Should UK investors take pre-emptive action?

Global equities continue to soar in the belief that "good" aspects of a Trump presidency – mooted tax cuts, deregulation and repatriation of overseas dollars – will prevail over "bad" policies, especially a trade tussle with China. And that's with no clarity on how big tax cuts and infrastructure spending will be funded.

US stocks now entertain peak values against corporate revenues, GDP and money supply, while bulls argue they're not stretched in terms of cyclically adjusted price/earnings (PE) multiples.

Such a CAPE ratio for the market, representing its index divided by the 10-year average of inflation-adjusted earnings, is presently 27.4 on the S&P 500 relative to 43.5 at the March 2000 peak.

Bears retort, adjusting for profit margins the CAPE ratio is 37.7, and the US economy near full employment means it will either overheat if Trump implements fiscal expansion, or in due course slow.

So, should British investors heed this for pre-emptive action?

If you combine the 10% post-US election rally with an historic sense for overvaluation, it has the look of a speculative blow-off. Meanwhile there are analysts who assert US stocks are only just embarking on another major leg of the bull market.

Maybe, but remember in September 1929 the respected US economist Irving Fisher declared the stockmarket had reached "a permanently high plateau".

One approach is to explore medium-term put options e.g. on exchange-traded funds such as the SPDR S&P 500 ETF, which trades on the New York Stock Exchange (SPY). A caution here, though, as this type of portfolio "insurance" could be wiped out by another market advance.

It is how a "sophisticated" investor might proceed, although anyone humbler might just prefer to raise their guard, like locking in gains. At some point, exuberant US stocks must reconcile the bad side of Trump policies, and the bill.

Debt/growth risks in China, need watching

There's a US/China parallel in the way stocks are advancing, despite economic uncertainties. The Chinese market is up about 12% already this year, playing down Trump's belligerence and expectations the Chinese economy will slow from 6.7% growth in 2016 to about 6% this year, and 4% in 2018.

Economic growth is closely tied with extraordinary credit growth: can the Politburo continue its balancing act? Goldman Sachs argues that while a hard landing isn't its base case for 2017/18, China risks need close monitoring.

"Sustained debt booms typically lead to slower growth, greater financial volatility and heightened risk of a financial crisis," says Goldman, which applies similarly to the Trump administration, led by an inveterate borrower and replete with ex-Goldman personnel.

A Politburo reshuffle is due at the end of this year, the expectation being President Xi Chi will bolster his position then take action on credit. Or perhaps are problems baked in?

Morgan Stanley is optimistic, arguing China will avoid a financial shock due to its high savings rate and current account surplus. Moreover, Chinese equities could outperform all other emerging markets in the next decade.

Despite a slowdown in Chinese heavy industry and construction, manufacturing and inflation data has been more encouraging. Potentially, the consumer and service sectors can continue to prosper.

The chief near-term risk is what Trump may declare on trade, the current absence of which is probably to keep China guessing. Peter Navarro, head of the new US National Trade Council, has mooted a 45% border-adjusted tax, effectively an import tariff which could prompt retaliatory tariffs.

With exports representing about 20% of China's GDP it would be a disruptive effect especially combined with the debt strains.

Signs of softening in the UK economy

This is the crux issue domestically, at a time of scant margin of safety in stocks - cyclicals are poised quite precariously, while anything demonstrably "growth" trades on a whopping multiple of earnings.

Toward the end of last year represented a last chance to buy imported consumer goods before retailers capitulated to weaker sterling and began raising prices, hence Q4 2016 showing slightly better-than-expected growth in consumer spending.

This, together with improved exports, offset weaker business investment (on technology, machinery and transport) in Q4, although the last five quarters have shown the lowest levels of business investment since 2010/11, which is a concern. The dominant service sector expanded in December albeit at the slowest rate in seven months.

Some distinctions are needed: retail sales weakened in each of the three months to January, although it was only the growth rate in overall household spending that slipped from 0.9% in Q3 2016 to 0.7% in Q4. So, it's not a serious slowing as yet.

Inflation is expected to rise from about 1.8% currently to near 3% later this year, and private consumption growth is tipped to halve to about 1.5%. Thus, shares exposed to value-conscious products and services are more likely to thrive than the likes of Hotel Chocolat Group  whose PE in the thirties is over twice the expected earnings growth rate.

Caution on oil & gas stocks

At the end of January, I pointed out how Trump's enthusiasm to boost the oil industry, plus shale drillers' flexibility, meant bullish oil traders were under-estimating the extent of US supply versus OPEC output cuts announced in November, and non-OPEC producers such as Iran, Libya and Nigeria continuing to raise output.

Then, mid-February, US crude oil stockpiles were declared at a record high. Coincidentally, there has accumulated a record extent of "long" trade positions in crude oil – a year ago there was a record extent of "shorts" when oil plunged briefly below $18/barrel.

After a circa 20% rally since November alone, into the mid-$50 zone, oil prices may, therefore, be exposed both on fundamental and technical market aspects. Will the OPEC cuts be enough to manage the market?

Charts for key oil & gas stocks have dipped during February and, interestingly, fat yields on big-caps have barely contained downside. Assuming consensus dividend forecasts, BP yielded 6.2% at its January high of 519p, but its price has dropped nearly 14% below 450p.

Highly indebted, non-dividend payers such as Premier Oil and Tullow Oil have dropped more, by 22% and 17.1%, respectively. Various smaller oil stocks have soared on the back of crude's rebound. So take care lest recovery to the mid-$50's represents a near-term high and oil bulls close out.

Longer-term, the hope is Saudi Arabia will promote oil market stability to pave the way for floating Saudi Aramco, its integrated oil company that would become the world's largest listed such business.

Moderately lower oil prices due to Trump and the "Republican Oil & Gas Party" encouraging US output would be a welcome inflation check in the UK, but mind how oil & gas stocks could see further downside.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.