As a consequence, fund managers are adjusting their positioning to reflect their doubts about whether President Trump can push through a large enough infrastructure spending and tax reduction programme to shore up this ageing business cycle. While President Trump initially showed promise, the so-called “reflation trade” of the fourth quarter of 2016 has now been mostly unwound. Investors who are recognising the current dangers should continue to reduce the weight of cyclical stocks in their equity strategies.
Stocks of companies offering high visibility and structural growth drivers such as those of the technology sector remain the most appealing. The challenge of the market concentration risk in that only a few mega-capitalisation companies dominate can be addressed by leveraging bottom-up grass root research that will allow managers to invest in some of the smaller mid-cap tech players.
In the medium term, the new paradigm for the euro–dollar pair has emerged as a potential source of market disruption. An acceleration of the US dollar weakening could boost US inflation, at the very moment where visibility on the Fed policy is shrinking due to the many members soon to be appointed soon by President Trump. If we get a more politicised Fed, where the next chairman ignores inflation, it may cause the market to begin to price bonds to take account of an “uncertainty premium” which would increase their cost. This will also necessarily affect the equity risk premium and may potentially unsettle equity markets as well.
If at the same time president Mario Draghi is forced to gradually taper the European Central Bank quantitative easing program, despite a strong euro being a source of tougher financing conditions for the eurozone, this could be a very unsavoury cocktail.
While in the US the recent hurricanes could provide a silver lining in that the need to coordinate relief efforts has allowed a Budget to be swiftly pushed through, this will do very little to allay longer term concerns on US credibility. A protracted weakening of the US dollar would be a headache for European investors as European companies earnings per share will have to be cut by 5 to 8 percentage points for every 10 per cent gain in the euro. There is nevertheless one region which stands to benefit from a weak dollar, both on the economic and political front: emerging markets. The good news is that emerging equity markets are even richer in technology holdings than in the US.
Jean Medecin is a member of the investment committee of Carmignac
