The Early View
Trump: Market-Friendly with a Sting in the Tail?

Please note that we delayed the publication of this month’s Early View by a few days to take in the result of the US election.

 

 

Even compared to most US presidential elections, one cannot help but feel this year’s result marks a stark shift in the political landscape. The Trump manifesto is more radical than many before it and has global implications, particularly in areas such as tariffs, tax, and foreign policy. Furthermore, at the time of writing, Trump appears to have achieved a Republican clean sweep of both houses of Congress, as well as winning the popular vote. This should ease implementation and provides a mandate not seen for a Republican president since 2004. In our view, a useful heuristic for markets in the second Trump term is to think of it as a short-volatility trade. Most of his policies should be market-friendly, but they come with a dose of extra tail risk driven by a potential willingness to break established frameworks and to change the status quo.

Indeed, the initial reaction has been risk-on: equities higher, bonds lower (particularly at the long end of the curve), the dollar stronger, and breakeven inflation higher. At the margin, the election result is seen as positive for US economic growth, which means less need for stimulus from the Federal Reserve and, arguably, less rate-cutting required in the near term (although the rate path remains, as ever, a very movable feast). The range and scale of the China-specific measures in Trump’s manifesto suggest that the ball is now very much back in President Xi’s court to follow through with effective internal stimulus for the Chinese economy. Investors will be watching for the announcement of counter-policies both in Asia and Europe over the next few months.

In particular, the move in the long end of the US government bond yield curve is the most eye-catching repositioning of markets, driven by a wider term premium that now reflects both higher interest rate uncertainty and increased fiscal risk.

The latter is one of the more interesting balances to watch over the next year – can the new administration stimulate sufficient growth and cut enough government waste (through a possible oversight mandate for Elon Musk and Cantor-Fitzgerald CEO Howard Lutnick) to justify looser policy on tax, thereby keeping the US debt-to-GDP ratio under control?

Outside of financial markets, commentators broadly expect that Trump won’t be able to resist showing the world he has ‘solved’ the Ukraine problem by essentially giving President Putin what he wants (i.e., keeping control of occupied regions). However, it's uncertain whether this will be enough to end the war, and there are concerns about the long-term implications of appeasing aggressive behaviour. In fact, long-term consequences are likely to be very low on the new president’s agenda, and therein lie the tail risks of the new Trump world: moving too far, too fast, and for the wrong reasons. Bearing in mind his age (at 78 he’s the oldest person to be elected US President), one should expect Trump to do everything possible to promote himself through short-term successes. This should mean that uncertainty increases, particularly with respect to China-Taiwan and the Middle East, but in an already unpredictable world, will markets really care about a little more unpredictability? Probably not, but once again, the value of nimble, reactive investment strategies could be at a premium for the next four years.

Key drivers of hedge funds' performance: An early October snapshot

Credit:

• It was a relatively quiet and mixed month for credit markets. Spreads were generally tighter but total returns (at the time of writing) for US investment grade and high yield were negative while US leveraged loans posted positive total returns
• Most corporate credit managers saw small gains in October. Convertible bonds continued to be a source of gains, driven by idiosyncratic events, certain credit-sensitive issuers, and some managers taking advantage of ongoing volatility in China-related names
• Certain high-yield long/short credits also contributed positively, as did some stub trades that saw ongoing compression in the discount to net asset value. Financial preferred securities experienced weakness, largely driven by the sell-off in rates. At the portfolio level, credit hedges were a detractor, while rates hedges contributed to gains
• Structured credit managers had a small positive month, largely driven by the income generated from holding these securities

Equities:

• Equity markets generally posted positive, but more muted performance as of close of business on 29 October. Markets moved around quite a bit from week-to-week on a combination of both macro (Middle East tension, China economic stimulus, US elections) and micro (third quarter earnings season) factors
• A common theme heading into the US election has been a general “risk off tone” coming from fundamental equity long-short (ELS) funds. We believe that ELS funds in general were more of a “first mover” here, with more moderate net and gross exposures heading into October, while other strategies reduced their net equity exposure (adding short positions) during the latter half of October in particular. Index and exchange-traded funds have been popular expressions of a more cautious stance in equities
• Performance-wise, ELS returns for the month have been relatively modest given where the market tracked. Alpha generation was again mixed, with strength on the long side offset by weakness in short positions (especially crowded names)

