Uncertanties in USA and EU

Doubts are increasing about the US policy mix, and the hopes of much fiscal stimulus and little protectionism that have buoyed markets since the election may not be how things eventually work out. Based on the new administration’s first two weeks, caution looks warranted.

Two weeks into a new US presidency, many are wondering how to deal with the dramatic shift in the country’s stance towards the rest of the world. The message from the White House seems clear: Donald Trump is determined to win at all times and at any cost, and in his world view, that means that the other side must lose. Win-win situations, which form the essence of free trade, seem incomprehensible to him. The era of US policy action driven by “enlightened self-interest” is clearly over, and this implies a serious risk of increased geopolitical and trade tensions. Assessing these risks is difficult at this stage.

Fundamental disagreements between Trump and the Republicans in Congress on issues such as Russia, the repeal of Obamacare, free trade and tax reform will take a lot time to sort out. From a political perspective, all these issues are related. If Trump acts unilaterally on trade, he may antagonize Republicans in Congress and make them less willing to cooperate on other issues. From a market perspective, it means that investors will have to live with considerable uncertainty about the Trump policy mix for the next few months.

The US economy may be further advanced in the cycle and more robust than in other developed markets, but potential headwinds may come from exchange rates, monetary policy and adverse Trump policy measures. Investors seem to be ignoring these factors. On top of this during periods where the reflation trade is dominant and risk aversion is declining, the relatively defensive US market is underperforming the rest of the world. We underweight the US.

The opposite may be true for the Eurozone, where political risks are already on everyone’s radar screen, but where earnings may get an extra impulse from a weaker exchange rate. The Netherlands and France will hold elections in the coming three months, and populist candidates are likely to make strong showings in both contests. While our base case is that the two countries’ political structures will enable the more traditional and less populist parties to prevail, the US elections and the Brexit referendum have taught us not to ignore the tail risks. Still, if the Eurozone political risk turns out to be overstated, this would create attractive investment opportunities once the event is behind us, provided the worst outcome has not occurred.

With economic and earnings data remaining solid and investor sentiment and positioning indicators continuing to hint at further pent-up demand for risky assets, our risk-on stance remains in place despite our worries over the direction of US policy going forward.

Valentijn van Nieuwenhuijzen – Chief Strategist e Head of Multi Asset – NN Investment Partners