When will the 'Trump rally' grind to a halt?

The Donald Trump-inspired stock market rally will soon lose its fizz, according to Sam Morse, manager of the Fidelity European Values and Fidelity European funds.

Since Trump's election victory, financial markets, particularly across the pond in America and here in Britain, have been in fine form, with both the S&P 500 and the FTSE 100 indices hitting record highs.

Trump's various promises on the campaign trail have certainly divided opinion, but as far as investors are concerned the general feeling is that there's money to be made, due to the proposed fiscal spending spree and tax cuts for American businesses.

Investor sentiment has been moving in a bullish direction, but as Morse notes, this is often a dangerous sign.

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'It worries me when everyone becomes uniformly bullish. I do think the rally is the last leg in this stock market cycle, but as we all know trying to predict the top of the market is pretty much impossible.

'I do, however, think that some of the uglier of Trump's policies, particularly his stance on protectionism, are dangerous for future growth,' says Morse.

'Another concern I have is that markets have been going up hoping that Trump will prove more bark than bite, but it now looks (in light of the travel ban, which has subsequently been blocked) that he will bite as well as bark.'

The manager adds that the US stock market is the most influential of all world markets, and a correction would likely impact European exchanges.

Other investors, including Richard Buxton, manager of the Old Mutual UK Alpha fund, agree that the 'Trump rally' may prove to be a classic case of markets moving too far, too soon. According to Buxton the rally hinges heavily on Trump's pledged tax cuts and spending sprees bearing fruit.

'A market correction may well play out in the second half of the year; markets are going up in hope that Trump's policies will be signed off, but there is always a danger that when markets are travelling higher they melt-up in euphoria,' says Buxton.

'There's also a risk of US growth undershooting expectations. It could take longer than expected for Trump's fiscal policies to feed through to economic activity.'


Another concern, highlighted in a paper published by JPMorgan last year, is that once the US economy hits full employment and is no longer fuelling growth by putting the unemployed back to work, economic growth will generally slow down, making the economy more vulnerable to a shock.

The paper also notes that as expansions progress (with US in its eighth year of economic expansion), there are two basic problems that can lead to recession: slower trend growth and cyclical excesses.

By cyclical excesses JPMorgan is referring to unsustainably high demand, for example for cars or houses or business investment spending.

A related problem is unusually high real interest rates, caused either by the Federal Reserve overtightening or just the strain put on credit markets by consumers and businesses trying to finance their exuberant spending.

But JPMorgan notes that 'none of these issues should be sufficient to trigger a full-blown recession right now'.

Morse's present caution is reflected in Fidelity European Values' low gearing levels, currently around 3 per cent. During Morse's seven-year tenure, the trust's gearing has typically been 6 per cent. Morse says that even before the Trump rally he had become bearish over the short-term outlook for the European market.

'The price/earnings ratio of the European market is quite high relative to its own history. I am not convinced valuations will be backed up by an uplift of earnings,' adds Morse.

In the absence of a rise in earnings, Morse expects at some point European markets will fail to justify their valuations and fall. He insists there are plenty of individual stock opportunities, however, highlighting consistent dividend growers such as consumer goods firms L'Oréal and Nestlé.

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