Monthly Global Perspectives - Columbia Threadneedle · Monthly Global Perspectives – December 2016 TAX REFORM A further key element of Mr Trump’s economic plan will be comprehensive

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Monthly Global PerspectivesDECEMBER 2016

WHITHER GLOBALISATION?TOBY NANGLE

FINAL THOUGHTSMARK BURGESS

US RETAIL SALES: ONLINE SELLERS POISED TO DOMINATETOM WEST

LATIN AMERICA POST THE US ELECTIONILAN FURMAN

US SMALLER COMPANIES TO BENEFIT FROM TRUMPONOMICS

DIANE SOBIN

WATCH OUT – RESPONSIBLE INVESTMENT

IS COMING OF AGEIAIN RICHARDS

WHAT THE TRUMP VICTORY MEANS FOR

COMMODITIES WILLIAM AMZAND

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Monthly Global Perspectives – December 2016

BACKGROUNDGlobalisation – the process by which commodity, capital and labour markets across the world have been opened up and meaningfully deregulated, allowing economic integration across national borders – has coincided with a period of substantial global economic growth. Trade has exploded over recent decades as tariff and non-tariff barriers have fallen, and technology has reduced distances among trade partners. Capitalists have become rich engaging in unit labour cost arbitrage, while more people based in emerging markets have exited poverty more quickly than any time in human history. And this process of globalisation has coincided with a sharp decline in inflation and real bond yields – one that we believe is causally-linked.

The manner in which these economic gains have been distributed is still best-captured by the work of Branko Milanovic, best-known for his ‘Elephant chart’. Essentially, Milanovic’s work points to faster income growth among the highest earners in advanced economies and middle-income households in developing countries, with slower income growth among lower income households in the West.

WHITHER GLOBALISATION?

Toby NangleGlobal Co-Head of Multi-Asset & Head of Asset Allocation, EMEA

nn Over the last decade, the rise of globalisation has coincided with a period of economic growth that has seen significant advances in technology, deregulation and trade.

nn While there have been many winners from globalisation – witness the rise of the middle class in emerging markets – there are a growing number of losers and they are making their voices heard – witness Brexit and the election of President Trump.

nn The growing strength of political populism has the power to derail the smooth passage of globalisation. As the political spotlight moves to continental Europe, the advance of the disenfranchised will place a lot of pressure on the financial system and impact significantly on global markets.

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‘Elephant chart’ showing change in real income, 1988-2008

Percentile of global income distribution

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Source: Branko Milanovic, World Bank, 2012. Note: Chart shows real income at various percentiles of global income distribution (calculated in 2005 international dollars).

The social, political and cultural implications of globalisation in the West have so far been beyond the scope of our analysis. But the recent votes for Brexit in the UK and President-elect Trump in the US, as well as the rise of electorally significant anti-globalisation movements across Europe bring alive these considerations when thinking about prospective policy. As such, it is not easy to invest without taking a view as to how these trends will develop.

Associating President Trump’s election with a backlash against globalisation appears intuitive. Looking at the breakdown of Republican voter support by income bracket we observe that while lower-income groups mostly voted Democrat, the swing towards the Republican Party by voters in these income brackets was the factor that delivered the Presidency to Trump. The single most important statistical variable associated with the electoral swings to both Trump in the US, and to Brexit in the UK, was the proportion of voters in an electoral catchment area lacking a college degree. While correlation is not causation, we observe that those without college degrees appear least well-equipped to adapt to the challenges and opportunities of globalisation. The narrative that this cohort was ‘left behind’ by globalisation and used the ballot box to strike back appears not without merit.

Looking to Europe we see near-term tests of the existing political order, where anti-globalisation movements are being championed by the Five Star Movement in Italy, the National Front in France, AfD in Germany, the Freedom Party in Austria and the PVV in Holland. We note that while democracy serves to diffuse tensions in most polities, the brittleness associated with monetary union in the case of the Eurozone could lead to fracture should an anti-globalisation movement win power and seek to leave the Eurozone.

The combination of globalisation, advances in technology and inflation-fighting central banks have hollowed out much of the middle-and-lower income occupations in European economies. Downward pressure on middle-and-lower-income occupation wages has persisted, while political leaders seeking to address the concerns of those left behind appear to have a variety of options available.

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At one end of the spectrum, there is the option to better compensate these lower-income groups through some mixture of welfare and public employment programmes – make-work as some call it. This has the merit of keeping alive a global economic programme of economic convergence that has proved hugely successful in maximising economic growth and development through international economic integration.

