Private banking

Wall Street marches towards record highs despite alarming rhetoric from the White House

Prospects for the coming months look positive, with investors focusing more on corporate results and economic fundamentals rather than on the US president’s unsettling rhetoric

PUBLISHED : Monday, 22 May, 2017, 2:45pm
UPDATED : Monday, 22 May, 2017, 5:45pm

For all the alarms created by US President Donald Trump on both the domestic and international fronts, Wall Street has so far shrugged off any concerns and maintained its march into record territory.

In doing so, the market has focused on corporate results and economic fundamentals, rather than flights of rhetoric. And with key indicators still pointing to steady growth and healthy returns, investors in the US – and elsewhere – can generally take heart about prospects for the months ahead.

“The US and the broader global economy have reached escape velocity,” says Adrian Zuercher, head of asset allocation, APAC, for UBS Wealth Management CIO. “Reflation has arrived and, though it is still early in the piece, we will see a virtuous circle of rising GDP, tax revenues, confidence and investment.”

All this, he notes, is positive for risk assets. For the rest of the year, the main economic drivers will include inflationary pressures in the US, commodity pricing and monetary policies. The latter are likely to switch to “neutral” as the relevant authorities await signs confirming a full-fledged expansion in credit and core inflation.

“In our view, global economic and financial conditions continue to support a tactical risk-on positioning,” Zuercher says. “Therefore, we are holding on to overweight positions in global and US equities against high-grade bonds. However, as equity valuations rise and central banks reverse their extraordinary stimulus measures, we will need to look beyond a simple ‘risk on’ or ‘risk off’ investment strategy. Instead, we’ll try to find specific price misalignments in all asset classes and geographies.”

With US President Donald Trump in office for more than 120 days, US fiscal policy and spending may prove to have made less progress than initially hoped, according to Grace Chow Wai-man, general manager and head of the wealth management division of Bank of East Asia. “With valuation getting pricy, although the US markets continued to advance in the second quarter, its yield to date gain quite noticeably started to trail [emerging markets] and some other [developed markets], making us to stand firm with our view that US inflation and growth will not be strong enough to warrant more than two more hikes in 2017,” she says. “Nonetheless, within equity space in the US, we favour financials and technology.”

Specifically, Chinese offshore equities are seen as perhaps the best opportunity in Asia, thanks to the mix of reflationary tailwinds, solid liquidity, and strong outbound flows from mainland institutional investors.

Seen from Asia, the US today is eerily similar to the ‘Goldilocks’ economy of 20 years ago, with growth neither too hot, nor too cold
Mark McFarland, chief economist, Asia, UBP

“China is well able to ride out any volatility en route to a new Sino-US trade agreement,” Zuercher says. “Linked to that, we remain optimistic, but selective, on the IT sector. Cloud spending should grow significantly this year, but there are risks from the sector’s dependence on the consumer-driven and now-saturated smartphone market.”

According to Adolfo Laurenti, global economist for Bank J. Safra Sarasin, if election promises are kept, deregulation and tax cuts should support the ongoing reflation theme, with a resultant plus for stock indices.

“The markets priced in tax cuts and fiscal spending after the US election,” Laurenti says. “However, implementation has been lacklustre so far. That uncertainty could lead to re-pricing and the ongoing threat of a conflict with North Korea could have a significant impact on markets.”

For Mark McFarland, chief economist, Asia, for Union Bancaire Privée (UBP), political risk in North Korea will be an ever present threat, but can still be kept in context.

Most markets have been trading at high valuations, with low inflation and decent growth rates underpinning prices. Hong Kong-listed equities should continue to benefit from the appetite for Chinese assets. And while fears about faltering growth, the impact of rising interest rates, and the fallout from political crises can never be dismissed, there are more reasons to be upbeat than not.

“President Trump’s initial taste for protectionism appears to have diminished greatly,” McFarland says. “If there is talk of a sell-off, it is part of the normal, healthy process of testing analysis and investment skill. Contrarians are a very necessary part of making prices in equity markets reflective of reality.” However, sounding a somewhat cautionary note, he also hints that US growth may be at an inflection point after many quarters of acceleration. Furthermore, many believe the US dollar is already overvalued, offering limited upside potential.

“Seen from Asia, the US today is eerily similar to the ‘Goldilocks’ economy of 20 years ago, with growth neither too hot, nor too cold,” McFarland says. “There is a risk of policy error, either by tightening too quickly or not responding to inflationary signals. Also, running off the Federal Reserve’s large bond portfolio – of US$4.3 trillion – will be difficult to manage without making long-term bond yields more volatile. At UBP, we have been reducing our high-yield bond positions because we believe these bonds no longer adequately compensate investors. However, we do believe in the global growth-reflation story.”