With Trump now officially US president amid concerns that a "sell the inauguration" sentiment may emerge at any moment, it was an appropriate moment for Credit Suisse analyst Andrew Garthwaite to release his report listing the 10 possible ways in which the bank's central views (and often the consensus) could be surprised. Below the bank highlights the factors its thinks could surprise adversely in 2017, together with its core views.
The quick summary:
- The S&P hits 2,500 before falling back to 2,000. Core view: the S&P 500 rises to 2,350 mid-year before falling to 2,300.
- EURUSD hits 0.90, before strengthening to end the year at 1.20. Core view: Credit Suisse's house view sees the euro declining to 1.03 on a three-month view and down to 1.00 on a 12-month view.
- Chinese GDP growth slows to 5% and with it the RmB weakens to 8. Core view: 6.8% GDP growth in 2017 and the RmB weakens to 7.33 at year-end.
- A Le Pen victory in France's presidential election. Core view: Francois Fillon becomes president.
- European defensives outperform by 15%. Core view: we are a small underweight of defensives, though we did add to them in our Outlook.
- President Trump's policies disappoint the market. Core view: corporate taxes will be cut, inflation expectations rise and protectionist policies toned down.
- The oil price hits $75pb by end 2017. Core view: The oil price will rise to $62 by the end of the year.
- The Nikkei rises to 25,000. Core view: we have a mid-year target for the Nikkei of 20,500.
- The European pharma sector underperforms by another 10%. Core view: we are overweight pharma and believe it can outperform modestly from Q2 this year.
- US 10-year Treasury yields hit 4%. Core view: CS US rates strategists have a 3% year-end target.
We will present more on these core 10 points over the next several days, but wanted to highlight one relevant point. While Garthwaite makes it clear it is far from his base case, he lays out the following assessment of what could kill the bull market.
The End Of The Bull Market
In essence, the first half of 2017 could look like a normal business cycle, but in the second half it seems plausible the cycle in the US could face significant challenges, and so could equities. The potential problems are as follows:
1. Too much fiscal easing pushes the labour market to beyond full capacity
As above, by the end of the year, the unemployment rate in the US could perhaps decline toward 4.25% if Trump embarks on fiscal easing. Indeed the OECD assume that his fiscal policies will boost GDP growth by c0.25-0.5% in the second half of this year. To use some simple numbers, if GDP growth accelerates to 2.7%, then with the rate of growth of the workforce around 0.75% and productivity growth of 1%, the unemployment rate could end up declining to around 4% by Q3 2017. Thus even taking into account the view above (that the full employment rate of unemployment may be lower than the Fed's forecast) the economy would still move beyond full employment.
The rise in wage growth would then start to depress corporate profits margins as well as increasing the risk that bond yields rise to what we view as the danger point of 3-3.5%. In addition, any pressure on profit margins at a time when corporate leverage is very high would in turn threaten capital spending plans.
2. The US bond yield starts to rise beyond our danger point of 3.5%
Rising US bond yields have the capacity to negatively impact equities in a number of ways: bond to equity valuations; corporate net buying (which becomes more expensive to finance); and the interest charge (with 1% on the corporate bond yield taking 4.2% off earnings). Equally at some point the risk is that the rise in bond yields affects economic growth. The OECD's global model highlights that 1% on bond yields is 0.2% off US GDP.
3. The Trump administration disappoints on corporate taxation and protectionism, but not on personal taxation
The mix of fiscal policies passed by the Trump administration, even if they prove positive for growth, could be challenging for equities. In particular, if the focus of the stimulus is on personal taxation, and if corporate tax plans are watered down, the combination could become quite negative for equities.
Such a mix would seem plausible. Personal taxation cuts tend be popular with both Republican lawmakers and with households. Under a budget reconciliation process (which requires measures to be budget neutral on a 10-year view), such cuts could be passed using sunset provisions, i.e. expiration after a decade, as was the case with George W. Bush's tax cuts. Such a policy would only push the economy to operate further above full capacity, placing more upward pressure on wages. It is possible that such a boost would be supplemented by a change in the tax code that further encourages US investment (with corporates being allowed to fully depreciate their investments in year one or choose interest deductibility).
The positive offset to the challenge to margins of an economy operating above full capacity is expected be cuts to corporate tax. However, we should at least consider the prospect that corporate tax cuts might prove smaller than hoped. A Gallup poll reported by CNBC found that 'a majority of both the general public and Trump voters oppose lowering taxes on big business and upper-income Americans…only 39% of Trump voters think corporate taxes should be lowered' (see CNBC.com, 13th January 2017). The House of Representatives is re-elected every two years and thus are incentivised to remainresponsive to public opinion. The political backdrop would appear to exist, therefore, for the tax cuts to be watered down.
Allied to this, there would appear to be a risk that protectionism could be worse than expected. The positive equity market reaction to Donald Trump's election was built on his initial focus on the constructive aspects of his campaign (in particular his mention of infrastructure spending in his acceptance speech), and apparent downplaying of the more controversial ones (he made no mention in that initial speech of a wall along the Mexican border or of protectionism).
Subsequent tweets and comments have, however, suggested that some of the more controversial aspects of Candidate Trump remain very much a part of President Trump's policy platform, particularly when it comes to protectionism. For example, in a recent interview with The Times (see The Times, 16 January 2017), he stated that he wished to realign the 'out of balance' car trade between Germany and the US, with a 35% tax on every foreign-produced car sold in the US. And some of his appointments have been trade hawks (such as Peter Navarro to the White House Trade Council, an economist who wrote the book 'Death By China'). If the border adjustment tax (which is WTO compliant as long as the tax credit is not more than the marginal tax rate) just results in a stronger dollar, then there would be more pressure to put up protectionist barriers.
It remains to be seen whether the WTO would allow such a tariff, or the implementation of a border adjustment tax, but were it to strike down either policy, it would in all likelihood increase the chance that the US simply pulled out of the WTO.
4. The end of equity bull markets
Historically, the closing 12 months of an equity bull market have been characterised by a spike higher, and then a larger than expected decline. In the case of the Hang Seng, KOSPI and TAIEX in '94, '89 and '90 respectively, the final year of the bull market was characterised by gains of around 80% on average. In the case of the Nikkei in 1990 and the S&P 500 in 1999, the final year of the bull market saw gains of c.25%.