At the other end, there is the option to step back from globalisation and towards autarky (economic self-sufficiency), either within national boundaries or within regional blocs of countries with similar domestic political concerns. This has the merit of keeping less-skilled domestic workforces in productive employment, although this strategy is still vulnerable to technological progress and is typically associated with stagnant living standards (as the aggregate economic gains of international economic integration are no longer taken).

From an investment perspective, the implications of such a tectonic shift away from greater economic integration are profound. The secular fall in world real interest rates that has boosted the valuation of future cash-flows appears to us related to global economic integration. This has delivered a constructive investment environment not only for high returns from bond markets but also equity and property markets.

While top-line revenues of labour-intensive firms will benefit from reflationary policies (associated with larger budget deficits and a move away from globalisation), the lack of labour slack in developed markets means that it is unlikely that we will see profitability rise proportionately as these same policies appear likely to accrue pricing power to labour. That said, firms with high levels of operational leverage would likely benefit, and firms with both high financial leverage and no near-term financing needs would profit from the money illusion that reflation delivers.

Economically, a move away from free trade and towards autarky at a national or regional level would leave all parties worse off at an aggregate level. It would erect barriers to emerging market economic development, as reshoring removes opportunities for the growth of relatively well-paid employment in emerging markets. Trade accounts for a significant proportion of most emerging market economies, meaning that there is the potential for significant disruption in many economies.

We will not know for some time whether the de-globalisation train has been set inexorably in motion. But the implications of this move from an investment perspective appear profound.

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GLOBALISATIONA key theme of the US election, in common with the UK’s Brexit vote, is a rejection of globalisation. If Mr Trump is to deliver on his campaign promises he will pursue a protectionism agenda that challenges free trade agreements and may see the reintroduction of tariff barriers for several industries. He will place ‘America First’ at home and abroad. In the near-term we therefore expect a further division between the domestic and international economy. US smaller companies look well placed to benefit from this divide, as they have higher domestic revenue exposures than their large cap peers.

FISCAL STIMULUSA second key development will be fiscal policy stimulus. Many lower-and-middle-income voters clearly felt left behind due to the stagnation in real incomes at a time when asset owners saw sharp rises in equity and property valuations. We expect Mr Trump to use fiscal policy stimulus to attempt to boost what has been a lacklustre monetary policy-led, economic recovery. Fiscal spending will also attempt to democratise growth, with spending in particular on infrastructure, construction and defence. If combined with a more protectionist stance, this can provide a short-term benefit to the Trump heartlands of Middle America.

In general terms, this can help more cyclical areas of the economy including industrials and materials. In the immediate aftermath of the election this led to some selling of higher growth names, as investors revised the valuation multiples they were willing to pay for secular growth. More specifically, we can see cyclical growth benefit smaller cap industrial companies with exposure to Middle America, with second order benefits in local banks. This can benefit machinery and construction businesses. It should also benefit semiconductor stocks, since modern construction and engineering projects involve several technology elements including computer aided design, GPS tracking and fleet management systems.

US SMALLER COMPANIES TO BENEFIT FROM TRUMPONOMICS

Diane SobinHead of US Equities, EMEA

nn Whatever views investors might hold about the US election, and its victor, there are now substantial grounds for optimism about the near-term prospects for the US economy.

nn We analyse the implications of the election and identify what we believe will be areas of interest for investors.

nn We see the US smaller companies market in particular as an area of opportunity.

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TAX REFORMA further key element of Mr Trump’s economic plan will be comprehensive tax reform. The Republicans, with a clean sweep of the Presidency, House of Representatives and Senate, have a once-in-a-career opportunity to simplify America’s byzantine tax code. As part of this, Mr Trump may enact the proposals he made in August 2016 by lowering corporation taxes from a top rate of 35% to 15%. In the near-term this can benefit the future earnings power of US businesses, providing a boost to stock market valuations. It may also see many multinational firms more willing to repatriate foreign cash balances that are currently trapped overseas. This excess cash will variously be returned to shareholders in the form of buy-back and dividends, can be used to fund mergers and acquisitions, and can add to spending on research and development. Greater R&D spending could provide a boost to employment in industries such as technology and biotech. The latter along with the pharmaceutical sector may also see a continued recovery trade, having seen valuations depressed on concerns that a Clinton administration would have adopted an aggressive stance on pricing.

