling that investors are getting ahead of themselves, possibly dangerously so.
For starters, US stocks are already expensive and are overvalued according to most measures.
This makes it even more difficult to justify current valuations given the huge uncertainty surrounding Trump’s economic and foreign policies, particularly when it comes to the vexed issue of America’s trading relationship with China.
Secondly, the post-election surge in the dollar is becoming a focal point of concern for markets.
The dollar index (a gauge of the greenback’s performance against a basket of its peers), which on Tuesday hit a 14-year intraday high in response to stronger US growth, has already shot up more than 5 per cent since the election. A further appreciation could start to take its toll on the US economy, particularly if Trump’s fiscal stimulus package is delayed or watered down.
Thirdly, in order for the great rotation to gain traction in the coming weeks and months, the 30-year-long bull market in bonds must definitively have run its course.
While this appears to be the case, it is still too early to write off the bond market. Indeed since mid-December, the yield on benchmark 10-year US Treasuries has fallen 13 basis points.
It is only once Trump takes office and his policies become clearer that investors will know whether they have been too sanguine about Trumponomics.
Nicholas Spiro is partner of Lauressa Advisory