The day of Donald Trump’s election back in November 2016 was quite a fascinating day to watch the markets (come to think of it, the whole second part of that year from June to November was a rollercoaster). Markets initially did not like the news much at all, then at some point during the day the tide turned and everything started rallying: US dollar, stocks, interest rates. That did not stop for quite some time.
It wasn’t so much that markets suddenly turned sanguine about all of the perceived bad aspects of a DT government. The worries about trade disruption and alienating allies were still there. But the prospect of a pro-growth government controlling all three branches had investors salivating and became the overbearing driver of returns. Corporate tax cuts, infrastructure spending, reducing regulations…
But lately the Trump trade has turned upside down
As of late, there is a real sense that that is changing and the worries are gaining the upper hand. The main culprit for the markets unease since early February have been Trump’s tirades on trade, blaming anyone from Mexico to Japan, Canada, China and the European Union for taking unfair advantage of the United States. These countries together represents two-thirds of all of America’s foreign trade and much of its exports.
On top of all this there are the worries about Mueller’s Special Counsel Investigation and whether any of it could eventually lead to impeachment. And don’t forget that by 2020 Trump faces new elections anyway.
So… Does this kill the market?
I read a quote from one portfolio manager in Australia this week proclaiming that the tweet-driven market was driving him insane and he was considering offloading all his US stocks. We are indeed in new territory here and I do wonder if there comes a point where Trump’s playing with the market ends up killing the bull market as a whole. US economic data tells us otherwise, but at some point something will give, right?
Long story short, Trump may be with us for quite some while, or his days may suddenly be numbered. How to invest for when that moment comes around? I see four main themes playing out.
#1 Long US dollar, short euro and yen
When Trump was elected, the US dollar initially rose from 98 to 103 (+5%). Since then however, it has been on a steady downward trend and only as of late seems to have potentially found a bottom around 90 (-8%). What gives?
The Trump “reflation” trade initially made the dollar stronger, but since then I have long suspected that the US administration has deliberately talked it down. While the longer term US government policy is still for a stronger US dollar (as that has certain benefits), in the short term a weaker dollar may help to “rectify” the trade imbalances the United States faces with other blocs and nations. Treasury Secretary Mnuchin seems to think so.
So it is ironic that while we expected a period of US dollar strength after Trump’s election, in fact that period may arrive after he steps off stage, as US economic policy returns to orthodoxy. The euro and Japanese yen are both at relatively strong point vs. the dollar compared to recent levels, so I would short them against USD.
#2 Long Mexican peso
In the run-up to the US election in 2016, Mexican peso declined to nearly 22.0 versus the US dollar. It has since recouped quite a lot and is back around 18, but many economists say its fair value should be closer to 15 or 16. A lot of the worries that have plagued MXN are likely to resolve itself when the new NAFTA deal comes into play, but it may take Trump fully stepping off stage for Mexican peso to regain its strength.
#3 Long US treasuries
Treasuries have become weaker as the rate hiking cycle has continued. Inflation levels are still expected to rise, since we are likely to be at full employment (and throwing fiscal stimulus at the economy at the same time), and on the back off that this trend should keep going for a bit.
At the same time you have to wonder when the next serious market downturn will take place and what is going to cause that. Or even how that is going to impact the position of “Mr Stock Market” Donald Trump. At that point we may reach the peak of this rate hiking cycle and things could turn around, or a flight to quality may raise treasuries all by itself.
#4 Long China and Europe stocks, neutral US equities
There are some reasons to suspect that China and European stocks will outperform their US peers in the event of Donald Trump stepping down. In both cases it will likely remove an irritant to their global trade ambitions, while in Europe’s specific case a weaker euro would likely be good for European stocks.
Portfolio construction: long USD and MXN, long treasuries and EU/China stocks
- The model portfolio contains some 40% in currency positions, consisting of long USD and long MXN. The remainder is filled up by 20% US treasuries and 40% European and Chinese stocks
- The volatility on this portfolio is some 6.4%, which is marginally higher than our Core Bond portfolio (4%). Both in terms of upside potential as well as downside potential this portfolio should be able to do well in the specific scenario it is designed for. In case the scenario does not exactly play out as envisioned, long stocks, long EM currencies and long USD should be able to balance things out quite neatly
|Short EUR||Proshares Short Euro ETF||EUFX||0.95%||10.0%|
|Short JPY||ETFS Short JPY Long USD ETF||SJPY||0.39%||10.0%|
|Long MXN||MXN cash||MXN||-||20.0%|
|US Treasury||iShares 20+ Year Treasury Bond ETF||TLT||0.15%||20.0%|
|China equity||iShares MSCI China ETF||MCHI||0.64%||20.0%|
|Europe equity||Vanguard FTSE Europe ETF||VGK||0.10%||20.0%|
Risk level: low / diversification: high / allocation: 0%-10%
- Dividend yield: 2.3%
- Ex-ante predicted volatility: 6.4%
- 1 year 95% Value-at-Risk: –9.5%
- Scenario 2008 Lehman Brothers default period: -10.0%
- Scenario Interest rates +100bps: +0.1%
- Scenario 2008-2009: -8.7%
- Scenario 2010 onwards: +50%