Donald Trump suffers a midterms setback, US stocks come back down to earth. Where do investors go next?
- Nicholas Spiro says Wall Street is still reeling from the October sell-off, but can’t expect more financial stimulus from the Trump administration
- If there is convergence across global equities, it is likely to be the wrong kind, with US stocks falling back to rejoin the pack
As recently as September 20, Wall Street’s leading S&P 500 stock index had delivered a year-to-date return of nearly 10 per cent. Its tech-laden counterpart, the Nasdaq Composite index, had performed even better, rising more than 16 per cent since the start of this year as the popular technology sector continued to turbocharge a rally in American stocks.
The so-called America First trade, although under pressure from high valuations and rising interest rates, was far and away the best bet for equity investors in increasingly volatile global markets.
Fast forward seven weeks, and the investment landscape has changed significantly. Last month’s fierce sell-off in stocks has pared gains since the start of the year to under 5 per cent for the S&P 500 and just under 10 per cent for the Nasdaq Composite. What is more, the once-resilient US corporate debt market is under strain, with the spread on high-yield, or junk, bonds last month recording the sharpest rise since early 2016, according to the Financial Times.
The fading outperformance of US equities is also evident from a glance at global markets. Last month, the MSCI All-Country World Index ex USA, a gauge of non-US stocks, fell less sharply than the Nasdaq Composite. Since Wall Street’s sell-off last month, the MSCI Emerging Markets Index has outperformed the S&P 500, mainly because of the sharp rebound in Chinese shares.
Following a period in which the buoyant US equity market decoupled from its slumping peers, the gap between US stocks and those in the rest of the world is starting to narrow. This convergence, moreover, looks set to gain momentum in the coming months.
In the US midterm elections this week, the Democratic Party retook the House of Representatives but President Donald Trump’s Republican Party retained control of the Senate. The outcome dashes hopes of further fiscal stimulus – Trump’s tax cuts last year were a major catalyst for the rally in US stocks – as the US enters a period of unprecedented political strife ahead of the crucial 2020 presidential election.
The Democrats’ victory in the House, which allows them to probe criminal allegations against the Trump administration, will harden the president’s combative stance and inject more vigour into his nationalist agenda. As Pimco, an asset manager, rightly noted in a blog last week, “trade policy risk is likely to continue unabated no matter the outcome” of the elections, particularly since most Democrats support Trump’s tough approach towards China.
Just as importantly, as I argued in an earlier column, when it comes to America’s economy, Trump’s best days are behind him. However, although growth is likely to slow next year as the stimulus from last year’s tax cuts ebbs, it will remain strong enough for the Federal Reserve to continue raising interest rates, setting the scene for a showdown between Trump and Fed chairman Jerome Powell. While investors have their own concerns about a hawkish Fed, more presidential pressure on Powell could spook bond markets, weighing on stocks.
And even if the performance gap between richly priced US equities and cheaper emerging-market stocks narrows in the coming months, it is unlikely to be due to the outperformance of non-US equities.
If there is convergence across global equities, it is likely to be the wrong kind of convergence, with US stocks falling back to the pack amid increasing market volatility.
The growing number of vulnerabilities, particularly those associated with the withdrawal of monetary stimulus by the leading central banks, is punishing all major asset classes. Only a handful, which currently include the US dollar and the US’ main stock indices, have delivered positive returns this year – and in single digits at that.
10th anniversary of the financial crisis
According to a JPMorgan report on October 26, at the height of last month’s sell-off, just 20 per cent of asset classes have delivered positive returns in 2018, “a share that has never been so low outside of 1970s stagflation episodes and the global financial crisis”.
Indeed, while most of the threats to markets this year have emanated from America – Trump’s trade offensive against China and a more hawkish Fed – it has been non-US assets, particularly in emerging markets, that have borne the brunt of the price declines.
With the America First trade now in jeopardy, investors have few places to take refuge.
Nicholas Spiro is a partner at Lauressa Advisory