Discretionary Macro:

• It was a positive month for discretionary macro strategies
• Managers generally maintained a tactical short position in US fixed income against long positions in European markets, which helped performance
• We expect some dispersion from mixed positioning in UK fixed income, following the sell-off in gilts after the Labour government announced additional borrowing plans in its budget
• More idiosyncratic themes in EM sovereign credit worked well, while profit-taking in developed markets yield curve steepeners helped shield gains during the flattening earlier in October. Japanese macro themes were also mixed as foreign exchange-biased expressions struggled amid yen weakness, while fixed income shorts made small gains. Trading in Chinese equity markets saw smaller losses, though we are yet to see meaningful positioning in China-related themes from macro managers given lingering concerns over the outlook

Systematic Macro:

• Trend-following strategies continued their poor run of performance in October. Losses principally stemmed from short US dollar and long fixed income positions, with yields rising in response to stronger-than-expected economic data, commodity price inflation, and Federal Reserve rhetoric around higher long-term interest rates
• Alternative trend strategies are also in the red with commodities a particular area of weakness as the full effects of the Chinese stimulus measures fed through, catching programmes short. Like more traditional trends, long fixed income positioning in more esoteric markets has also detracted, though long corporate credit provided some respite
• Broader systematic macro strategies have again delivered mixed performance. We’ve seen some managers generate profits in commodities – where long gold and short natural gas positions benefited from significant moves, as well as from short US treasury and German Bund exposures as yields backed up. Others found trading in fixed income tricky – particularly those with a more meaningful allocation to trend models

Micro Quant:

• Performance for statistical arbitrage strategies has generally been disappointing. Strategies driven by alternative data have similarly struggled
• There’s no obvious reason for this weakness, though rumours of some risk reduction by a subset of market participants continued
• Differences in investment time horizon don’t appear to be the main driver of performance, with small losses widespread among managers
• Momentum, high-beta, and high-growth stocks have been the top performers from a factor perspective. Like September, any quantitative managers tilting against value stocks should have prospered

Event-driven:

• Following some material negative catalysts during the month, event-driven strategy returns were under pressure in October
• The Federal Trade Commission (FTC) litigation to block the US$8.5 billion Capri/Tapestry deal was ruled in favour of the regulator, which constituted a significant surprise to the market, as the FTC’s allegations were deemed weak
• Another surprising deal break in Hong Kong caused losses, as the state-owned acquirer was unable to secure an extension to the approval process
• Merger spreads widened sharply at the end of the month, largely due to the Capri/Tapestry break
• Global new deal activity was fairly quiet, likely also due to the impending US election
• Covestro, a plastics group, received a firm billion offer from ADNOC after a long due diligence process
• Rio Tinto announced the US$6.7 billion acquisition of lithium miner Arcadium
• Another Japan situation, Alimentation Couche-Tard increased its bid for 7-Eleven convenience stores by 20% to c. US$47 billion, after their initial US$38 billion bid was rejected
• Private equity firm Advent is reportedly preparing a takeover offer for UK-based Tate & Lyle, a supplier of food and beverage products
• Codere Group, a casino and online gaming business based in Europe and Latin America, successfully completed a multi-jurisdictional recapitalisation of its EUR 1.4 billion secured debt
• Atos’s accelerated safeguard restructuring plan was approved by the specialised Commercial Court in France

On the radar:

• In the short term, all eyes are on the market reactions to the new US political regime, and which parts of Trumps manifesto are likely to be prioritised in the ‘first 100 days’. Currently commentators are cautiously optimistic that announcements will be pro-growth first, before some of the more controversial measures around tariffs and immigration are tackled
• Longer term, the focus remains on growth and inflation, and the forward path of rates across developed economies. The new political landscape will take time to feed through into monetary policy, and investors will be watching breakeven inflation rates and long bond yields as a guide to long term fiscal stability

 

All data Bloomberg unless otherwise stated.