Aviva Investors equity funds: US Election positioning
We are long-term investors in high quality businesses and believe the best way to deal with the uncertainty associated with developments such as the US election result is to remain true to our philosophy and processes and to ensure risk is appropriately diversified.
This has certainly been a year of surprises. Through all the uncertainty, however, one factor has remained constant; you cannot trust the polls. Our investment philosophy and approach to equity investing has also remained, and will remain, a constant. We believe the best way to deal with uncertainty is to remain true to our philosophy and processes and to ensure risk is appropriately diversified. We invest for the long term, typically three to five years, which means we have to look through market events and volatility and constantly remind ourselves why we initially bought our stock holdings. We own sustainable and scalable businesses that we believe will deliver strong returns through market cycles and indeed market events.
We should also consider the wider implications of the vote for Brexit and Trump. We do not underestimate the significance of the American people electing Donald Trump as their next president. Undoubtedly this result engenders greater political risk for equity markets than a victory for Hillary Clinton would have. However, our investment process is about making considered long-term decisions.
We appreciate that investors may have concerns over the outcome of the US presidential election and have summarised the initial thoughts and reactions from our regional equity teams below:
2016 is certainly turning out to be the year the pollsters’ predictions prove wrong, while political developments have been the key driver of global equity markets. Interestingly, the UK equity market reacted relatively calmly to the outcome of the US presidential poll with just a few sub-sector exceptions. Investors appear to have learnt the lessons from reacting precipitately following the Brexit vote. Back then, the domestically-focused FTSE 250 Index fell by 13.6 per cent over two days, but within six weeks was back at pre-Brexit levels.
The implications of historic votes, such as Brexit and Trump’s victory, evolve over months and years, not days. Four months after Brexit, we continue to see impressive UK manufacturing and consumer data readings. At Aviva Investors, we remain true to our philosophy and beliefs, and are long-term investors who do not make knee-jerk reactions. It is also important to remember that Donald Trump will not be inaugurated until 20th January 2017. So we will take time to consider the new landscape, rather than reacting immediately to Trump’s electoral campaign rhetoric.
There are some facts we can consider now, however. UK companies have significant earnings exposure to the US, so any major change in policies will have to be monitored closely. Trump has explicitly advocated the repeal of Obamacare, which in the short term should be positive for pharmaceutical companies. However, one would still expect measures to be introduced to control the cost of drugs. Consequently, and in line with our position as long-term investors, we will seek clarity on this issue before changing our views on the pharmaceutical sector.
From an economic perspective, a Trump win, following so soon after the Brexit vote, may have negative consequences for upcoming European elections. There will be greater uncertainty about the possibility of a radical party gaining widespread support and further undermining the stability of the European Union. Forthcoming polls include the Italian referendum on constitutional reform (Sunday 4th December 2016), the French presidential election (April – May 2017) and the German federal election (date to be confirmed but scheduled for August 2017 – October 2017).
On a sector basis, pharmaceuticals should be one of the biggest beneficiaries of Trump’s victory. The sector has been under pressure following negative comments from Clinton with regards to the pricing of drugs by major pharmaceuticals companies. Share prices reacted positively across the sector on 9th November when the electoral result became clear. Novo Nordisk, which has commented recently about pricing pressure, and which lowered its long-term growth guidance at its latest set of results, was a notable performer.
Construction could be another beneficiary and the sector’s stocks reacted positively to the result. Trump is perceived to want to increase infrastructure spending and, therefore, US-exposed construction firms will be beneficiaries. CRH plc, which is heavily exposed to the US, provides an example.
Automakers and their component suppliers could be among the losers, given many have significant exposure to North America. The sector has benefitted from the dollar’s strength against the euro and some investors may harbour concerns given Trump’s desire to protect domestic US manufacturers. Luxury goods companies exposed to the US, such as LVMH, Burberry and Hermes, also sold off due to concerns about Trump’s view on imports into the US. The consumer staples sector also reacted negatively. For example, Anheuser-Busch InBev suffered on concerns over its exposure to the US, and the uncertainty surrounding the economy, and Mexico. The financials sector initially reacted badly. However, Southern European banks weighed down the overall sector, whilst the larger Northern European banks proved more resilient due to the reaction of bond markets. The lack of exposure of banks such as ABN and ING to oil also supported the sector.
The market’s early reaction proved muted, certainly compared with the aftermath of the Brexit vote. Whilst the initial risk-off trade was understandable, the market appears to be placing increased emphasis on Trump’s plans to boost public spending and reduce corporation tax, rather than some of the more extreme parts of his political agenda. The tone of Trump’s speech following his poll win was certainly more conciliatory than his campaign rhetoric suggested it might be, and indicates that he understands the need to dilute some of his more aggressive policies in order to reach an accommodation with Congress.
In terms of sectors, we anticipate a relief rally in healthcare firms, which have suffered a significant valuation de-rating this year, reflecting Clinton’s campaign focus on drug pricing. That said, there is still uncertainty over the impact on the sector of Trump’s plan to repeal Obamacare. In addition, there are recent signs that pharmacy benefit managers have been exerting greater pressure on drug pricing (via increased rebates). Taken together, this will likely suppress share price gains.
