Investor mood may be uncertain after the US election but the fundamentals supporting US equities look solid.
After a long and brutal US Presidential election campaign, Donald Trump has emerged victorious. While most of the campaign on both sides was negative, Trump’s populist messages of lower taxes, gun rights and a conservative religious agenda, allied with opposition to trade agreements and illegal immigration, were ultimately successful in knitting together a winning coalition.
Shortly after the election result was announced, global financial markets reacted in predictable risk-off fashion, with global stock markets and oil prices falling while gold and US Treasuries rose. The Mexican peso fell, as did the US dollar.
With the surprise result dominating investor concerns and headlines in the short term, it is important to take a step back and assess the situation as long-term investors.
Our chief global strategist, Dry David Kelly, aptly stated: “Markets had been anticipating a Clinton win, which would have represented a continuation of the status quo. Donald Trump’s victory, by contrast, has elevated global uncertainty, partly because of the danger of the trade war and partly because it is not clear which parts of a very ambitious agenda of tax cuts, increased defence and infrastructure spending, deficit reduction and healthcare reform can or will be implemented.”
For investors, however, the question is not how markets have reacted, but what is the long-term outlook in the wake of the US elections? It is uncertainty that lies at the heart of this outcome, and while markets do not like uncertainty, the unexpected election result looks set to deliver more of it.
Understanding this post-election uncertainty - and the reasons why markets might be spooked by it - is good for tracking market movements.
But valuations and fundamentals are better indicators when it comes to long-term returns.
The US equity market had previously faced two challenges: a high US dollar and a low oil price. These two headwinds appear to be fading, making the US equity earnings story one that we can look forward to developing as this year draws to a close, into 2017.
The strong dollar has hurt company revenues which sell their wares abroad. US exports would have looked less competitive compared with other exporters with such a high US dollar. In fact, the relationship between US industrial revenues and a high US dollar is almost exactly inverse; when the dollar is high, revenues fall.
The second shift that will support US equities is a stable and rising oil price. While the US economy does not overly depend on oil production, a substantial amount of the S&P 500 market cap and weighting comes from energy producers.
The benefits of low fuel prices to the US consumer have been moderate, but for global investors, another point to consider with a rising oil price is how this can support S&P 500 earnings.
One might worry that a low oil price was benefiting certain industries, but when examining the earnings-per-share (EPS) growth of specific industries, it looks as though US automobile companies were, in fact, the bigger beneficiaries.
Automobiles have increased earnings somewhat, because US auto sales have actually hit record highs for this cycle. Airline EPS has also increased considerably, which one can assume is partly supported by lower fuel costs.
But air freight and logistics do not have the same EPS increase, which suggests the EPS improvement for airlines may be driven by other industry-specific undercurrents.
Overall, while we believe there may some benefits, earnings for sectors associated with crude oil usage or oil overproduction beneficiaries have not grown their EPS. This bodes better for US earnings now that the oil price is stabilising and EPS for oil producers is set to increase.
By Nandini Ramakrishnan, Global Market Strategist, J.P. Morgan Asset Management
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