Mr Trump has indicated a belief in less government involvement in regulation, which can also bring some near-term benefits. These include lower barriers to business creation and growth, and less capital being allocated to cover regulatory costs. These benefits can be seen in more regulated industries including energy, banks, telecoms and health care.

If we draw together various strands of the next administration’s likely policy, we can make a strong case for reflation. This stems from the combination of higher fiscal spending, a concentration on areas of the economy already seeing some tightness in labour markets, and the potential for higher import prices due to tariffs. In this environment it is likely that the Federal Reserve will step up the pace of its interest rate hikes. In the days following the election we saw the US treasury curve steepen meaningfully as investors discounted better GDP growth, higher inflation and faster interest rate rises. This environment should benefit interest-rate sensitive banks and life insurers. While the Trump administration’s policy on bank regulation is yet to be defined in detail, any movement towards deregulation, including on aspects of Dodd-Frank, may boost earnings potential for the financial sector.

RISKSThe forthcoming policy agenda is not without its risks and uncertainties. Some risks include greater protectionism, a concomitant risk to international relations, tighter controls on immigration and potentially higher fiscal deficits. While these represent real challenges, some are more structural in nature and have bearing on the long-run output potential of the US economy. Our case is that in the near-term the benefits of incremental fiscal stimulus may outweigh these concerns, especially if the domestic US economy is viewed relative to growth in other regions.

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THE OUTLOOK FOR SMALLER COMPANIESIn terms of implications for smaller companies, we expect to see better topline growth from cyclical areas of the market than we have seen in recent years. One area of focus will be the trajectory of margins. We do expect incremental wage pressure, which calls for some compression in margins. However, many cyclical stocks are currently below their normalised operating rate and enjoy substantial operating leverage. This may help to protect margins for smaller companies, so that the stimulus applied to topline growth can translate through into earnings growth. Selectivity at a stock level will be crucial to informing this analysis.

We alluded to some of the risks facing investors, not least in the realm of geo-politics. While the course of international events over the next four years is difficult to predict, we believe that smaller companies should remain relatively better insulated. We believe that any material weakness in the smaller companies sector may present an attractive entry point for new investors to the asset class.

As active managers we will continue to analyse the macro and micro implications of a Trump presidency for the US smaller companies market. We remain confident that whatever the market environment we will continue to take advantage of the opportunities we see for the benefit of our clients.

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US retailers have entered the most important part of their year, starting with Black Friday and Cyber Monday and then rolling on to the rest of the holiday season. It’s always a critical period, but the stakes are arguably even higher this year after a disappointing performance in 2015. If projections pan out, this year could be a much better one.

RETAILERS ARE TAKING ON LESS RISK THIS YEARLast year retailers underperformed because of the unseasonably warm weather in November and December – it was 72 degrees on Christmas Eve in New York City, a full 32 degrees higher than the historical average. The warm weather across much of the country led to underwhelming foot traffic at malls and particularly weak demand for cold weather clothing. This resulted in retailers being left with excess inventory – well into 2016 – that they were forced to discount in order to clear.

This year retailers have reacted by being far more conservative with their inventories – a key part of their efforts to shift more business risk onto brands. With lower inventories, retailers won’t be left as exposed if sales disappoint once again this holiday season. This strategy puts more pressure on brands to provide extra inventory if and when sales are strong – brands, in effect, are being forced to carry more of the risk (and cost) of matching consumer demand or are faced with leaving potential revenue on the table.

IF FORECASTS ARE AN INDICATION, RETAILERS SHOULD BE IN BETTER SHAPEDespite the conservative approach, this year could turn out to be better for retailers. The National Retail Federation forecasts that consumer spending will rise by 3.6% this holiday season, well above the 10-year average of 2.5% and slightly ahead of the seven-year average of 3.4%, since the economic recovery began in 2009. Consumer confidence surveys are also heading in the right direction, with higher levels in 2015 and 2016 than in the previous four years.

US RETAIL SALES: ONLINE SELLERS POISED TO DOMINATE

Tom WestGlobal Head of Fundamental Research

nn Consumer spending is expected to rise this holiday season, but the benefits won’t be evenly spread.

nn Mainstream retailers, under pressure from Amazon and off-price stores, are shifting risk to brands.

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Consumer confidence is trending higher

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US Consumer Sentiment Index

Source: University of Michigan Consumer Sentiment Index as of October 2016.