In terms of potential new policies, Trump’s plan to allow US corporates to repatriate their offshore cash holdings at a 10 per cent rate would be a major boost to those companies that have large cash piles sitting outside of the US. Technology companies such as Apple, Microsoft and Google would be the main beneficiaries of this development and, as a consequence, some firms may deploy cash for M&A purposes. Infrastructure stocks (construction, materials and engineering names) should also benefit given Trump has indicated he would look to boost infrastructure spending.
Emerging Markets & Asia-Pacific
Following Trump’s victory, the South Korean market was predictably weak. This was reflected in both the currency and the stock market. The weakness was particularly visible in exporters such as Samsung and Hyundai Motors, whilst the more domestically-focused companies, such as KT&G, a domestic tobacco manufacturer, and Kangwon Land, a casino operator, remained resilient
The Chinese markets provided a slight conundrum; the domestic A share market remained resilient, falling by only 0.5 per cent following the result, whilst the Hong Kong-listed Chinese companies fell by nearly 3 per cent. The domestic and retail focus of the Chinese domestic market has gone some way to insulating it from global events.
With the currency stable, the impact was felt directly through the equity market with blue chip technology companies such as TSMC falling by 3.5 per cent. Despite the protectionist rhetoric during the US presidential campaign, we struggle to see how the US can extricate itself from the supply chains that are so integral to its technology products.
India has helped further muddy the waters. On November 8th, the government announced the removal of all INR500 and INR1000 notes from circulation (£6/£12), removing the notes from legal tender as at midnight on November 8th. These notes account for 86 per cent of currency in circulation. Moreover, 98 per cent of consumer purchases are paid for in cash. The correction in the Indian equity market, which normally proves more resilient in volatile times, is in our view more closely linked to this event rather than the outcome of the US presidential poll. Hero Motorcorp (a scooter manufacturer) and ITC (a cigarette maker) both dropped by 3-4 per cent, suggesting that the currency announcement rather than the US election outcome is the focus of investor concern.
The Peso was at the epicentre of the market’s concerns over Trump’s potentially isolationist policies. It rallied from a record low, but was down by over eight per cent by the time the market closed on 9th November. The protectionist rhetoric during the presidential race presents a clear headwind to Mexico. We expect some of our more export-oriented investments to perform poorly at first. Rassini, the Mexican autoparts manufacturer, in all probability will perform exceptionally poorly. However, we take some comfort from the fact that its manufacturing capacity is split between both Mexico and the US, and furthermore, it now supplies 100 per cent of the leaf springs that go into US pick-up trucks. Imposing tariffs on these goods would simply result in direct price inflation to the US consumer. This cannot be said of all our investments in Mexico. However it does go some way to illustrate the level of integration between the two countries. Whether Trump’s presidency will be as protectionist in practice as he sounded during the electoral campaign is a big question for the Mexican economy as a whole and not just the directly-impacted exporters.
Turning to the rest of EM, Russia could benefit from the early lifting of sanctions related to the Crimea/Donbass conflict, whilst in Turkey there is a perception that Trump is less likely to bring pressure on issues such as human rights and the free press than Clinton would have done. This has had opposing effects on the two equity markets with investors selling off Turkey, reflecting the view that Erdogan will have a free hand to impose his authoritarian rule, whilst Russia rallied, despite oil price weakness.
The long-term outlook for EM remains constructive, underpinned by structural drivers that cannot be changed overnight. Over the medium term, China remains our main concern, due to excessive credit growth. It is only the near-term trajectory for emerging markets that at this point is affected by current events. We, however, remain relatively sanguine. The current strength of the Chinese economy, exceptionally loose global monetary conditions, cheap valuations, and a gradual recalibration of developed market political risk should all be supportive of emerging market assets.
The Topix Index closed 4.5 per cent lower on 9th November, having fallen by as much as 6.2 per cent earlier in the day. Investors’ initial fears focused on the risk to the Trans-Pacific Partnership free trade agreement, the possible impact of a strengthening yen against the US dollar on Japanese corporate profit growth and a lack of visibility on what the US Federal Reserve would do in December. Markets recovered later in the day with the yen rising by as much as 3.9 per cent against the US dollar. The yen ended the day with a 2.2 per cent gain.
The election result, and the likely policy measures, such as tax cuts, protectionist trade measures, and restrictions on immigration, may not prove adverse for the US economy, at least in the short term. Consequently, the outlook for the large Japanese corporates which are producing many goods within the US, e.g. Toyota Motor, Fuji Heavy Industries, remains positive. It is worth remembering that Japan is the main ally to the US in the Asia region. We understand the need to appear tough to get elected, but, President-elect Donald Trump is a businessman and he, and his team, are aware that the US will find Japan, rather than China, its most reliable partner in Asia.
In addition, for a number of years, Japanese corporates have been investing significantly within the US to manufacture locally, which may not be the case with other Asian countries. There is an opportunity to buy quality companies, specifically in domestic/defensives sectors, if the market as a whole sells off. We are also considering whether a tough trade stance by the US could lead to a strengthening of ties between Japan and South Asian countries. It is worth noting that the Topix Index trades at 13.6x on a price to earnings basis vs. 18x for the S&P500 Index.
Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (Aviva Investors) as at 10 November 2016. Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Some of the information within this document is based upon Aviva Investors estimates.
The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Past performance is not a guide to the future.
Portfolio holdings are subject to change at any time without notice and information about specific securities should not be construed as a recommendation to buy or sell any securities.