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Analysis

Investment clock: Trump vote could strengthen overheat phase

by Trevor Greetham

Fri 2 Dec 2016

Investment clock: Trump vote could strengthen overheat phase Enlarge Chart loading Image

The markets had another political surprise in November with the election of Donald Trump as US president, an event, like Brexit, seen as highly unlikely before it happened. This development creates major global uncertainties but investors see the glass as half full as reflationary fiscal policies are expected to boost the US economy.

Even before Trump’s election the global business cycle was moving into an ‘overheat’ phase characterised by positive global growth and rising inflation, according to the Investment Clock, a model-based framework linking asset returns to different phases of the global business cycle (see chart). Reflationary fiscal policies under Trump are likely to keep us there by boosting US growth and raising inflation risks. Stocks and commodities tend to beat bonds in the overheat phase and this trend is likely to continue.

The election of Trump has been taken badly by the bond market as it marks a transition from monetary ease towards fiscal ease. So far, most of the rise in bond yields has been driven by an increase in long term inflation expectations. This makes sense. Mindful of downside risks presented by high levels of personal and government debt central banks are likely to keep policy relatively loose and let inflation rise from its current low level. This is a positive backdrop for stocks, particularly for Japanese equities which tend to do well when the dollar is strong.

The summer doldrums are well and truly over and US equity markets are making new highs, as often happens in the typical year-end rally. While fundamentals are positive for stocks, there remain many important unknowns as to how a Trump presidency will operate. With Royal London’s investor sentiment indicator now at euphoric levels, the current rally may not provide the best entry point to buy. Fed rate hikes have the potential to rattle stocks in the short term, but aggressive tightening is unlikely and dips would provide a good opportunity to buy stocks.

Trevor Greetham is head of multi asset, Royal London Asset Management