ONLINE SELLERS ARE POISED TO DOMINATEGrowing consumer appetites are welcome news for apparel retailers in the short term, but pressure from online competition continues unabated. Amazon is taking an increasingly larger share of consumer spending, notably in the apparel sector, where it is predicted to become the market leader next year, surpassing Walmart and Macy’s. As part of Amazon’s push into fashion, the online retail giant has revamped merchandise display on its website and has launched a fashion advertising campaign in the US and Europe.

Brick-and-mortar retailers continue to feel pressure from the change in Americans’ buying habits and the move online. Macy’s, for example, has announced plans to shut 100 stores, or about 15% of its storefronts, by early 2017 as store-level profitability has suffered and the justification to keep these stores open has become more difficult. Traditional retailers are being forced to continue to invest in their own e-commerce initiatives or face the hard fact that they could lose an online sale to a competitor. The purchase of Jet.com by Wal-Mart Stores for $3 billion in August highlights the high cost a traditional retailer is willing to pay to position it to effectively compete in the evolving and challenging environment.

There are some bright spots in the brick-and-mortar world, though. Off-price retailers like T.J. Maxx, Burlington Stores and Ross Stores are doing well despite generally not having a big online presence. Consumers like their value proposition as well as the treasure hunt aspect to shopping in a place where you can’t be sure what you might find.

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There has been an expectation that brands themselves would more easily navigate the shift in consumer shopping habits. The reasoning was that strong demand for a brand such as Nike could drive a consumer to make a Nike purchase, whether in store, online or directly from the brand. But it is increasingly apparent that brands face their own set of challenges, such as navigating the changing environment of store closures, retailer bankruptcies (such as Sports Authority) and inventory conservatism by traditional retailers.

Here too, Amazon is disrupting the traditional relationship brands have had with department stores. Stores traditionally negotiate upfront prices for goods with brands and, if a particular item doesn’t sell as well as hoped, go back to the brand to ask for a markdown allowance to help offset the loss in profitability of having to sell the goods at a lower price. Amazon is different in that it pushes hard on pricing upfront but does not go back to its partners for any markdowns, even if sales disappoint.

Online pricing is a critical area for brands. Many retailers have policies of matching competitors’ pricing, and in an online retail environment, price discovery is a much easier process for consumers. With the amount of price-matching that goes on in the industry, it means that if lower prices appear on Amazon – often the first place consumers search – low prices quickly reverberate across the industry. The situation is complicated by the fact that there are often multiple sellers of items on Amazon – from Amazon itself to the brands or other independent vendors. To try and control the retail and pricing landscape a little, many brands are choosing to work more closely with Amazon, providing the e-commerce giant with their products and even putting employees into Amazon offices to ensure the relationship runs smoothly.

Whatever happens this holiday season, the main trends in the retail industry are likely to continue. The “Amazonification” of retail is here to stay. The trick for brands and retailers alike is to ensure that they are able to adapt and move in line with consumers’ changing habits.

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The origins of values-based or ethical investing can be traced back through history and the role played by religion. However, the seeds of modern interest in this area are perhaps more closely associated with the social changes and political climate of the 1960s (think Vietnam and civil rights), 70s (labour rights and apartheid) and 80s (tobacco and nuclear campaigning) and, in the 90s, with corporate scandals like Maxwell, Polly Peck and BICC.

2000 then saw the launch of the UN Global Compact, providing a key underpinning for the ESG (Environmental, Social & Governance) focus of today. Initially, the investment management industry’s response to this demand was relatively esoteric. Over this period, a niche market developed for exclusionary and socially responsible investments and then thematic funds focusing on specific issues like forestry, water and, more recently, renewable energy.

In the meantime the list of corporate scandals continued to grow (Worldcom, Enron, Parmalat, BP Macondo, Rana Plaza, Siemens, Olympus, Toshiba, widespread Pharmaceutical mis-selling and VW). These combined with the effects of the financial crisis have been building a head of steam for change. Today social and political challenges and popular debates around climate change, corporate accountability and growing social inequality are front and centre in the media and in policy making. This has been fueled by social media, global connectivity and new generations of consumer who are attuned and informed about the issues. All told, a perfect storm that has given this field a new level of prominence and importance.

Today’s landscape looks far more varied. A handful of trailblazer products have gradually given rise to an entire investment field that is underpinned by ESG factors. However, until recently concerns about trade-offs with financial returns and excessively dogmatic or rules-based approaches, have remained a drag on popular take up.

