Global Investment Strategy

Weekly market insights and possible impacts on investors from the Wells Fargo Investment Institute Global Investment Strategy team.

March 27, 2017

Peter Donisanu, Investment Strategy Analyst

Trump Trade versus Macro Trends

  • The global equity market pause last week has been attributed by some market watchers to a reversal of the “Trump Trade,” given disappointment over U.S. domestic and foreign policy.
  • Whatever the catalyst for the sell-off may have been, we believe that improving trends in macroeconomic fundamentals likely will underpin equity-market performance this year.

What it may mean for investors

  • We recommend that investors look through near-term events and remain fully committed to, and fully invested in, their long-term investment plan.

Last week, major global equity markets paused following a strong rally during the first few months of the year. Some market observers have attributed this recent pause to a fade in the “Trump Reflation” trade. As a result, some investors have questioned whether equity markets are poised for a sharp sell-off. The U.S. election outcome may have initiated a rally in riskier assets, yet we believe that the seeds of this year’s market rally have been germinating in an improving macroeconomic environment. Nevertheless, we feel it is likely that prices may have come too far, too fast, potentially positioning equity markets for some consolidation.

Macro Trends

In this week’s report, we highlight some broad macro trends (about which we recently have written) that we believe have supported a broad rally in global risk assets. In recent months, global equity markets, particularly those in the U.S., have received a boost in anticipation of policy changes that could support economic growth following the election of President Donald Trump and Republican majorities controlling the congressional agenda. While last week’s sell-off in equities may reflect market participants’ uncertainty on policy implementation, we believe that positive macro trends may provide equity markets with enough support to put aside the pessimism of last year. We also expect these views to be balanced against potential risks that we are closely watching. We highlight some key takeaways from our recent reports below:

The Global Economy Has Improved1 — Economic activity in the U.S., China, Europe and Japan appears to be in a synchronous recovery. The recent rebound comes after years of uncertainty surrounding the Chinese and U.S. economies, energy prices and international trade. Chart 1 shows that economic conditions have improved compared to those of five years ago, more so in the developed economies of Europe and the Pacific basin than in others. The trends are not strong yet, but suggest further gains in economic growth. As a result, we expect that economic growth will underpin a moderate recovery in corporate-earnings growth and normalization in central-bank policies. In fact, earlier this month, we slightly raised our international earnings expectations for 2017.

Chart 1. Wells Fargo Investment Institute Economic Diffusion Indices Suggest Global StabilizationChart 1. Wells Fargo Investment Institute Economic Diffusion Indices Suggest Global StabilizationSource: Wells Fargo Investment Institute, Bloomberg; March 22, 2017. Past performance is not indicative of future results. The Wells Fargo Investment Institute (WFII) Economic Diffusion Index is a composite measure of changes in a given country’s key economic metrics relative to a rolling five-year rolling lookback period. Metrics tracked include labor and productivity, trade, inflation, monetary conditions and consumer spending. A score above zero represents expansion while a score below zero represents contraction.

International Trade Confirming Economic Growth2 – Uncertainty surrounding international policies has dominated the discussion on global economic growth. In our opinion, the recent rebound in global trade is an important, but overlooked, development. This reacceleration in trade confirms our belief in a synchronous, yet modest, rebound in the global economy. Data on shipping containers passing through key international ports shows that volumes have accelerated in recent months (Chart 2). Indeed, the World Trade Organization’s World Trade Outlook Indicator (WTOI) suggests that the volume of trade should continue to rise through the first quarter and potentially through the first half of this year.

Chart 2. International Volume of Shipping Containers at Major Global Ports is on the RiseChart 2. International Volume of Shipping Containers at Major Global Ports is on the RiseSources: Wells Fargo Investment Institute, Institute of Shipping Economics and Logistics; February 28, 2017. Past performance is not indicative of future results.

Expect the Unexpected3 – The outcomes of Brexit and the U.S. presidential election in 2016 came as an unexpected surprise for financial markets. Nevertheless, market participants were able to look through the political uncertainty associated with these events, pushing some global equity markets to all-time highs. In our opinion, any potential black-swan (unexpected, but high impact) events this year are likely to emanate from Europe as key elections in France and Germany conclude—and from the U.S., where foreign and trade policy is up in the air. A key fat tail (low probability) risk that we are tracking comes from China as policymakers work to address precariously perched credit conditions.

