Our Insights

About personal finance, investments and markets.
January 31, 2017

Should you review the US exposure because of Trump?

ETF are our preferred investment products. But that doesn’t automatically mean that all ETF are a good investment. The index composition remains key and most globally diversified indices have one thing in common: at the moment, they have a historically unusually large weighting in US stocks. This is particularly true for the most popular index – the MSCI World. While the MSCI World Index has performed exceptionally well since the end of the financial crisis, we think investors need to be mindful of the risks that Donald Trump poses.

The trouble with chasing performance

According to the efficient market theory, rational investors will allocate based on where the greatest expected returns are and that capital flows will follow value. This is actually the exact opposite of how the markets really work in practice! Anyone involved with retail and even institutional money will tell you that reality is quite different. Flows don’t follow value, they follow performance. It isn’t just that investors follow performance, they literally chase it. Whichever fund or asset class did best over the last 1-3 years typically gets most inflows. Always has been, always will be.

One of the best performance chasing vehicles for an investor looking for global exposure has been the MSCI World Index. In 2016, the MSCI World increased a solid +8.2% and over the last 5 years, it delivered a strong annual return of 11% (all in US$). It is no surprise that ETFs on the MSCI World have seen the biggest inflow of any index that invests world-wide.

But it is important to take a closer look and ask why exactly the MSCI World peformed so strongly. It is quite simple: it has an extremely large weighting in the US and the US stock market was outperforming most other major countries coming out of the financial recession. As of Dec 31, the US accounted for 60% of the market cap of the MSCI World. US GDP as a percentage of global GDP is closer to 15% however.

The real question for MSCI World Index investors therefore is whether the strong outperformance of the US equity market can continue. A lot of this depends on Donald Trump.

Is Trump good for the stock market?

This is a fascinating question. Most market commentators expected a big sell-off in case of a Trump election win in November 2016. However, markets rallied very strongly and actually most global markets were up around 10% in the month following his election. All good then?

Since his inauguration on Jan 20th, Trump revealed more of his policy stance:

  • Declared Nato ‚obsolete‘
  • Signed on Holocaust Memorial Day an order to limit immigration from some Muslim countries
  • Wished the end of the EU, congratulated the UK on Brexit and picked an EU ambassador who compared the EU to the Soviet Union
  • Signed an order to begin Mexico border wall and floats 20% tax on Mexican imports to pay for wall
  • Refuses to release his tax return
  • Refuses to divest from his business interests thus creating conflicts of interest
  • Lied repeatedly on several easily verifiable facts such as crowd size on inauguration day

To be clear: All countries with strong long-term returns are inclusive, stable, rule of law democracies. Based on historical evidence, we can categorically say, that pseudo-populist authoritarianism is not good for equities. Just look at the following table and see for yourself how investors treat the authoritarian regimes of China, Russia and Turkey – they all trade with a low P/E multiple. The future performance of the US market heavily depends on whether you believe Trump will uphold the institutions that have been at the core of the US and EU prosperity and freedom. At what point do market participants start to consider that “faith in our institutions” might be the new “subprime is contained”?

CountryHead of State2017 P/E
ChinaXi Jinping11x
RussiaVladimir Putin7x
TurkeyRecep Erdogan8x
USADonald Trump18x

Lest you think I am being overly dramatic here, maybe you would like to read what the rating agency S&P is saying about the risk of advanced economies becoming more like emerging markets with weaker political systems:

“We believe it may no longer be possible to separate advanced economies from emerging markets by describing their political systems as displaying superior levels of stability, effectiveness, and predictability of policy making and political institutions,” wrote Moritz Kraemer, chief sovereign ratings officer, in a 2017 outlook report entitled “A Spotlight On Rising Political Risks.”

Investing is complex and regime shifts don’t happen overnight. They are also difficult to identify well in advance. But sometimes it is a small change that tells us a lot about the future of a society. Immigration is one of them. One of the key success factors of the US has always been the openness to immigrants and ability to integrate. How important this is can maybe gleaned from this short list of US tech companies founded by 1st/2nd generation immigrants:

Apple
Google
Facebook
Amazon
Oracle
IBM
Uber
Yahoo
eBay
AT&T
Tesla

It is hard to believe that an isolationist and protectionist US will display the same dynamism going forward.

This is not just about politics

But Trump isn’t the only reason why we think that excessive exposure to US equities might be the wrong investment stance today.

  • Valuation: pick any valuation metric you like, but the end result is always the same – US equities trade on a high multiple

US Aktien

  • Corporate profits: US corporate profit margins are at record high at a time when wages accelerate, interest rates go up and commodities prices are moving higher
  • Monetary policy: the Fed is less accommodating. The last program of quantitative easing, QE4, was finished in 2014 and interest rates are now in a hiking cycle
  • Business cycle: It is hard to argue that we are still early cycle when the unemployment rate is below 5%. We are definitely in the second part of this cycle, most likely in a late inning.

Summary

You should not just blindly buy any index fund. Always check the index composition and ask yourself if it makes sense. Although US equities should still be part of a global diversified portfolio, 60% as in the MSCI World Index today seems too high. We also think it is doubtful that the MSCI World Index can repeat the performance of the previous 5 years.