US stocks have surged to record highs since Donald Trump won the US presidential election. To justify these unprecedented levels, investors are making many assumptions on how the Trump era might manifest itself across politics, economics and ultimately returns. These assumptions include that Trump will prove more moderate in power than on the campaign. Another expectation is that fiscal policy will play a bigger role in driving the US economy, which will lead to faster inflation and higher interest rates. Investors are assuming that Trump will adopt a more protectionist approach to trade but only in token ways so it doesn’t sabotage the US economy. They are confident he will refrain from any taunting of the Federal Reserve that crimps its independence. But these central scenarios appear to be on flimsier footings than many might think. Thus 2017 could prove more turbulent for US stocks than many assume.
Bond yields are rising, especially since the unexpected victory of Donald Trump in the US presidential election. The big question hovering over bond markets now is whether or not the recent drop in bond prices signals the end of the 35-year bond bull market. Or is it just another brief disruption to the long-term bond rally as occurred in 1994? While it’s too early to be definitive, the current move appears more cyclical than structural as most of the longer-term drivers of longer yields remain in place.
The challenge for investors is that valuations on most assets are at best fair, and, in most cases more demanding, meaning the risk of loss in many assets is elevated. In the context of our investment framework, there are limited assets offering appealing returns for the risk embedded in owning these assets. In this framework, broader Australian equities stand out as offering reasonable medium-term returns given undemanding valuations. At the other end of the spectrum, we remain concerned about A-REITs (even though they have performed poorly of late) as valuations remain stretched and their sensitivity to small changes in bond yields remains high. Interestingly, while sovereign bonds offer poor return prospects the potential for big losses from owning bonds is relatively low. On balance, the concentration of assets in the lower left-hand quadrant is consistent with retaining a conservative stance notwithstanding enthusiasm around a Trump presidency. As we have seen during the campaign, the reality and the rhetoric may be poles apart.