Effects of Political Uncertainty May Be Transient4 – Some economists had expected the surprise outcome of the Brexit vote to have an immediate negative impact on the U.K.’s economy. This outcome was supposed to occur as economic-policy uncertainty increased in 2016 following the vote. Nevertheless, various survey results have shown a steady improvement in business leader sentiment in Britain and Europe. Globally, we have observed rising levels of business optimism even though political uncertainty has been on the rise around the world. It is possible that the optimism is overdone in the short term, as we describe above. Economic improvement and political change may not develop as quickly as positive sentiment currently anticipates. Consequently, we see room for additional market swings in the coming months.

Chart 3. Uncertainty Surrounding Political and Economic Policies are on the RiseChart 3. Uncertainty Surrounding Political and Economic Policies are on the RiseSources: Wells Fargo Investment Institute, Economic Policy Uncertainty; March 22, 2017. Global Economic Policy Uncertainty Index – digital archive search of 10 leading newspapers for articles containing ‘uncertainty’ or ‘uncertain’; ‘economic’ or ‘economy’; and one of the following policy terms: ‘congress’, ‘deficit’, ‘Federal Reserve’, ‘legislation’, ‘regulation’ or ‘white house’ (including variants like ‘uncertainties’, ‘regulatory’ or ‘the Fed’. 1997 is the starting point for the Index, indexed to 100.

Investment Takeaways

The Trump Reflation trade may be fading, and we expect equity-market prices to soften in the coming weeks as policy implementation disappoints. We believe that market participants’ renewed focus on improvements in the global economy could put a floor under global equity prices, likely preventing an all-out bear market selloff. Nevertheless, there remain significant political risks in the U.S. (trade policy may produce tariffs) and in Europe (populist victories may not take a country out of the Eurozone but may begin to roll back reforms that have underpinned the recovery so far). These risks may yet produce swings in sentiment that could carry over to financial markets. A deeper discussion on each of these points can be found in the footnoted reports.

While concerns about unpredictable or unforeseen events are likely to rise during the year, we believe that uncertainty poses risks as well as opportunities for investors. We recommend that investors position their portfolios for potential political and market volatility. This includes maintaining long-term target allocations to fixed income and assets that do not track equities, including real estate investment trusts (REITs) and alternative investments. We recommend that investors seek to exploit price drops in equity markets as entry points to investments in sectors that can benefit from the current economic cycle.

We also suggest that investors avoid trying to time the equity markets, particularly as it relates to risks surrounding Europe, China, or the U.S., as being out of the markets at the wrong time can be costly. As such, we believe that it is important for investors to look through the uncertainties related to these events and remain fully committed to—and fully invested in—their long-term investment plan.

1 Global Investment Strategy Report: “Global Economic Growth is Stabilizing—So What?”; January 17, 2017.
2 International Briefing: “The Proof is in the Trade Pudding”; March 3, 2017.
3 Global Investment Strategy Report: “Be Prepared for Black Swans, Fat Tails”; February 21, 2017.
4 International Briefing: “How Could Markets Respond to European Elections?”; March 17, 2017.

Risk Factors

All investing involves risks including the possible loss of principal. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities.

Alternative investments carry specific investor qualifications which can include high income and net-worth requirements as well as relatively high investment minimums. They are complex investment vehicles which generally have high costs and substantial risks. The high expenses often associated with these investments must be offset by trading profits and other income. They tend to be more volatile than other types of investments and present an increased risk of investment loss. There may also be a lack of transparency as to the underlying assets. Other risks may apply as well, depending on the specific investment product.

Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.

Investments in fixed-income securities are subject to market, interest rate, credit/default, liquidity, inflation and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond’s price. Credit risk is the risk that an issuer will default on payments of interest and principal. This risk is higher when investing in high yield bonds, also known as junk bonds, which have lower ratings and are subject to greater volatility. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.

There are special risks associated with an investment in real estate, including the possible illiquidity of the underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.

Global Investment Strategy is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by the Global Investment Strategy division of WFII. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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