US Election Special Part II

SH – Simon Hildrey / JK – James Klempster / TP – Thanos Papasavvas

SH: Welcome to part two of our US election special video. Today, we’re going to talk about 'Season 2' of Trump and the clean sweep by the Republican Party in the recent elections. With me today is James Klempster and Thanos Papasavvas. Thanos, let me start with you. We've had this result, it's a clean sweep as we’ve said. What do you think is the impact of this election?

TP: I think there are a number of key factors here. The first is that the American people have given a clean mandate for Trump. He's got two years until the next midterm elections with a clear sweep of both houses of Congress, the Executive Branch, but also a right-leaning Supreme Court. I think there are going to be a number of factors both on the domestic side and on the foreign policy side. On the domestic side, I believe that there will be some retribution in terms of the previous administration. I think there will be focus on tax reforms, which will be broadly expansionary from an economic point of view. There's going to be focus on deregulation, and we've seen the impact even of Musk and focuses on energy and financial industries.

More broadly, I believe that we're going to be seeing some further uncertainty in terms of the geopolitical developments vis-a-vis the relationship with Russia and Ukraine, what impact that has in terms of the European and NATO developments, China, but also in the Middle East.

SH: There's a lot to unpack here, Thanos. Let's start with tariffs, a much talked about subject. Do you think these are going to be as widespread? Do you think Trump will impose tariffs as much as people think?

TP: We think that tariffs are a negotiating tactic. It's the stick with which to commence negotiations and try and find some better ground for the US. We do not believe that on day one he's going to impose 60% tariff on China, rather 10-20% across the board if he can find ways of benefiting his position by avoiding that. In terms of the 10-20% tariffs, we don't believe it'll be detrimental or significant in the US economy, partly because of its resilience, but also a lot of the retailers will be able to absorb some of those price increases. And also the US dollar would be appreciated. So the impact to the US consumer would not be as dramatic. Recent reports would suggest that of a 5% impact on GDP over 20 years or 1.6% over a couple of years. It's not expected to be that significant. The 60% would.

SH: What about for the rest of the world, the economies outside the US?

TP: I think the key point there is if we look at the broader regions, the one region which is in a more difficult situation is the European Union, because it stands between China and the US in terms of the political alignment. Also Europe and Germany in particular, have significant economic structural changes. They no longer rely on the cheap energy from Russia. They do not have the strength of the Chinese consumer to export their goods, and  they also don't any longer get the free army and defence support. They have to pay their fair share contribution of NATO GDP. So it will impact the eurozone area, and particularly because the European Union does not have, if you like, the negotiating power that a China does.

SH: James, are you concerned about the economic outlook for countries because of Trump?

JK: That's a big question to answer. There's a lot you can encapsulate into that. Clearly, I think we've got to separate the short-term impacts that you might see in markets from a more meaningful, longer-term direction in terms of GDP and economies and everything else.

Looking at the big picture, one of the best references we've got is Trump's original presidency. He's not an 'unknown unknown' in the conventional sense this time around. Overall, if you look at the economic picture in the US, you say that he was broadly positive for the economy in the US and it seems as though in the round he would want to do the same again this time. I think certainly the consensus is that would be the case.

Looking outside of that, there are risks to certain areas that they do get impinged by these policies. Ultimately for us, as long-term investors, we don't buy GDP. I think that's a really important thing to always bear in mind. We invest in asset classes like equities and fixed income. And while, of course, there is a linkage between economic performance, inflation, all the rest of it, and the performance of asset classes, it's not a direct coupling, there is a degree of flexibility. So while it will perhaps give a tailwind, if it's a positive or a bit of a headwind if it's less of a positive, there's still opportunities for investors even in a variable economic scenario.

SH: The other subject I want to ask about is inflation - a lot of people have said Trump's presidency will be inflationary. Do you agree?

