November 17, 2016    6 minute read

Opportunity Trump

Current Trading Strategies    November 17, 2016    6 minute read

Opportunity Trump

 

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In the early hours of November 9th, 2016, history would be altered. Donald Trump, with a minority victory, was granted the keys to the White House. The markets panicked and fretted as uncertainty was aplenty. The media had managed to portray Trump as a villain, lacking the necessary credentials. This portrayal implied that, in the unlikely event of a Trump win, the markets would be roiled. Trump was victorious, and the markets did exactly the opposite.

Markets Defying Expectations

Astonishingly, the Emini S&P 500, regarded a bellwether equity index, finished the day in the green. The safe-haven US 10yr note finished the day 20 basis points higher. The most frightening part is that amongst the entire investment community from all the ‘gurus’ that constantly give opinions to the paid for subscription newspapers and financial broadcasters, there was hardly an individual that predicted a Trump victory let alone the aggressive risk on trades that played out.

Our first event

The conclusion: nobody knows what is going to happen. Financial professionals like to think they know but anyone who has been in the financial markets long enough will tell you truthfully: it is all probability and guesswork. Therefore, the question traders and investors should be asking is: where to now? What does the future hold for the financial markets after an unexpected Trump win?

A Clear View

It is a wonderful thing to be indifferent. It allows you to view the markets with a clear perspective instead of enforcing a preconceived bias. To be clear, it is not about who won the election. A trader’s job is to identify opportunity. Donald Trump for all his faults represents exactly that: opportunity. The single biggest threat to global financial markets is change. Change brings uncertainty. Once the uncertainty dissipates, change will bring great opportunity.

The President-Elect has ‘trumped’ the status quo and is set to embark on an aggressive policy shift. Large infrastructure spending, tax cuts, adjustment of NAFTA agreement, Dodd-Frank and Volcker rule amendments and numerous geopolitical policies are just some of the drastic changes being proposed. While the devil is in the detail, one thing is certain: Trump will change the financial landscape. As a result of the change here is some ‘guesswork’ about the potential for future market trends.

The Key Figures In The US

The synopsis, according to Trump, is that he will embark on a stimulus package of between $500bn to $1trn. This will spur domestic and global demand. Labour force supply dynamics in the United States will be tested as it nears full employment. The result will be higher wage growth and increased consumer spending as the ‘good times return’.

Trump’s spending spree will imply higher inflation than the Federal Reserve is currently forecasting. The committee has indicated it expects a median of three hikes in 2017. The market has barely priced in two full hikes for 2017. Therefore higher inflation will be of great concern for the committee, as the guidance given by the Federal Reserve is a gradual path of rate hikes. The key is whether the stimulus programme is a one-off or whether it spurs the growth engine in the US to life. Theory means little if it is not converted into opportunity. On this thesis here are some of the plays to focus on:

A steeper rate curve, implying a steeper path of rate hikes than the market and the Federal Reserve are currently pricing – this steepness is traditionally seen when growth and inflation are in abundance. It is possible to have higher inflation and not higher growth once the initial stimulus wears off, this is the fear. However, it is now safe to take bets on the idea that the Federal Reserve will be prompted to hike at least three times next year. This is assuming inflationary pressures do not rise more rapidly than the forecasts of the committee. Currently, the market is only pricing in three hikes for the end of 2018. This presents a fantastic risk-reward.

The Long And The Short Of It

As a result of a steepening curve and more hikes priced, one would only be accumulating dollars. The divergence between the US economy and the rest of the world became evident toward the back end of 2015, as illustrated, this play is now both technically and fundamentally very valid. The best play would include long dollar against any other central bank that continues to cut rates or purchases bonds under quantitative packages. These include the Bank of England, the European Central Bank, the Bank of Japan and the Bank of Canada. Take your pick but a diversified portfolio of long dollar and short Canadian dollar, euro, pound and yen would be ideal.

Of key technical importance is the euro. The central bank is due to meet in early December, and it is likely they extend their current programme of bond buying beyond March 2017. The key will be the amount purchased. Any hint of a small taper will give short term boost to the euro, but with little fundamental or technical support for the euro, it feels as though the euro at parity in the next six months is a high probability play.

dxy

(Dollar Index; Source: Reuters)

eurusd

(EURUSD FX Weekly chart; Source: Reuters)

These are just some of the financial market plays to execute. Not because they are mainstream media ideas but because they make fundamental and technical sense to a trader. There are lessons to be learnt from Brexit, Trump, and even Leceister Football Club: one should not believe everything they hear in the media but more importantly expect the unexpected.

Change is thus an excellent thing as it forces society to open its eyes and rethink the status quo. It is only when one reevaluates that one truly begins to evolve as a species. Trump will prompt open discussions amongst people. Finally, people will have the opportunity to see something different. It might work, it may fail dismally. But what alternatives does one have? One chooses to change because at least with change comes opportunity. Trump may just be the right kinda wrong.

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