Dollar/FX. Stronger US dollar is a
consensus trade, and there's no compelling reason to be contrarian.
Rate hikes from the Fed will be dollar positive, but more importantly
loose fiscal policy will gin up the economy, and make dollar
denominated assets more attractive to international investors. (Both
FDI and portfolio flows should increase as a result) This, much more
than interest rate differentials in overnight policy rates, will
drive up the dollar in the next two to three years.
Notice the sharp contrast in policy out
of Mexico, the emerging market hit hardest by the Trump shock. The
central bank is hiking interest rates, and brought overnight rates up
to 5.75 percent, a full five hundred basis point differential with
the United States. However, the Mexican Government continues to cut
public spending, which hurts the broader Mexican economy. As such,
while holding overnight Peso balances is more attractive than before
due to Banixo's rate hikes, holding longer duration Mexican assets,
such as stocks or real property, is less attractive because
government austerity is slowing the economy. While Mexican
authorities remain terrified of further Peso depreciation, under this
policy regime, it will be hard for the Peso to regain a strong
footing. I expect the MXN to remain in a range between 20-21.5 for
next few years.
Bonds.
Yields have shot up since the election.
Trump's fiscal splurge will both increase the supply of Treasury
securities, and give the Fed cover to hike rates. Both these factors
point to lower bond prices and higher yields. However, investors
appear overly confident that Trump can deliver a massive
spending package. It appears more likely than not that a Republican
Congress with acquiesce to Trump's demands, but it seems unlikely
that Trump can deploy one trillion dollars of infrastructure spending
quickly. Thus, the deficit (and therefore government's financing
needs) may be much lower in the next few years than investors expect.
This could keep yields lower, and will also weigh on stocks. Under
this scenario, a correction in the dollar is also possible. On the
upside, Republicans might be able to pass large tax cuts, and
politically justify the increase in the deficit by using so called
"dynamic scoring." Politics, aside, an increase in the
deficit always and everywhere increases private sector incomes, which
boosts corporate earnings as consumers spend more. Big deficits will
be good for stocks. It would take an unknown event, such as a major
war or another financial crisis, to halt this rally.
Stocks.
As stated above, the stock market
remains broadly supported by the impending fiscal bazooka about to go
off. However, one sector that appears a bit overbought already are
regional banks. Dodd-Frank repeal won't help earnings too much. Small
banks just can't compete with the scale and scope of larger banks,
especially on the technological front. Although many on the right
claim that the new regulatory burden on them is higher, the real
problem they face is a shrinking customer base as consumers
increasingly choose the speed and convenience of the mega-banks.
Going forward, I don't expect regional financials to outperform the
broader market.