WATCH OUT – RESPONSIBLE INVESTMENT IS COMING OF AGE

Iain RichardsHead of Responsible Investment, EMEA

nn Responsible Investment has been evolving and new approaches offer compelling opportunities.

nn This recognises that well-governed companies are better positioned to manage the risks and challenges inherent in business and are better able to capture opportunities for growth.

nn Effective stewardship of capital enables active investors to capture proactively the opportunities that well-run and improving companies offer in delivering sustainable growth and returns for investors.

nn Done responsibly, this role in allocating capital is important in enhancing productivity, sustainable economic growth, prosperity and welfare.

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But that is only one part of the story. Beyond appealing to a new breed of more socially and environmentally conscious consumer, another catalyst for change has been the growing body of evidence that not only do these approaches not require the sacrifice of financial returns but that, done well, they offer both added performance opportunities and meaning.

That evidence was pulled together and tested in research published in 2015 by the University of Hamburg’s School of Business, Economics and Social Science, working in collaboration with Deutsche Asset & Wealth Management. The study reviewed well over 2,000 empirical studies and meta-studies on the links between ESG and corporate financial performance. Its finding that roughly 90% of the studies supported the conclusion that financial returns do not have to be sacrificed, offers a clear signal of the validity of the role that this discipline can play in investment. Rigorously assessed, the evidence shows a world of opportunity for those with the patience to navigate the wealth of information we now have.

At the same time the tired excuse of the ‘fiduciary duty’ as a barrier to responsible investment has been debunked by the UK Law Commission and by similar studies done across Europe on the legal frameworks that apply.

This is not altogether surprising. Companies that pay close attention to their governance and standards of practice are generally well run and better able to respond to the challenges and opportunities of a changing world, economic need and opportunity. In contrast those involved in, sometimes repeated, controversies and problems show the signs of ineffective or complacent leadership, poor practice and weak culture. This has increasingly attracted negative media attention and reputational damage. In a world that increasingly relies on reputation, brand and intangible value, that can only be harmful to the standing and prospects of a business and its performance. While this is a relatively simplistic characterisation of the dynamic, it does highlight the exciting opportunity for the next phase in the evolution of ESG in investment.

Well-informed decision-making and robust stewardship are the bedrocks of acting responsibly as an investor. Every portfolio manager will perform due diligence on the companies they choose to invest in. Most firms will have proprietary models designed to assess financial prospects according to defined investment criteria (e.g. a focus on income, value or growth).

Approached sensibly ESG can and should integrate seamlessly into ‘mainstream’ investment, as part of both the upfront and ongoing due diligence process across most traditional portfolios. Given the evidence of the relationship between ESG factors and company performance, this ought to be logical. No one wants to invest in companies which are poorly run or damaging the environment and communities they operate in – it makes no long-term investment sense, in terms of either the sustainability of the business and shareholder value or of its licence and ability to operate.

We have long argued that it is possible to invest responsibly without sacrificing financial return and a good proportion of our institutional clients agree, reflected in the US$26 billion we manage across a range of responsible investment strategies that meet their values and objectives.

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One of the answers to this trend is the adoption of a systematic approach – exploiting technology to create intuitive, evidence-based tools which can be intergrated seamlessly into investment analysis and portfolio management, such that effective ESG analysis is an integral part of the whole process.

Combining the knowledge and experience of portfolio managers, different analyst disciplines and quantitative experts allows intelligent, systematic and proprietary frameworks to be created and bought into by all. These combine with fundamental investment research, internal debate and decision-making. Effective portfolio construction, assessment and monitoring of portfolios and individual investments can follow naturally from this, with the prospect of powerful evidence-based solutions that meet the needs and aspirations of consumers.

This type of approach incorporates a range of tools that work together alongside and complementing traditional financial analysis. For example, sector specific mapping, developed collaboratively and led by sector teams, maps and frames material industry ESG issues that are relevant to investment decisions and linked to the financial drivers and risks central to investment analysis.

It also offers scope to maintain evidence-based, responsible investment dashboards, which integrate proprietary ratings and risk flags that offer scope for systematic second checks to be made on the merits and risks inherent in investment opportunities and choices.

These building blocks enhance the scope and insight that can be gained from profiling the overall characteristics and exposures in portfolios, whether that is about the alignment with major trends (e.g. in healthcare solutions) or externalities (e.g. climate change), considered in the context of risk-adjusted returns. This helicopter view of the quality and opportunities embedded in a portfolio also opens up additional, interesting avenues for creating powerful, transparent client solutions.

