Posted by on January 15, 2017 1:53 pm
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We start our Sunday with some gloomy predictions from Morgan Stanley’s appreciately named “Sunday Start” periodical, in which the bank’s Chief Global cross-asset strategist, Andrew Sheets, explains why the market return under the Obama administration will be a tough act to follow. His argument in a nutshell: “good market environments often involve a shift from economic despair to optimism, and a shift in psychology from ‘fear’ to ‘greed’. Both occurred over the last eight years, producing returns well above the long-run average. Whichever party was next to take the White House, it was going to be a tough act to follow.”

Which is not to say that MS is damning the “Trump market” before he has even stepped into office:

Things, of course, could get better, and we certainly hope that strong returns continue. But investors looking to keep the good times rolling should remember a key thing from the above: Starting points matter, making it logical to start with things that haven’t had a particularly good time over the last eight years.

The bank’s advice: invest elsewhere, especially in places – like Europe and Japan – which have failed to enjoy the US asset bump, because as Morgan Stanley calculates, “non-US equities have underperformed the S&P 500 by 90% over the last eight years. In US dollars, they underperformed by 108%. Again, a better starting point, and a preference for Japan and European equities in 2017 remains a core view.”

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From Morgan Stanley’s Andrew Sheets

A Tough Act to Follow

Next week’s inauguration of Donald Trump as US president will mean wall-to-wall discussion of what his policies mean for markets and the legacy of his predecessor. My colleagues will discuss the former in next week’s Start, and I am in no way qualified to comment on the latter. I’d like, instead, to discuss what unites both themes – that returns will likely do worse under the new administration than under the departing one, and where exceptions to this may be.

That statement may seem deeply unfair to an administration that hasn’t even had a chance to pass policy, and incongruous with the sharp rise in investor and business confidence in recent surveys. But it’s linked to a simple idea. Good market environments often involve a shift from economic despair to optimism, and a shift in psychology from ‘fear’ to ‘greed’. Both occurred over the last eight years, producing returns well above the long-run average. Whichever party was next to take the White House, it was going to be a tough act to follow.

And what an act it was. Eight years ago, stocks were in freefall, credit markets were frozen and a highly leveraged US banking system was struggling to avoid collapse. Car sales had fallen 50%, consumer confidence was at all-time lows and the housing market, the single biggest store of wealth in the United States, was witnessing foreclosure rates not seen since the Great Depression. Two foreign wars and falling tax revenues were pushing the budget deficit towards historical highs.

It was a troubling time. Market pricing, unsurprisingly, reflected that despair. The last time the market cared this much about what a new US president would do, the S&P 500 was at 805, high yield bonds yielded 18.1% and the VIX stood at 56%. Those same numbers today? 2257, 5.8% and 12%.

Those changed levels reflect a remarkably changed backdrop. Today, US car sales and consumer confidence are historically high, residential and commercial real estate prices are above prior cycle peaks and US banks are now trying to return capital, not raise it. US credit markets saw their highest-ever level of bond issuance (US$1.3 trillion) in 2016, jobless claims have hit a 40-year low and the budget deficit is back to the average seen since 1980. The S&P 500 equity risk premium was 5.8% in 2009, and now it stands at 1.4%. Returns under the outgoing administration, in short, enjoyed both cheap starting levels and a large rate of change. The incoming one may not have either.

Things, of course, could get better, and we certainly hope that strong returns continue. But investors looking to keep the good times rolling should remember a key thing from the above: Starting points matter, making it logical to start with things that haven’t had a particularly good time over the last eight years.

One is European Value. The sector has underperformed for 10 years, and has only just started to bounce. Our European equity strategists think it will be in the unusual position of combining low valuations with strong earnings growth in 2017, while remaining under-owned. More broadly, non-US equities have underperformed the S&P 500 by 90% over the last eight years. In US dollars, they underperformed by 108%. Again, a better starting point, and a preference for Japan and European equities in 2017 remains a core view.

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