TP: The attempts of what he will try to do will be inflationary in terms of reducing the employment through immigration, through the fiscally expansionary policies on tax cuts. So the tax cuts will remain for the individuals, and he wants to push the corporate rate down to 15%. I think they'll probably negotiate it towards 18% from 21%. So these are fiscally expansionary policies.  The trade tariffs will also create inflation. However, and this is the key point, in my view the Fed will remain orthodox. Jerome Powell is there until 15^th May 2026, and he will raise rates if he needs to in terms of containing inflationary pressures. Even in 2025, if we see the resilience of the US economy, we could potentially see an increase in interest rates. But even beyond Jerome Powell, I believe that whoever is appointed as the next Fed chairman, he or she will be orthodox, prudent, and managing the policy in line with the Fed philosophy and ethos, especially because by that time, Trump will only be there for another 18 months. So why align with the departing president and not maintain the ethos of the Fed? So although the policies are going to be expansionary in terms of growth and potentially inflationary, the Fed is there to make sure that things do not get out of hand and raise rates if we need to.

SH: James, anything to add to that?

JK: I think it's a great question. When we look at the inflationary impact of the new president, I think we've got to look at it in the context of a bigger picture, which is a more thematic shift, if you like, over the last decade or so in an era where we're seeing globalisation be less prevalent. We're seeing other inefficiencies roll in through geopolitical schisms and a more general polarisation of the global economy away from one sort of singular axis that we had perhaps 10, 15 years ago in a very meaningful way in the US. All of that speaks to us to less efficiency, less competition. And in that era, you'd expect to see a more inflationary environment. It's less efficient ultimately, so you get greater pressure on prices. And that then, to our minds, means that inflation will around the world be higher, but not necessarily high. Certainly off the lows we became accustomed to in that period between the Financial Crisis and Covid, that very low almost interregnum in inflation we had then. And so the risk of perhaps Donald Trump's policies in particular, there is a presumption they are inflationary. The risk there then comes in that it exacerbates what's already in play. Could it be more meaningfully inflationary or is it a case of actually it falls into line with the bigger trend that we believe is in play anyway?

SH: When we recorded the first part of this video, I think you and John were fairly optimistic about equity markets if Trump was to win. Is that still your view?

TP: Yes, it is still the underlying view that as long as, and this is the preface, as long as his policies are not so expansionary and destabilising from aggressive trade tariffs that adversely impact market volatility uncertainty, which would adversely impact the equity markets. We maintain that as a central case scenario and we are positive broad equities, within the US area we would prefer some sectors more specifically such as consumer discretionary and healthcare. That's a separate point. More broadly, we are still positive equities, but we also like fixed income because we do believe that inflation will be under control. And hence, going back to what James was saying, the diversification benefit of holding both fixed income and equities as part of the underlying portfolios.

SH: James?

JK: Ultimately, there's two different perspectives I think you need to have on that question. The first one is political change is a regular feature of the world we've lived in and worked in for many decades. It's an inevitability. When you look at businesses and stocks and indices that we invest in, whether through active managers or passive, the point is they're an aggregation of businesses that are collected together. And businesses, they're run by generally fairly competent people or very competent people, whose role is to grow and return for shareholders, regardless of political winds.

If you look back through decades of stock market history, there's plenty of evidence that that happens on average through lots of different political environments and everything else. So again, the short-term risk is through noise and through sentimental challenges that come through potential for presidential messaging that we certainly saw in the first presidency. But it doesn't necessarily detract from the long-term path that these markets can follow, whether it's US or outside the US.

We're broadly constructive on markets. They look fairly well supported. They've got a reasonable economic backdrop. The inflation environment is not too high to cause a challenge. And so in the round, those two points together make us conclude in a similar manner to Thanos, that we can be broadly constructive on equity markets from here. But obviously careful on valuations, which in some pockets of the world do pose a bit of a challenge.

SH: Can we just dig into that a little bit more? Because we've got an incredible amount of geopolitical uncertainty and risk. We've have inflation that seems to be under control, but has people suggesting might not be. You talk about benign background, but in fact, in many ways you look at the world, it isn't.  Are markets becoming more dislocated from that?

JK: That's a great point. The conundrum is obviously that we are confronting a lot of challenges. I suppose the counter argument perhaps is that you're always confronted with a lot of challenges in markets and the acuteness of those dissipates through the passage of time, but in the moment, they always feel pretty challenging.

