Donald Trump’s first week as US president has re-energised Wall Street bulls while sharpening concern about the risk of higher inflation and trade protectionism.
The sense of fatigue that hung over much of January has been replaced by renewed enthusiasm for equities, as investors sent the S&P 500 to fresh highs and the Dow Jones Industrial Average finally broke above the 20,000 threshold.
As the billionaire took office this week, there was strong appetite for details on whether — and how — the administration would make good on pledges made during the campaign. Markets didn’t need to wait long. On Tuesday, Mr Trump backed two contentious oil pipeline projects, which was enough to bolster confidence that the newly installed government would move quickly.
“There was real, fundamental follow-through,” says Kate Moore, BlackRock’s chief equity strategist. “We got through the doldrums and have had a return of animal spirits.”
However, the Trump trade — reflecting hopes of tax cuts, higher infrastructure spending and an easing in business regulation — that had dominated financial markets since November also underwent a subtle shift this week. While financial shares still shone, it was sectors that will benefit from infrastructure spending and cope with higher inflation that led the way. Up nearly 4 per cent, the materials sector was the best performer on the S&P 500 with precious metals and miners seeing gains.
Raman Srivastava, deputy chief investment officer of Standish Mellon, says that renewed bullishness about US growth comes alongside signs of an economic pick-up both in the developed world and emerging markets, and that is likely to quicken inflation globally this year.
“We’re seeing more assurance that economic growth is picking up. Potential growth is still higher than nominal growth, but the output gaps are narrowing, so we like inflation-linked securities,” he says.
And a greater focus from investors on the inflation threat this week helped tame the dollar. Analysts at Bank of America Merrill Lynch highlighted how the currency lost further momentum, while US bond yields and market inflation expectations rose. That is a contrast to the broad move higher in the reserve currency since the election.
‘’We argue the current divergence partly reflects concerns around trade protectionism, which would be associated with lower growth and higher inflation over time, and to a lesser extent the view that central banks will be cautious in tightening monetary policy in the face of higher inflation,” the analysts at Bank of America Merrill Lynch noted.
A week after the changing of the guard at the White House, Mr Srivastava is also readying his funds for more choppiness given the unpredictability of the new administration. “It’s an environment with a lot more uncertainty. So things will be more volatile,” he says.
While Mr Trump’s promise of pro-growth policies has swelled risk appetite, money managers’ nerves have long centred on whether the protectionist stance on trade that was a rallying call of the Republican’s campaign would prove a priority in office. The first week on the job suggests it will.
“The trade issue is the single biggest policy risk here,” says David Donabedian, chief investment officer at Atlantic Trust. “We are watching very closely how that unfolds. Is it a lot of sabre-rattling and rhetoric or are we going to see seriously heightened tensions and tit-for-tat actions that lead to a reduction in global trade.”
Mr Trump this week said he wants to pay for his wall along Mexican border by imposing a 20 per cent tax on imports. Mexican president Enrique Pena Nieto cancelled a planned summit with the new president.
“I worry that if the rhetoric or actions escalate to a dangerous place that instead of companies being optimistic about the future, they will hold back on investments and retrench until they see what the implications will be,” adds Ms Moore of BlackRock. “I think that is a big risk.”
If Mr Trump’s decision to use his first week to drive his trade agenda has been sobering for investors, many believe the hallmarks of the Trump trade — a shift into equities, shorter duration in bonds and a firmer dollar — have further to run.
“Trump is a game changer,” says Vincent Mortier, deputy chief investment officer at Amundi, Europe’s largest asset manager. “For the next three months, we don’t think there will be big shocks to the trade.”
If that scenario does play out over the next three months, then unease around valuations is likely to grow. The S&P 500, for example, is trading at 17 times forward earnings. Some investors say a judgment on whether US equities are too expensive depends on how strong the current recovery in corporate earnings proves, and the degree to which it is eventually underpinned by any stimulus and tax cuts.
“We can’t count on 17 [times] p/e going to 18 or 19,” Mr Donabedian says. “If the budding earnings improvement story falters then this market is ahead of itself and is going to struggle.”
Maybe. But for now the animal spirits that were more subdued at the start of the month have returned. “So many people missed the train,” Mr Mortier says of the rally in equities. “There will be powerful ‘buy on the dips.’ It has legs.”