Many of these factors may not be systematically captured by conventional analysis, but are intrinsic to holistically considering and cultivating long-term investment prospects and a more rounded understanding of the quality characteristics of the choices being made. A perspective advantage.

Importantly this will increasingly offer much greater scope for consumers to understand what their investment choices lead to, in terms of the characteristics, nature and dynamic of the portfolios they are using.

Harnessing analytics and technology in an intelligent, purposeful way is opening up a world of possibilities, not least full mainstreaming of ESG within the foreseeable future. One can only imagine the potential impact if every fund embraced this kind of can-do approach to responsible investment.

The age of responsible investment is truly upon us!

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The table below shows the importance of trade in general, and exports specifically, to the larger Latin American economies. It is clear that Mexico is the most vulnerable economy to any potential changes in US trade policies. Chile, being an open economy, is also vulnerable to the potential rise of protectionism, though it’s important to note that the majority of Chile’s exports are to other emerging market countries. Colombia also stands to be impacted given its sizeable portion of exports to the US, although those effects should be mitigated by Colombia’s relatively low levels of economic openness and high degree of exports to other emerging markets. Brazil and Argentina are less exposed to the US election theme, as their economies are relatively closed and they export less to the US.

Latin America exports and destinations

Trade Exports by destination (% of total exports)

% GDP US EU China EM

Argentina 23% 6% 14% 9% 69%

Brazil 27% 13% 18% 19% 58%

Chile 60% 13% 13% 26% 52%

Colombia 39% 28% 17% 5% 45%

Mexico 73% 81% 5% 1% 9%

Peru 45% 15% 16% 23% 46%

Source: IMF Direction of Trade Statistics, November 2016.

The Mexican stock market remains volatile amid fears of radical changes in US trade policy. However, a deeper look into current affairs indicates just how complex the situation is. Since the introduction of NAFTA in 1994, the level of cross-border integration has increased significantly. Take for example the auto industry: over the last 20 years Mexico has doubled its share of US auto imports. More generally, many of these imports are for intermediate components that are used in the manufacture of goods made in America.

LATIN AMERICA POST THE US ELECTION

Ilan FurmanPortfolio Manager

nn As the dust begins to settle, the impact of the election result on Latin America remains asymmetric, as countries in the region have different exposure in terms of trade and exports to the US.

nn That said, should Trump follow through on some of his pledges, which have centred on trade and immigration, Mexico is the most exposed among the Latin American economies. However, we have already begun to see some of Trump’s controversial campaign rhetoric soften.

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This evidence emphatically supports the notion that the trade relationship between the US and Mexico is far from being one-sided; indeed, Mexico actually supports the US manufacturing industry. Therefore, we view a worst-case scenario – a full cancellation of NAFTA – as unlikely given its benefits to both nations. Instead, a more moderate re-negotiation process is expected. In the short term, however, Mexico is likely to remain under pressure given the high level of uncertainty regarding US policy and its own fiscal challenges due to lower oil prices.

Against a backdrop of a declining peso and the de-rating seen of Mexican equities, valuations begin to look interesting. This creates opportunities on a selective basis, including high-quality consumer companies that have de-rated, such as Walmex. Also, as seen over the past few months, Mexico’s central bank is raising rates to support the Mexican peso. Given the currency’s depreciation following the US election, another rate hike is likely, benefitting the profitability of local banks such as Banorte. Overall, we remain cautious towards the Mexican market, given the high level of short-term uncertainty.

Regarding Brazil, we have seen a negative market reaction after the US election with the Brazilian real depreciating and the local stock market selling off. This can be attributed to the rise of yields on US treasuries, making high-yield currencies such as the BRL less attractive.

That said, Brazil can be considered relatively isolated from the Trump effect given the fact it is a closed economy and has a low exposure to the US in terms of exports. Furthermore, the investment opportunity relates to the new government’s reform agenda and its change of policy direction, both aimed at stabilising Brazil’s fiscal position and returning the economy to a sustainable growth model. We remain constructive on Brazil, as early measures from the current government have been very positive. For example, we are seeing improvements in the strategies of state-owned companies and important fiscal reforms, such as the spending cap bill, a measure that would cap growth in public spending, which is at an advanced stage of approval.

We are also positive on the utility sector, which is benefitting from changes in the regulatory framework and facing interesting growth opportunities in the form of new greenfield projects or acquisitions. We also like names that benefit from the recovery in industrial production, and we are continuing to pursue companies that can generate growth in a low GDP environment.

