Donald Trump will become the 45th President of the United States. Against all odds, stocks rallied and safe havens such as gold and bonds underperformed dramatically. The most frequent argument that explains this behaviour is that Trump’s policies will spur growth and favour inflation. Mr Trump’s program contains many uncertainties: what exactly is his program? Will it be implemented? How many years will we have to wait to see the first results? Will the majority of Republicans in Congress vote for some of the more controversial measures? It is far too early to develop a new economic scenario, the US economy will not change dramatically in the coming weeks or months.
Just after the announcement of Trump’s victory, markets’ behaviour was logical: a Treasury rally (the 30y at 2.52%), gold above 1330, a Swiss franc rally reaching 0.9550 against USD, S&P futures at the limit down (-5%). Then during the day, all these markets turned, with equities rallying substantially and safe havens starting to decrease. In this environment, the only behaviour which seemed “normal” was the dramatic drop of some Emerging currencies (the Mexican peso being the most emblematic) and the widening of Emerging market bond spreads. The Treasury sell-off was exaggerated and explained by record volumes of transactions.
The stock market rally is fragile. A market being stopped at the limit down in the morning and closing “in the green” is extremely rare (the last time this happened was in 1988) and the probability of seeing the market re-testing the limit down level during the following month is high. The picture will probably be clearer after the Fed meeting on 14th December.
Our global outlook has not changed. Trump is not a magician and during his 4-year term, the US will not avoid a recession. In terms of growth, the trend will remain broadly the same. Regarding inflation, a so-called reflation is, in our opinion unlikely. We strongly believe that since last Tuesday, the US and China are at war. Trump’s protectionist measures won’t be implemented because China will threaten to use two “nuclear weapons”. First and foremost, they can sell trillions of Treasuries, an unprecedented selloff leading to recession and stock market collapse. Secondly, if Mr Trump really wants to tighten the rules and increase rates of customs duty, China will immediately reply with a brutal devaluation of the yuan (bear in mind the reaction of the stock market to the soft devaluation in August 2015). More generally, China is still a huge deflationary contributor. To summarize our thoughts about the behaviour of the bond market today, we strongly believe that it resembles the “Taper tantrum” from June 2013, which is the reason we are calling it the “Trump tantrum”.
Regarding the management of the three bond funds, we maintain our strict discipline. First and foremost, the Euro Bond Fund was not impacted and we are comfortable with the policy implemented in October (where the duration overlay policy was removed and replaced by floating rate notes). Secondly, in the Quality Emerging Bond Fund, we decided to retain all our Emerging bonds, even though they could suffer substantially in the short term. Finally, the main risk we hold is being long duration in this curve steepening environment. As a result, we focused our attention on 30y Treasury behaviour. We immediately decided that the TIPS were not an issue due to the strong increase of inflation expectations. When the 30y broke the first level of our stop-loss policy, we decreased the modified durations of the Global Bond and Quality Emerging Bond funds. Should 30y yield reach the second level of our stop-loss policy, this would be the beginning of a new era for US Treasuries, probably a 6-9 month bear market. This could happen at any time if the Chinese press the “sell button” as a warning shot. On the other hand, the Fed could play the role of the ultimate counterparty in order to maintain long Treasury yields at decent levels. On a medium term horizon we still believe that yields will stay low, very low and that the economic environment will be gloomy, Central banks will be ultraaccommodative and bond-friendly. In the short term, we have to be ready to cut our positions if required by our risk management tools. Our message is that these levels are a buying opportunity for medium to long term investors who can cope with short term volatility (in Emerging bonds in particular).
The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Funds as of 16/11/16 and are based on internal research and modelling.