Investors are advised to diversify their portfolios as the change of administration and inflationary pressures in the United States will add to uncertainties in the markets, according to S&P Dow Jones Indices.
“The so-called Trump inflation has already started,” Tim Edwards, senior director of index investment strategy at S&P Dow Jones Indices, told EJ Insight in an interview in Hong Kong.
If Donald Trump’s administration implements his plans to launch big infrastructure projects, increase tariffs and repatriate jobs to the US, there will be inflationary pressure on wages, commodity prices and consumer prices, he said.
He said that since such an inflationary trend will have different effects on bonds and equities, as well as different sectors, investors should diversify their investments to reduce risks.
“Over the years, ‘bad’ news happened and we were happy about it because it meant more fiscal easing and stimulus. But that has ended,” Edwards said. “We now have a negative correlation between equities and Treasuries.”
Good news about the US economy is now positive to the stock markets, he said.
VIX signaled Trump victory
Edwards pointed out in a blog on Nov. 4, a few days before the US presidential election, that the spread between VIX, an indicator of near-term volatility conveyed by S&P 500 stock index option prices, and S&P 500 1-month Realized Volatility Index had reached extremely rare levels.
Similar situations of widening spreads were seen during the Gulf War in 1991, the Asian financial crisis in 1997 and the Greek debt crisis in 2011.
“If Trump does indeed win, we cannot claim that the VIX didn’t warn us,” Edwards wrote.
After Trump won the election, the VIX decreased but the S&P 500 1-Day Sector Dispersion (underweighted) reached 1.97 percent, the highest level this year. Financial and industrial sectors outperformed interest-rate-sensitive sectors such as real estate, utilities, consumer discretionary and consumer staples.
He wrote in another article that “stock-level volatility has risen, but correlations have dramatically fallen”.
Edwards said it is hard to predict how long such dispersion will last but “when it is high, it tends to stay high”.
In fact, quantitative easing, which kept dispersion low for many years after the 2008 financial crisis, is over but a lot of political decisions will be made by Trump next year, he said.
US stocks remain expensive
Dow Jones Index has risen 10.1 percent this year to close at 19,191 points on Thursday while S&P 500 Index has gained 7.2 percent this year to 2,191 points.
“The US equity market has been quite expensive … The market can’t keep going up without some fundamental growth,” Edwards said.
“The good news is that we have seen some fundamental growth. But the market is still expensive. We are still in a reasonably high-risk environment.”
In general, investors may face more risks next year than this year as different regions are having different directions in their monetary policies while volatility and dispersion will remain in the US stock markets in the Trump era, he said.
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