With regards to Argentina, we are positive on President Macri’s ability to stabilise the fiscal position, lower inflation and restore investor confidence in the country. The overall picture somewhat mirrors the Brazilian story, as internal challenges are more relevant than the potential changes to global trade policies. One sector already benefitting from Macri’s early measures is farming.

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As regards the Andean region, given the economic openness of Chile, Peru and Colombia, the region could be exposed to a potential slowdown in global growth through higher trade barriers. In terms of our portfolios, we are upbeat on the margin with Chile, due to the prolonged valuation de-rating of its stock market and prospect of pro-market and pro-growth candidates in the upcoming 2017 election.

To conclude, the impact of the US election on the region is likely to be asymmetric, as countries like Mexico are very exposed to US policy direction but countries like Brazil and Argentina less so. Mario Cuomo’s famous quote ‘you campaign in poetry and govern in prose’ seems very relevant to the current situation. That is, whatever the campaign rhetoric, actual policy measures and their implementation remain to be seen. For these reasons, we continue to be constructive regarding investment opportunities in the region, with a higher focus on companies benefitting from positive policy developments or exposed to secular growth trends.

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In the run up to the US election, analysts voiced a strong consensus as to potential commodity market impacts. The typical safe haven assets such as gold should see a pickup, while risk-on assets would be under pressure. In reality, commodity markets were mostly unfazed, the price of gold initially went up by $50, just shy of touching $1,340, but settled unchanged on the day. Copper, on the other hand, generally seen as a risk-on asset, displayed an unusually strong performance, by adding 3.4% on the day of the election, and another 3.5% the day after.

It put the metal markets in focus, stimulated by the Trump rhetoric, but that notion disregarded the fact that the price impact was limited to copper, and less on the other industrial metals. The trigger was probably a re-allocation of risk by Chinese speculators, which led to massive buying of copper as the Shanghai Futures Exchange increased the margin costs on the other industrial metals. If it was solely driven by Trump policy proposals, it was overdone – a classic case of correlation not implying causality. But it did raise the question of how much economic growth this price move would imply and whether the Trump election plan warranted this market move.

‘WE’RE GOING TO REBUILD OUR INFRASTRUCTURE’ 1

Trump made it absolutely clear that he’s looking to jumpstart the economy through infrastructure expenditure. His proposal is to add 1 trillion dollars of infrastructure spending2, on a variety of projects, over a decade and fund it by awarding tax credits to stimulate equity investments and possibly taxing overseas profits of US companies. These projects would directly pump capital into the economy, creating jobs and improving demand; both demand of raw materials as well as consumer demand.

WHAT THE TRUMP VICTORY MEANS FOR COMMODITIES

William AmzandPortfolio Manager

nn With the Republicans holding a majority in the House and the Senate, Trump will lead a unified Republican government. He reiterated his economic plans in his victory speech which focused on tax reductions and infrastructure.

nn In the words of the Speaker of the House, Paul Ryan, after the victory: ‘The opportunity is now here, the opportunity is to go big, go bold and do things for the people of this country’.

nn This rhetoric begs the questions: How will going big and bold affect the commodity markets? And will it also represent an opportunity for the commodity investor?

1Donald Trump, Victory speech, 9-11-2016 2Trump Versus Clinton On Infrastructure, Wilbur Ross, Peter Navarro, 27-10-2016

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One trillion dollars over a decade, equates to $100 billion annually, which is roughly equal to 0.5% of US GDP. The copper moves on Election Day and the day after blew straight through the 2017 price forecasts, and even through some 2018 forecasts. With the demand growth trend of copper being around 2.5%3 annually, the price action implies a multiple of this growth for 2017. Given the 0.5% of potential growth in GDP for 2017 and a six-to-nine month implementation period for the plans, the copper price move seems overdone.

With the focus on infrastructure spending, zinc and nickel are most directly exposed and will therefore exhibit more price sensitivity to implementation of the plans. Although Trump didn’t mention it explicitly in his victory speech, if the upgrading of distribution grids is on the list, copper is likely therefore to exhibit the same price sensitivity.

Even though there could be a price correction for copper in the short term, on a longer-term horizon, it is difficult to deny the plans are appealing from a demand perspective. However, there is more to consider.

