“Escape Velocity” and the Return to the Old Normal?

Brian Tomlinson
Written by

12th December 2016

The surprise victory of Donald Trump, and his planned tax cuts and expansionary fiscal policies (infrastructure spending) potentially contain the necessary ingredients to help America achieve economic growth escape velocity. Finally, America may be able to break free of the wretched clutches of the great financial crisis of 2008, and enjoy sustainable economic growth which is above the 3% Gross Domestic Product (GDP) trend growth that so many economists have been hoping for over many years.

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Trump’s plans and implications for US market

Trump's plans and implications for US markets

Source: Allianz Global Investors, 12/12/2016. This is for illustrative purposes only, no indication of future results.

This is a game-changer. This is a phase transition. Where both US and European bonds with long duration will likely be eschewed due to the anticipated rise in US inflation, and where equities are preferred due to stronger US economic growth and the benefits of dual tax cuts for both corporations and consumers…a familiar theme harking back to Reaganomics.

Ultimately, GDP growth of 4% (compared to 2% average since 2009) and an expected inflation rate of 3%, which is above the Federal Reserve target of 2%, means the following for investment strategy:

 

US Consumer Price Index

Source: Bloomberg, 12/12/2016. Forecasts and past performance are not a reliable indicator of future results.

1. Rising bond yields (curve steepeners). This is good for banks, as steeper yield curves increase banks’ carry and net interest margins. Insurance companies and pension funds benefit as rising yields reduce their future liabilities.

US Government Yield Curve

Source: Bloomberg, 12/12/2016. Forecasts and past performance are not a reliable indicator of future results.

2. Strong US Dollar (supported by global flows of funds attracted to strong economic growth and rising yields). US small caps should continue to outperform large caps because a strong US Dollar is a headwind for multinationals when they convert their foreign earnings to a higher dollar.

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Dollar Index (DXY)

Source: Bloomberg, 12/12/2016. Forecasts and past performance are not a reliable indicator of future results.

3. Equities rallying despite rising yields due to tax cuts on both corporations and consumers.

This has the feeling of a return to the good old days…back to the old normal…finally.

4. The US 10-year breakeven inflation rate is currently at about 2%, and I have a target of around 2.7%. US inflation-linked treasuries therefore look undervalued given this outlook.

US 10-Year Breakeven

Source: Bloomberg, 12/12/2016. Forecasts and past performance are not a reliable indicator of future results.

Question: What about financial repression? Is it still present?

Answer: Oh, YES! It will still be alive and well in the USA, UK, and especially in Europe.

Why? As long as Central Bank policy rates remain below the rate of inflation… then savers will be repressed… especially in Europe with inflation forecasted to be 1.3% in 2017, and the ECB policy rate at -0.3%. So savers in Europe will still be losing 1.6% by holding cash.

Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested.

This is not a recommendation or solicitation to buy or sell any particular security.

Past performance is not a reliable indicator of future results. If the currency in which the past performance is displayed differs from the currency of the country in which the investor resides, then the investor should be aware that due to the exchange rate fluctuations the performance shown may be higher or lower if converted into the investor’s local currency. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer companies at the time of publication. The data used is derived from various sources, and assumed to be correct and reliable, but it has not been independently verified; its accuracy or completeness is not guaranteed and no liability is assumed for any direct or consequential losses arising from its use, unless caused by gross negligence or wilful misconduct. The conditions of any underlying offer or contract that may have been, or will be, made or concluded, shall prevail.
 
This is a marketing communication issued by Allianz Global Investors GmbH, www.allianzgi.com, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42-44, 60323 Frankfurt/M, registered with the local court Frankfurt/M under HRB 9340, authorised by Bundesanstalt für Finanzdienstleistungsaufsicht (www.bafin.de). This communication has not been prepared in accordance with legal requirements designed to ensure the impartiality of investment (strategy) recommendations and is not subject to any prohibition on dealing before publication of such recommendations.  The information contained herein is confidential. The duplication, publication, or transmission of the contents, irrespective of the form, is not permitted.

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