Weekly Market Update – 19th May 2017

• Most global share markets fell over the last week on the back of the political crisis around President Trump. US shares fell 0.4% after recovering some of their losses later in the week, Eurozone shares fell 1.1%, Japanese shares fell 1.5% and Australian shares fell 1.9%. Australian shares are now down around 4% from their high earlier this month and have been hit by the weak global lead combined with pressure on the banks as a result of the Budget’s bank levy along with expectations for slowing credit growth and weakness in retailers on the back of weak retail sales and fears around the competitive threat from Amazon. Chinese shares managed to buck the global trend and see a 0.6% gain. Reflecting the risk off environment bond yields generally fell, but commodity prices mostly rose helped by a falling US dollar. The weaker US$ and good jobs data also helped support a small bounce in the A$.
• The standard narrative right now seems to be that the ‘Trump trade’ drove the surge in global share markets since the US election and that this will now reverse because of the political crises surrounding President Trump. In our view this may be a little too simplistic. First, the main reason for the rally in shares since last November has been the improvement in economic conditions and surging profits that has occurred globally and not just in the US and which had little to do with Mr Trump. Second, the political crisis around the President won’t necessarily stop the pro-business reform agenda of the Republicans. In fact, unless things become terminal for Mr Trump quickly it’s more likely to speed it up. There is no doubt the political risks around President Trump worsened over the last week with increasing talk of impeachment and concern that it will impact the Republican’s tax reform agenda. However, it’s a lot more complicated than that:

  First, impeachment is initiated by the House of Representatives and can be for whatever reason the majority of the House decides and conviction, removal from office, is determined by the Senate and requires a two thirds majority.

  At present Republicans control the House with a 21 seat majority and won’t vote for impeachment unless it’s clear that Mr Trump committed a crime (and so far it isn’t obvious that he has) and/or support for him amongst Republican voters (currently over 80%) collapses.

  However, Mr Trump’s overall poll support is so low that if it does not improve the Democrats will gain control of the House at the November 2018 mid-term elections and they will likely vote to impeach him. Then it’s a question of whether Mr Trump can get enough support amongst Republican Senators to head off a two thirds Senate vote to remove him from office.

  This is all a 2019 and beyond story, but the point is that Republicans only have a window out to November next year to get through the tax cuts/reforms they agree with Mr Trump should happen. So if anything, all of this just speeds up the urgency to get tax reform done because after the mid-terms they probably won’t be able to.

  Now there is another way for the Vice President and Cabinet to remove a President from office under the 25th Amendment of the Constitution which is aimed at dealing with a President who has become mentally incapable. While some may claim this one is a no brainer, Vice President Pence is a long long way from doing this.

  The bottom line is that while the noise around President Trump and particularly the FBI/Russia scandal will go on for a while it does not mean that tax reform is dead in the water.  On this front work on tax reform is continuing including in the Senate and Mr Trump’s infrastructure plan (which is likely to be around leveraging up Federal spending and encouraging states to privatise their assets and recycle the proceeds) looks likely to be announced soon.

• Share markets have had a great run and are due a decent 5% or so correction as a degree of investor complacency (as indicated by an ultra-low VIX reading two weeks ago) has set in and the latest scandal around President Trump may just be the trigger. North Korean risks are another potential trigger and after all it is May (“sell in May and go away”). Australian shares are down 4% from their high early this month, but global shares are only down 2% or so. However, providing the current Trump scandal largely blows over for now allowing tax reform to continue it’s unlikely to derail share markets beyond any short term correction. Valuations are reasonable particularly for share markets outside the US, global growth is looking healthier, profits are rising (by around 14-15% yoy in the US and Japan and by 24% yoy in Europe) and global monetary conditions remain supportive of shares.

• It seems to have been a week for political scandals. Aside from those around President Trump, a corruption scandal has engulfed Brazilian President Temer highlighting that big risks remain around Brazil and allegations have emerged regarding Japanese PM Abe (although he is likely to survive them).

Major global economic events and implications