One of the main ways that we want to make sure we don't become overly concentrated in terms of risk in portfolios is through diversification and through having a long-term perspective. Again, one of the points Thanos made in terms of the value of fixed income as a portfolio construction tool, as a source of income, you're being paid to wait in levels that are in excess of inflation, even from government bonds now, which is something we haven't seen for quite some time.

So when we look at building portfolios today, when we go through our tactical process, we've actually got a nice problem to have. There's lots of different asset classes that look on balance pretty attractive to us. We like equities, we also like the diversifiers through fixed income as well and certainly credit, high yield and other pieces as well.

I can understand the argument that says well there's lots of challenges out there and you've got to make sure that's suitably accounted for. But again, part of that comes in through valuation. Part of that comes in through discipline, and part of that is managed through having lots of different returns drivers through diversification.

TP: If I may just add to that on the geopolitical component, because you did raise there are a lot of geopolitical risks out there. That's true. From an absolute point of view, there's a lot of geopolitical risk. But we're also looking at it from a relative point of view, because if the broader market participants see a lot of risk and we sense that the risk may not be as acute as those market participants expect, then it could be a positive contributor towards a risk portfolio. For example, in the Middle East a year ago, our view was the Middle East is much less fragile than what the market expectations were for a number of reasons. So I think it's not, geopolitics is not just an absolute risk, it's a relative risk versus expectations. And there you can be positive geopolitical risk rather than concerning a negative.

SH: I want to ask about fixed income. John and James have talked about this diversity in interest rates potentially going forward, the impact on duration. What are your thoughts, and does that mean that fixed income actually is becoming more interesting as an asset class?

TP: Definitely. I think fixed income, in our view, is a great diversifier for the portfolio. We like equities, but we also like fixed income. Within fixed income, the reason why we like it is, two key components. 1) it offers real return, real absolute real yields, because inflation is contained. 2) it provides diversification should our scenario or slightly more constructive scenario in the economy prove to be wrong, that's where the equity markets or risk assets would sell off, but the fixed income would do well.

We've been positive on the government side. And James and John have had an amazing call on the credit markets, which I'll leave James to discuss.

JK: Yes, we have seen our positive view on high yield investment grade credit be well rewarded over the last year or so. Taking the view that essentially twofold, you've got a value credit based on the spread you see over the reference rate, the government bond rates, and certainly looking back 18 months or so ago, they were attractive. They've come in quite a bit, which means that the spread is now less compelling than it has been historically.

It's questionable whether you would say that particular element of the total return is attractive today. It's not too bad, but it's probably not particularly attractive. And through that, obviously, we've had the benefit through some capital appreciation, which has come through that spread compression. But crucially for us today, when we look at them going forward from here, both high yield and investment grade credit, the total yield is still very attractive. One of the interesting things about fixed income, is you're told on the day of entry what you can expect your rough total return to be, the yield coming in on a compound basis through that ownership period. So for us, spreads are tighter now. You've got under 300 for global high yield, under 100 for investment grade. But when you add that on to prevailing global government yields, which range between sort of threes to fours and a half in the case of the UK and the US in particular, the total yield is actually very attractive still.

TP: One thing we get asked is what about the increase in correlation between equities and fixed income as we saw in Covid, where the equities sell off and then the fixed income sells off again. What about that scenario? And our view is that the reason why that happened during the Covid period is because the central banks lost the credibility and the fight on inflation.

This time around however, the Fed is not going to make the same mistake. The Bank of England, the ECB will not. So if we do see inflation, which we have not seen yet, we'll see if that happens as and when, but if we do see inflation getting a little bit out of hand, the central banks will be very proactive in raising interest rates and capping that inflationary pressures. So we do not agree that we could have an environment where both equities and fixed income sells off. Therefore, we see it as a diversifier.

JK:. The other thing we've got to bear in mind is the historical context. It wasn't that long ago, but 2021/22 yields were still close to or at all-time lows. And so even a sniff of inflation would have had a pretty material impact, as we saw as that sort of inflation realisation came through. Clearly, as it went further and it proved not to be transitory and in any sort of meaningful sense, yields went further still. But part of it was the fact that perhaps the activity of central banks wasn't quick enough and decisive enough. Part of it was quite simply it was fundamentally overvalued and it came from a very low yield base and that reset had to happen. We've had the reset now.

