20th January 2017
Major stockmarkets have rallied as much as 12% since Trump was elected as president. Fund manager Schroders looks at why and whether markets are getting ahead of themselves or not below.
Stockmarkets rarely rally in the face of political and economic uncertainty.
The combination of Brexit, Donald Trump’s election, the return of inflation and prospect of higher interest rates would normally undermine demand for shares.
But instead, stockmarkets have rallied with some indices hitting all-time highs. Investors expect his policies to reinvigorate the US economy, and perhaps for this effect to spread out further.
The chart below shows the performance of major markets, in local currency terms, since his victory was declared on 9 November 2016.
The US market’s gain is dwarfed by those in Europe, with the Eurostoxx 50 up 8.7%, and Japan, with the Nikkei 225 14.1% higher. The figures are calculated in local currencies.
How markets are valued after the rally
The table below illustrates valuations for various indices and how they are valued on two key measures.
The P/E (price-to-earnings) ratio compares a company’s share price and its earnings over the past 12 months. This comparison between share prices and company profits is widely used, with lower figures suggesting better value and vice versa.
The CAPE (cyclically adjusted price-to-earnings) ratio does the same but averages the profits over 10 years to smooth distortions created by the business cycle. This measure has gained attention in recent years.
In the table, we have compared these valuations with their historic norms – the average over the past decade.
Are stocks expensive or cheap?
The data is offered as a simple observation and rather than as guidance on whether to buy or sell. The US and the Japan have high CAPE valuations with the US above the long-term average. For some backers of these markets, these valuations are justified by the prospects of the companies. The UK market is in line with its long-run average while Europe is slightly higher. Both markets are significantly cheaper than stock markets in US and Japan.
A view from Schroders’ Chief Economist Keith Wade:
“Investors have fully bought into Trump’s promise to ‘make America great again’: activity will be stronger and trade deals more favourable to the US. Inflation and interest rates are heading higher.
“At this stage the reflation trade (buying assets that will benefit from higher inflation) has strong momentum as investors jump on the Trump band wagon. However, the impact of the new president’s fiscal policies will not be felt until end-2017 and into 2018. There are some tricky waters to be navigated before they take effect.
“At present markets do not seem to be anticipating problems either in terms of delays by Congress, or in boosting growth significantly.
Such optimism is likely to be questioned: prepare for a reappraisal of the Trump trade.”
The S&P 500
Since Trump’s election the S&P 500 index, the most widely quoted measure for the US stockmarket, has risen by 6%.
Why the rise?
Trump’s policies have lifted confidence. He wants to spend huge amounts of money on infrastructure, has promised to create millions of jobs and bring business back to the US. This should be good for economic growth in the US. It could even kick-start faster growth elsewhere.
These policies have also raised expectations of higher inflation as employment rises and increases consumer spending. A little inflation might be good for the economy. It effectively reduces the value of debt as wages rise. Consumers may then spend the spare money to buy more goods.
How is it valued?
The S&P is on a P/E ratio of 21.6 times, which is below its historical average of 22.9.
However, the increase in prices has pushed the US stockmarket to valuations that appear high on some measures. On the CAPE measure, the US is now at 23.4 against an average 19.8 over 10 years.
The FTSE 100
Since Trump’s election the FTSE 100 has risen 6.3%, in sterling terms.
Why the rise?
The FTSE 100 has enjoyed a boost from a weaker pound. Generally speaking, when the pound goes down, the FTSE 100 rises. The majority of FTSE 100 company profits are generated outside the UK, so when profits are converted into pounds companies get more for their money.
Is the rally justified?
The sharp rise in the FTSE 100, however, has seen its P/E ratio rocket to 34.4 times.
Part of the reason for UK stocks looking so highly valued is because the FTSE 100 is heavily weighted towards the mining and energy sectors, which are experiencing temporary weak earnings because of a fall in commodity prices.
It is for this reason that some investors prefer to use the CAPE ratio, which can smooth out some anomalies. The FTSE 100 trades on a CAPE of 13.7 times, which is inline with its long-term average.
A view from Schroders’ UK Equities Fund Manager Sue Noffke
“Earnings for the UK market overall should benefit from the large proportion of the index that is made up of commodities and resources stocks. These parts of the market are being helped by easier comparatives from early 2016 and a full calendar year of weaker sterling for overseas earners.
“This should both improve balance sheets and the ability to pay dividends, especially for oil companies, or the ability to pay some dividends through capital returns to shareholders, such as through share buy backs.
“Additionally, the expectation of higher interest rates should help financials over the course of 2017.
“Those areas that are more consumer-related, such as domestic cyclicals and consumer staples which did so well in recent years, may struggle from weaker consumer spending power.”
Since Trump’s election the Nikkei has risen 14.1% in yen terms.
Why has the Nikkei rallied?
Trump’s policies should boost earnings for cyclical shares (companies such as miners and energy firms, which tend to benefit more when the economy and demand improves), and export-reliant businesses, which could see earnings improve if demand picks up from the US.
Rising interest rates in the US have weakened the Japanese yen, which should boost profits for Japanese firms converting earnings from dollars to yen.
How is it valued?
Despite the significant rise in the index over the last two months Japanese shares still look fairly valued on a P/E of 17.8 times, compared with the historical average of 17.2 times.
The CAPE valuation of 24.4 times is significantly below the ten-year average of 31.6 times.
Since Trump’s election the Eurostoxx 50 has risen 8.7% in euro terms.
Why has the Eurostoxx rallied?
Trump’s policies have triggered a rise in inflation expectations and the prospect of future rate rises to keep inflation under control.
Interest rate rises are good for banks which are able to improve their profit margins.
The Eurostoxx 50 includes a number of large banks.
How is it valued?
On a P/E of 19.5 and a CAPE measure of 13.4 the Eurostoxx is starting to look a little expensive compared with its respective long-term averages of 15.5 and 12.9.
A view from Schroders’ Head of UK and European Equities Rory Bateman:
“The recovery in corporate earnings is likely to be the key factor driving European markets higher this year. European earnings for 2017 are likely to show high single digit growth and a number of important sectors such as banks and commodities should see profits recover from depressed levels.
“In addition to an improving earnings picture, valuations continue to look attractive in Europe, relative to history and other developed markets, which gives some scope for a re-rating on top of the earnings improvement.
“There are a number of significant political events in Europe this year which will create volatility and periods of weakness. The Warren Buffett adage “be greedy when others are fearful” would have served investors very well during 2016 and we believe there will be plenty of volatility – and thus opportunity – during 2017.”