Donald Trump hasn't been slow to take credit for stock market momentum since he took office. Anchoring perceptions of his success to a volatile bellwether may come back to haunt Mr Trump in 2020, but America remains the home of more world-class companies than anywhere else, and this should be reflected in global portfolios.
Just holding an exchange traded fund (ETF) tracking the S&P 500 would have done incredibly well for UK investors since the financial crisis. This year alone, the index of America’s largest companies by market capitalisation is up 25 per cent – although gains from an unhedged position are affected by changes in the pound to dollar exchange rate.
Does passively tracking the market remain the best way to own a slice of America? Historically, stockpickers have struggled to beat US benchmarks – the largest companies are just so good at generating return on capital it’s very hard to isolate stocks that meaningfully outperform. Yet current dynamics could make for more dispersion in price changes.
Big tech stocks (the so-called FAANGs and Microsoft (US:MSFT)) have starred in the past decade. Unlike the dotcom mania of the late 1990s, steady organic profit growth has underpinned the boom. Silicon Valley’s ability to conjure growth through innovation attracted investors in droves after the financial crisis, especially as yields on safe US Treasury bonds tumbled, making the risk of holding stocks more worthwhile.
Capital allocation decisions by active investors have been compounded by another huge trend of the 2010s – buying the index with ETFs. The cheap open-ended funds haven’t dictated S&P 500 weightings, but when buying the market becomes widespread behaviour there are implications for the efficient pricing of individual stocks. This may provide a tailwind for the double-digit value rally that began in the summer.
Is ‘The Donald’ right about his market clout?
The presidential election, and the influence it has on the incumbent, will be a big factor this year. There are a couple of no-hopers contesting the Republican nomination, but most people expect Mr Trump to be running. His possible Democrat rival could be one of the left-wing candidates, Bernie Sanders or Elizabeth Warren; Barack Obama’s former vice president, Joe Biden; or entrepreneur Michael Bloomberg. Pete Buttigieg, the young mayor of South Bend, Indiana, is an interesting outsider.
How does the race for the White House affect markets and the economy? Firstly, there is the stimulus provided by billions of dollars of campaign spending, but also President Trump’s desire to keep the economy on track (in the third quarter of 2019, year-on-year GDP growth was 1.9 per cent) should also be reflected in policy. The line taken on China is interesting – tariffs on Chinese goods will affect prices in voters’ shopping baskets, but that needs to be weighed up against real wage growth – a positive trend Mr Trump can argue, not unreasonably, is the result of his stance against offshoring jobs.
Balancing tough talk that appeals to patriotism with the short-term boost to earnings forecasts that dovish noises on China give to companies will be a theme of the year. In the longer term, despite the president’s bombastic manner, his stand-off with Chinese counterpart Xi Jinping is more than an expression of toxic masculinity. After decades of complacency, America is making a stand against a mighty rival and whatever their personal feelings about the Commander-in-Chief, plenty of Republicans and Democrats on Capitol Hill understand the need.
Being the world’s most important single export destination is the card Mr Trump is playing, which is a game of high stakes. American corporates will see their margins dented by supply chain realignment, but Mr Trump threw them an enormous bone in the form of tax cuts in 2017-18 and, furthermore, his willingness to stand behind tech giants and face down bleating by the European Union, shows ‘America first’ can have advantages for big business.
Fiscal stimulus adds to a source of vulnerability – America’s enormous debt pile – but given long-term underinvestment has left US infrastructure in serious need of an upgrade, the distinction needs to be made between borrowing for this purpose as opposed to just sucking in imported goods. Huge slugs of the corporate tax giveaway found their way into shareholders’ pockets (and chief executives’ bonus packets) via enormous share buybacks. It remains to be seen whether corporate America will now start to invest more repatriated cash in the domestic economy, where it can have a multiplier effect.
Of course, the belligerence of Mr Trump does create an environment where companies can be put off investment, but if progress can be made on trade deals then positive signs of capital expenditure rising, such as the surprise upward revision to US manufacturing PMI in November, may continue. Being a net importer is not necessarily a bad thing and some partners reinvest a lot of their surplus in America itself. Japan is a case in point and its ratification of the trade deal prime minister Shinzo Abe signed with President Trump is a boost for 2020.
Political hurdles exist for the US-Mexico-Canada Agreement (USMCA), however. Trade representative Robert Lighthizer is close to getting support for the deal in Congress, but sticking points remain as Democrats come under pressure from unions. There are now fears important wins for big tech and pharmaceutical companies will come under pressure in the horse-trading to get the bill passed.
Toxic relations between Mr Trump and Speaker of the House of Representatives, Nancy Pelosi, provide an intriguing backdrop. She is leading Democrat efforts to have him impeached, which are unlikely to succeed, but the political strategy is clearly to rake up as much dirt as possible to derail his re-election campaign. Democrats are also treading a tight rope with USMCA: they don’t want to hand Mr Trump a victory, but neither can they afford to be seen putting political animosity before American prosperity.
Fed in no rush to cut rates further
Compared with dealings with Ms Pelosi, the president’s interactions with the Federal Reserve are cordial, but that’s not saying much. Tirades berating Fed Chair Jerome (Jay) Powell were commonplace on Mr Trump’s Twitter account in 2018 when the central bank was hiking interest rates. Asset allocators were wrong-footed when the Federal Open Markets Committee (FOMC) made a dovish pivot and cut rates three times from July. Having peaked at 2.25-2.5 per cent in December last year, the target Federal Funds Rate is now 1.5-1.75 per cent.
Expectations for rates have come off considerably compared with a year ago, when the median forecast made by FOMC voters was for the upper bound to be 3.125 per cent in 2020 – by September this year that fell to 1.875 per cent. The Fed is loath to promise further cuts, so investors cannot bank on a repeat of the surprising late-cycle stimulus to markets that occurred this year. That said, Mr Trump won’t be shy in voicing and tweeting his displeasure if he feels the Fed could be more accommodative.
Unemployment levels fell to a record low of 3.5 per cent in November, validating Mr Trump’s boast when he took office that he’d be “the best jobs president ever”. Year-on-year wage growth, recorded as 2.6 per cent by the PayScale Index for Q3 2019, is outpacing annual inflation, which as of October stood at 1.8 per cent. Add in reasonably robust GDP growth and the overall macro picture doesn’t suggest the need to either cut or hike rates from this point.
The Fed has shown a willingness to act when the financial system has needed lubricating, however. When the overnight bond repurchase or ‘repo’ rate spiked in September, the Fed acted quickly to diffuse worries of a crisis. The repo rate is what banks charge for overnight collateralised lending (usually involving Treasury bonds) and has an essential role in maintaining liquidity for financial institutions to fund their activities. A shortage of cash among the four biggest US banks meant the central bank had to intervene with $75bn of overnight loans and it extended this facility.
Treasury Secretary Steve Mnuchin and Jay Powell have met regularly to discuss containing risk, and while the latter has been at pains to stress the Fed’s actions don’t constitute a return to quantitative easing (QE), the central bank is expanding its balance sheet, so some would argue it’s a matter of semantics. The Bank for International Settlements (BIS) has blamed banks for all building positions in Treasuries instead of cash, resulting in a shortage of the most current assets for lending.
The report apportioned some blame to banks’ lending to hedge funds, which have used repos to fund arbitrage trades. Lending to the funds is more profitable, but syphoned liquidity from systemically essential day-to-day borrowing and lending. Effectively, having finally spotted this activity the Fed is now underwriting it, which all seems depressingly familiar.