SH: So the 60/40 portfolio is very much alive then?

JK: Absolutely. We've been banging that drum for quite some time. And whether it's 60/40 or some other combination of asset classes together, as I said earlier on, we've got an abundance of opportunity in our selection for tactical asset allocation. There's lots of asset classes that look attractive to us over the medium to long-term. And particularly when you think about building those portfolios, you have diversification benefits. So the combination, we believe, can be greater than the sum of the parts.

SH: Are there any particular asset classes you would highlight?

JK: We tend to look over 12-18 months. On that time horizon, within equities, we're broadly positive on equities. We like the UK market and we like UK smaller companies within that cohort as well. It's a market that's really been pretty unloved since 2016 arguably. There's been almost an international buyer's strike on the UK stock market and it's fallen to, or not kept up with other markets, which meant that the relative valuation of the UK compared to other markets is very attractive indeed. And then on top of that, smaller and mid-cap companies have done even less well versus larger cap markets. So you've got a double whammy in terms of the valuation in the UK.

We also like emerging markets. We like Asia ex-Japan and we also score Japan highly as well. So all of those in a scale of 1 to 5, we score those as a 4. We're a bit more circumspect on the US. We feel that that has a lot of good news in the price. So we have that as a 3, although we like smaller companies in the US and Europe, we're a bit more circumspect still. So we score Europe as a 2 out of 5 currently in the equity space.

SH: Would you both expect the concentration risk to lessen over the next 12 months in the markets?

TP: Not necessarily. I think the concentration risk may continue. We're going through a period with the US because it is the biggest component of the index, but in a similar way, Switzerland also has a lot of concentration. And historically, there have been periods of concentration. We don't necessarily see that in the interim period shifting. In due course yes it will. But we don't necessarily expect that to happen in the near term. We're not calling for that.

JK: It's a loaded question, of course, because there's two ways you can adjust concentration. One is the very expensive ones coming down and the other is everyone catching up. Let's presume it's everyone else catching up. It's very difficult to put a time scale on that. But again, with history as a guide, it's very unusual for very large businesses to persist at a level of very high profitability, very high multiples, which creates that concentration. It's pretty unusual from a historical context, particularly in the US. As Thanos said, you have seen it elsewhere. There are other more concentrated markets out there.

SH: Are there any other asset classes other than bonds and equities that you would highlight for next year?

JK: Within the alternatives universe, we're doing a lot of work in there at the moment, and getting a feeling for where we might find opportunities to add diversifiers in or potentially returns enhancers as well. We have a basket of real assets in the portfolio presently. We have that as a neutral a 3 out of 5. So we do think it's a useful allocation to have and a useful diversifier. But I suppose when you take a step back and you look at our broadly constructed view overall, there's a lot competing for capital in the portfolios.

With equities looking fairly attractive, fixed income and credit looking fairly attractive as well, we see there's lots of scope for returns and diversification in there already. So there'll be other stages in the cycle where you'd have a greater desire to have more in your alternatives than we have today.

SH To finish off, I know it's a small economy in the world these days, but James mentioned the UK. It has been out of favour. Are you ending the year more optimistic or less?

TP: No we're positive on the UK for similar reasons, partly because of the valuation story.  Fundamentals, the only issue we have with the UK is that the inflation tends to be slightly more sticky and we're concerned, especially in the last few weeks, when the governor was talking potentially better than expected rate cuts. I have a mortgage, I'd love rates to go down, but I'd rather keep them where they are until the inflation pressures are off.

So we are positive for the UK, but we're also positive for China, because we do believe that Xi Jinping is realising the impact this has been having on the consumer and the sentiment, and it's imperative for the Chinese Communist Party to maintain economic growth and social cohesion. So although he may not act with a bazooka, and he may not go back to China as it was three years ago, we do see some gradual shifts in policy response through fiscal and monetary stimulus. So we are positive for the UK, but we're also positive for China.

SH: So continuing the stimulus that we're seeing?

TP: As and when necessary, continue with more stimulus coming through. And that will also need to be a firm position for him if he wants to have a strong hand in negotiating with the US as well.

SH: Thank you, Thanos. Thank you, James. And thank you for watching, we'll see you next time.