Since July this year, we stayed cautious on equities on the back of Brexit-related uncertainty. We’ve retained a defensive posture as we continued to see asymmetrical risk-reward on the back of increasingly extended valuations and looming political risks in the U.S. and Europe. Following the recent Trump victory, we are inclined to keep this position moving forward, at least until some clarity on his economic policies emerge.
Valuations-wise, global stocks are still trading at fairly extended valuations. Earnings growth seems lack lustre and the macro environment is beset with even more political and policy uncertainty following Trump’s shocking victory. At this point, it is still too early to say definitively what his policy objectives are and whether all his campaign promises will see the light of day even with a fully Republican Congress. Clarity will only come with time, and given prevailing uncertainties we expect volatility to remain elevated and market sentiments to be particularly sensitive to changes in political rhetoric.
Given these factors, we would prefer to stay defensive and keep our negative stance on equities.
Before 9 November, in terms of regional equity allocation, we expressed our negative stance evenly across all the developed markets including the U.S., Europe and Japan.
We stayed neutral on Asia ex-Japan on a relative basis for two reasons: (1) Cheaper relative valuations versus Developed Markets and (2) Improving macro prospects in the region.
Going into the U.S. presidential elections, we had expected a Trump victory to be followed by a short-term knee-jerk market correction, much like the Brexit episode.Had the correction been compelling enough, we would have considered adding risk by way of Asia ex-Japan stocks. However, we did not see this happening and, in line with other reasons, move to downgrade our view on Asian ex-Japan from neutral to negative.
1. Less favourable risk-reward at current valuations considering the macro-risks ahead
Signs of an imminent Trump win as U.S. state results were being announced on 9 November led most Asian bourses lower with the MSCI Asia ex-Japan index retreating sharply by as much as 4 per cent.
Yet the correction was short-lived as markets rallied after Mr Trump struck a more presidential tone in his victory speech. Conciliatory remarks from Mrs Clinton as well as the current Obama administration assuaged concerns over a potentially disruptive political transition. By the end of the trading session, the MSCI Asia Ex-Japan index fell just 2.4 per cent, and rallied during the next two sessions thereafter.
Absent any sharp correction post-Trump, Asia ex-Japan stocks continue to trade above its own historical long term average at 13 times price-to-earnings with scope to revert to its long-term average. While it is trading at a discount to its Developed Market peers, the gap has also narrowed. Admittedly, relative valuations may still seem attractive, but Trump-related macro risks ahead mean risk-reward for Asia ex-Japan stocks is less favourable at current valuations.
Chart 1: While Asia ex-Japan stocks are still cheaper than developed markets, the gap has narrowed
2.Volatility will likely remain elevated
The recent positive market reaction gives us pause, considering that much of the price support is clearly sentiment-driven. After all, Trump’s policies are no clearer today than it was before his win. And so we are not particularly keen to add risk at this stage considering that markets are being supported more by political rhetoric than fundamentals. Given prevailing policy uncertainties, volatility will likely remain elevated and may weigh on risk sentiment.
3.Trump’s anti-trade agenda may hurt growth prospects in Asia
Among Mr Trump’s broad policy objectives, his anti-trade push seems most dangerous for Asia. Global integration has been at the heart of the Asian growth story and any threat to curtail trade or globalisation through tariffs may hurt growth prospects in the region.
Through the course of his campaign, Trump has threatened a 45 per cent tariff on imports from China and 35 per cent on Mexico, aside from overtly stating his intentions to repeal NAFTA and potentially withdraw from the WTO. The office of the President of the United States wields a lot of power in international trade agreements and should Trump move forward with these controversial policies, he could incite a trade war and lead the world into another recession.
The big question is whether he will tone down his anti-trade rhetoric when he takes office on 20 January 2017. This is unlikely to become clear for some months and such policy uncertainty could spell higher volatility ahead. Absent any clarity on Trump’s policy intentions, we would be better served adopting a more cautious stance on Asia ex-Japan.
U.S. equities rebounded in November as the Republican victory across the White House, Senate, and House has triggered expectations of a meaningful shift in U.S. policy mix towards growth-boosting fiscal and structural policies. U.S. financials, in particular, benefited from the perception of easier regulation and higher rates environment under the new regime.
Equity valuations have benefited from the “lower-for-longer” interest rate environment despite the lack of earnings growth. The post-election rally to record levels, notwithstanding the rise in yields, suggests that the market sees growth acceleration outweighing the impact from higher rates. Clearly, there is not enough information at this stage to arrive at such a conclusion with conviction.
Nevertheless, U.S. equities remain more defensive on a relative basis, especially as a Trump presidency could portend more problems ahead for emerging markets via trade protectionism. In this case, we move to upgrade U.S. equities from Negative to Neutral.
Even as we stay cautious on equities more broadly, we still see some selective and tactical opportunities in certain Developed Market sectors. More specifically, we see short-term tactical opportunities in the (1) Healthcare and (2) E-Commerce sectors.
Why healthcare?
Healthcare stocks were particularly vulnerable to Hillary Clinton’s aggressive rhetoric on regulating drug pricing in recent months, especially when polls seem to suggest a clear Clinton victory. As a result, Biotech stocks were badly punished. However, Mr Trump’s victory offers some reprieve as his administration is likely to be light on regulations offering some upside to this sector.
On a fundamental basis, most large biotech and pharmaceutical companies derive economic return through a combination of economies of scale, product innovation and penetration of new markets, rather than on price increases alone. So recent stock movements in response to regulation of drug prices over the past few months seem overstated.
Why E-Commerce?
E-commerce names seem fairly insulated from any potential ruckus caused by Mr Trump’s economic policies considering they provide more specialised payment functions and are not directly involved in the sale of physical goods globally (revenue-channels which could become stressed should Mr Trump pursue his anti-trade agenda).
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