‘A POTENTIAL DISASTER FOR OUR COUNTRY’ 4

The quote is referring to the Trans-Pacific Partnership. Trump has reiterated that he will issue an executive action on his first day in office to withdraw from the Trans-Pacific Partnership. With the focus on domestic industry and workers, protectionist policy has been a cornerstone of his campaign, and there is no doubt he will continue this in his presidency. As global trade slows as a consequence, this will harm the global economy and eventually hurt US demand as well.

More directly related to commodity markets, a protectionist policy runs the risk of fragmenting commodity markets. Limiting trade, either by trade barriers, custom delays or increased tariffs, will create pricing differences between domestic and international markets. This could potentially lead to higher domestic prices, again hurting demand.

‘FISCAL CONSERVATIVES IN THE HOUSE ARE NOT GOING TO SUPPORT ANYTHING THAT IS NOT PAID FOR’ 5

Although Trump is leading a unified Republican government, there might still be some pushback on his plans. The current proposals will be difficult to execute without increasing the debt level. After eight years of promoting austerity, Republican fiscal hardliners will be sceptical. Considering Trump as a dealmaker, it isn’t difficult to imagine that the current proposals will be watered-down to appease the Republican hardliners.

3MetalBulletin Research, Global Copper Demand Forecast, 22-11-2016 4Donald Trump on the Trans-Pacific Partnership, A Message from President Elect Donald J. Trump, 21-11-2016 5Republican Congressman Raul Labrador on the proposed infrastructure spending, 22-11-2016

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‘IF I AM ELECTED PRESIDENT I WILL IMMEDIATELY APPROVE THE KEYSTONE XL PIPELINE’ 6

A key part of Trump’s energy plan is focused on making the US energy independent. The Keystone XL project is one of many that can be revived under a Trump presidency and would indeed add to this goal. Considering this within a global framework, where the Middle East has been the historic provider of crude oil for the US, it leaves us to wonder how this ties into future foreign policy plans.

Given the protectionist approach towards the economy, driven by an ‘America First’ sentiment, it wouldn’t be a far-fetched conclusion on further disengagement in the Middle East. This could increase the geopolitical risk in the region, adding a premium to the energy prices, potentially increasing future oil price returns.

Although a lot is still in development, it seems the risk is on the upside for commodities. Tax reforms and infrastructure spending will provide the US economy with a long overdue boost; the protectionist policies could push domestic commodity prices higher; and a possible ‘hands off’ approach to the Middle East increases the risk of higher energy prices. However, it remains to be seen how much of Trump’s plans survive unscathed, given the fiscal stance of the Republican party and the earlier mentioned protectionist policies could also impact global growth negatively.

6Donald Trump on Twitter, 18-08-2015

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Final thoughts: Mark Burgess, Chief Investment Officer, EMEA, and Global Head of Equities

The rejection by US voters of both the Establishment and globalisation (which we also saw with the UK referendum on EU membership) has clearly ramped up geo-political risk. With upcoming elections in Europe, including key elections in France, Holland and Germany next year, these tensions are set to remain with us for some time.

If the rejection of globalisation continues to spread across Europe there will be profound implications, not least for the region’s fragile banking system. Were we to see a further destabilisation of the Eurozone brought about by populist parties looking to take a significant member state out of the single currency that would place a lot of pressure on the financial system and impact significantly on global markets.

In equity markets, the response from investors has been to rotate out of defensive ‘bond proxy’ sectors into cyclicals; while US equities that generate domestic earnings have been in favour due to the isolationist nature of Trump’s pre-election rhetoric, which has benefited smaller companies in particular. Financials are also a beneficiary of a steepening bond yield curve, as banks’ ability to recapitalise themselves is materially enhanced, and we have seen this reflected in what has been a fairly vicious sector rotation. If Trump pursues a protectionism agenda, we will likely see further divide between the domestic economy and the international economy.

Clearly, we are still processing the likely consequences of a Trump presidency, but if the market is right in deciding that the new administration’s policies will signal the end of the long bull market in bonds and induce an uptick in growth and inflation, the ‘lower for longer’ dynamic we have seen in markets in recent years will likely change. That is to say, the phenomenon of core bond yields heading ever lower, effectively forcing investors into risk assets as a result, may no longer be a key driver. If the shape of the bond yield curve is here to stay, our investment strategy will begin to look somewhat different.

But another key question is: if we see rising interest rates on the back of an uptick in inflation, how will we afford it, given high levels of indebtedness in the developed world? Certainly it’s not obvious how higher coupons would suit any of the developed market governments at the moment.

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