The Bank of America-Merrill Lynch (BofA-ML) survey of global fund managers for January 2017 says the long US dollar is the most crowded trade and that, after the inauguration of Donald Trump as US President on 20 January, some of the contrarian trades would be to go long emerging markets, the UK, the euro, commodities and shorting the US dollar.
Since Donald Trump was voted as US President in November 2016, his promises of tax cuts, higher spending on infrastructure, higher tariffs and penalizing companies that produce goods abroad have led to rising US yields and a stronger dollar, which in turn has led to money flowing out of US equities from emerging markets.
But has that trade run out of steam? As we head closer to Trump’s inauguration, some of the optimism seems to have fizzled out. Trump’s policymaking remains ambiguous and no one knows whether the proposals made earlier will actually translate into policies. What happens when Trump realises that being in power necessarily means compromises? Indeed, US bond yields have come off their highs and the US dollar has hit a one-month low.
Could it be a case of “buy the election, sell the inauguration”? That seems to be warranted by investor positioning, but it won’t be an easy trade. Most indicators suggest the US economy is on a firm wicket, which in turn could lead to the US Federal Reserve raising rates faster than anticipated. That will boost the dollar and weigh on emerging markets.
As far as the Indian market is concerned, domestic factors like the Union Budget and state elections will be the triggers apart from global cues. Among sectors, Trump protectionist measures may hurt Indian exporters like textiles, auto components, pharma and IT services. Until more clarity emerges, some analysts have a cautious stance on these sectors.
“Impact on India would be a sideshow, at best. Whether these companies lose share or margins, have to incur costs in setting up local facilities or are able to just pass on higher costs will depend on the competitive scenario, but we see a cause for worry,” said foreign brokerage firm Jeffries in a report. But foreign investors are expected to make a comeback in Indian equities once the impact of demonetisation fades and the Central Board of Direct Taxes (CBDT) moves to put its circular on indirect taxation related to taxing foreign investors on hold which could attract funds.
The BofA-ML survey shows investors are sitting on cash and there’s a lot of money on the sidelines. The survey says that current allocation to emerging markets is 1.1 standard deviations below its long-term average, which increases the chances of a rebound. It also points out that while allocations to energy is at a 5-year high, investors are net underweight on emerging markets, which is strange since both these asset allocations usually move in tandem. It concludes from this divergence that emerging markets will be the last “cyclical catch-up trade”.
US investors have embraced Donald Trump with surprising enthusiasm. They are likely to regret it, but how soon is the question.