Markets in a dither over The Duck
In just two weeks the United States and the rest of the world face D-Day — when Donald Trump is sworn in as the 45th president of the world’s largest and most powerful economy.
Although it is anyone’s guess which of his threats or promises he will go through with, the markets are, for now, choosing to see the brighter side of his presidency.
US stock markets rallied into the New Year and the dollar continues to trade at its strongest level in 14 years. This is in response to, in as far as a Trump policy stance can be discerned, the expectation that his agenda will be pro-growth and reflationary.
The optimistic sentiment of his presidency, which will take a hard-headed stance on immigration and trade, has prompted some investor outflows from high developing countries. But the recovery of commodity prices, for which Trump’s infrastructure plans are thought to be partly responsible, bodes well for commodity-producing economies such as South Africa, and many investors are bullish about developing economies.
More generally, commodity prices are at strong levels but still the threat of investor outflows to recovering developed economies such as the US looms large.
“Markets are confused at the moment,” said Nedbank group economist Dennis Dykes, noting that, in the short term, the fiscal changes Trump will effect in the US hold promise but in the longer term the potential effects on trade do not bode well.
“Expectations of fiscal expansion in the US, anticipated to help break the deflationary grip on the developed world, could lead to more vigorous growth in the short term,” said Dykes. Trump is more likely to push through with fiscal reform given that, as a Republican, he does not face a divided Congress.
“But, from a long-term perspective, the anti-globalisation-type moves expected from Trump will not benefit emerging markets or the rest of the globe more generally,” Dykes said.
Last year, emerging markets experienced the weakest inflows since the global financial crisis in 2008, according to the Institute of International Finance. In the week ended December 21, the institute reported, outflows from dedicated emerging market equity funds (excluding China’s local renminbi-denominated equity market funds), totalled $3.4-billion, the second-largest outflow in a week in 2016.
The institute said there were a number of factors such as the rising US yield that can be attributed to expectations of a reflationary US under Trump but also to a more hawkish US Federal Reserve. Idiosyncratic events in some emerging markets have, however, weighed on domestic prospects and exacerbated portfolio outflows.
Dykes said the full impact of these factors is yet to be seen. “As far as emerging market outflows go, we haven’t seen all the effects yet.” Although South Africa has seen some outflows, foreign investors continue to have a substantial investment in the JSE and bond market.
But further outflows in 2017 will be less about Trump and more about the reaction of the Federal Reserve, Dykes said. Unlike last year, the debate about the Fed’s moves will not be about whether it will hike interest rates but rather about how many times it will hike them.
“It definitely seems that fiscal stimulus could be inflationary down the line and the US labour market a lot tighter than we anticipated,” he said.
Undoubtedly, a rise in inflation and interest rates would make the US a more attractive place for investors to put their money. But there is a great deal of money in the global system because of stimulus in places such as Europe and Japan, which means we will continue to get a reasonable share of it, though any dramatic rise in US interest rates would change that,” Dykes said.
Dollar strength has been the most important headwind to emerging-market performance over the past few years, according to Richard Titherington, the chief investment officer of emerging market and Asia Pacific equities at JP Morgan, in an opinion piece recently published on Moneyobserver.com. Renewed dollar strength, he said, is likely to dampen the performance of these markets relative to developed markets in the short term. But, he said, history suggests the dollar’s bull run is nearing its end.
Other market watchers anticipate that the dollar is set for a strong year and, “if things start to catch alight, which is quite possible, that’s where the emerging market risks come in”, Dykes said.
A strong dollar is typically bad for commodities. “If the dollar gains 4% more, commodities are going to come off 5% to 10%,” said Peter Major, the director of mining at Cadiz Corporate Solutions.
Most commodity prices recovered markedly in 2016 — iron ore, gold, manganese, chrome, coal, tin, zinc, copper and a few others — said Major, adding that he thought these were now too high. This recovery is seemingly being driven by speculative demand, which is usually ahead of real demand. “But it’s not usually out of the clear blue sky like it is this time. To me, this speculative demand doesn’t have much substance behind it … This looks to be based on huge wishful thinking.”
Recently, rumours have emerged that China’s efforts to cut industrial capacity will lead to shortages of raw materials. Coupled with an anticipated increase in infrastructure spend under a Trump presidency, these developments could possibly justify where commodity prices are today, Major said.
Although South Africa is not really dependent on any one commodity or any geopolitical centre, one would do well to watch development in the US and China closely, Major said. “You have two eyes in your head and that is just enough — one for each of these two giants. Both influence the world economy hugely.”
He said he would be surprised if commodities move 10% higher in the coming year. “But I can see a lot of them falling.” Although, he added, “forecasting is more impossible than ever before — Trump is totally unpredictable, and the Republican Party nearly the same”.
Economic insights for emerging markets by the financial services company, Nomura, rates the biggest external risk as the Trump presidency, noting it is already having an effect.
One example cited by Dykes is the dismantling of the North American Free Trade Agreement, a three-country accord negotiated by the governments of Canada, Mexico and the US that came into force in 1994. It will be a long and complex process, but already many US companies are growing nervous about it. This week, Ford scrapped a $1.6-billion new plant project in Mexico and will extend its plant in Michigan instead.
Nomura said that in the months ahead, Eastern Europe, the Middle East and Africa as an asset class should outperform Latin America or Asia, given their lower levels of connection to US rate hikes or Trump policy, including protectionism.
“While it is difficult to find region-wide domestic themes for 2017, we see a challenging external environment from the Trump presidency and higher US rates, sharply magnifying domestic issues in EEMEA [Eastern Europe, the Middle East and Africa] countries,” according to Nomura research analysts.
“The US might go ahead with cutting imports from certain countries but that doesn’t affect us directly,” said Dykes. “But, indirectly, if China suffers, we will see other emerging markets suffer. So South Africa is vulnerable there.”
Considering several implications of a Trump presidency, Nomura analysts said they expected Turkey to come off worst, alongside the oil-producing Middle East.
“South Africa and Russia are less badly affected (though, on Russia, we think the market overestimates the positives from a Trump presidency if there are lower oil prices as a result of his policies), and, in Poland and Hungary, the effects are more neutral,” according to Nomura’s analysts.