How the Trump trade is affecting investment portfolios

Since Donald Trump’s thumping election win our Alpha portfolios have recovered losses from the prior month, when markets were waiting on America’s vote and our UK-centric positions had taken a bit of a knock after the government’s unpopular budget. Thanks to their exposure to equities, our tactical asset allocations (TAA) actually fared a little better in November than appropriate benchmarks amongst the sterling-denominated ARC Private Client Indices (aggregate performance indices based on the portfolios of professional members), which on average had more significant holdings in alternative assets. Although, the ARC benchmarks have performed better overall since we started applying our rules-based TAA to our Alpha strategies. 

Source: ARC Private Client Indices, Investors' Chronicle, LSEG

Gold is the one alternative asset present in the Alpha portfolios but although our sterling-hedged positions lost three per cent in November, the fact gold has strong positive momentum over three and six months and is up almost 30 per cent over one year ensures we won’t make a tactical switch away from the yellow metal. Gold remains a valuable diversifier given its low correlation with other asset classes, although it is typically negative to strong moves in the US dollar (actually another good reason it should form part of investors’ reckoning).

Strategically, we seek dollar risk in the Alpha asset allocations. Over the long-run the greenback has proven a useful haven for UK investors in times of strife, which is why the bond-focused portions of our models prefer unhedged US treasuries.

It’s important to note that our system’s target strategy weights for dollar-denominated bonds are upper limits and allow for flexibility: rules for tactically switching between holdings have gilts (UK government bonds) and other sterling bonds on the menu. This is a recognition that except when momentum massively favours safe dollar assets, many UK investors will want bonds paying them a reliable fixed income in pounds that doesn’t fluctuate due to currency risk.

Last month, however, one aspect of the Trump trade was a surge in the dollar, which meant our portfolios went full apple pie on the dollar risk limits. We have portions of the portfolios strategically reserved for sterling bonds, so we still hold some gilts. 

Dollar bonds the tactical model is favouring are intuitively sensible. Overwhelmingly, it is pointing towards holding short-dated Treasury Inflation Protected Securities (Tips). Due to not having long until maturity, the price of these bonds are less sensitive to changes in the market rate of interest, and the link between their coupon and the rate of inflation protects the real value of those cash flows. So, although there is some currency risk (which may break to the upside anyway), holding these bonds is a defensive move.

Other US bonds the tactical model now points toward, yet with more cautious weights, include US government treasuries with longer to maturity. The effective time in years that it takes a bond to achieve the current market rate of interest, based on the yield of fixed cash flows relative to its price today, is called its duration. The longer this is, the more sensitive the bond’s price is to changes in interest rates.

The long-dated US Treasuries have greater duration risk, something that could work against investors if bond markets demand higher yields on worries the Trump agenda, which includes tax cuts yet no plans to rein in America’s expensive federal entitlements, is fiscally irresponsible. The reason for holding these long-dated government securities, however, is for the income. So, the real calculation is whether the yield looks good versus the likely path of inflation.

Inflation is caused by too much money chasing too few goods, and there are two aspects of so-called “Trumponomics” which look troublesome. Firstly, there is the potential for tariffs to restrict the supply of goods. Secondly, draconian immigration policies could cause bottlenecks in the supply of labour, raising costs for producers while simultaneously giving workers greater bartering power at a moment when there is less for pay packets to buy, which sets the dynamic for a wage-price spiral.

Although not unfounded, these fears can be moderated by the observation that many of America’s trading partners are in a parlous state: Korea and France are on the brink of constitutional crises, Germany faces recession, Japan stagflation and the UK is a low productivity, high tax basket case. Most projections of the damage tariffs will do to the US assume none of these weak actors will blink in negotiations with the world’s most important economy.

On immigration, the harsh rhetoric of the election cycle was primarily focused on criminals crossing the US Southern border, and certainly wasn’t directed at skilled legal migrants. It may be wishful thinking, yet not implausible, that pragmatism could win out regarding productive undocumented arrivals, once the dangerous and headline-grabbing criminal minority are removed. 

Slashing regulation and taxes will be a strong boost for US companies, although there could be valuation concerns with the momentum-based TAA keeping our Alpha strategies invested in US dollar investment grade and high-yield (greater credit risk) corporate bonds. The spreads these yields offer above similar maturity US government debt is tight, raising questions over whether they adequately compensate the risk of default which doesn’t exist when buying bonds issued by the US government.

Equities still offer the best reward for investors buying into corporate America. Stock market indices have been buoyed by strong third quarter earnings for many of America’s largest companies and the prospects of a continuing US reflation trade heading into 2025. Our TAAs reflect this by staying firmly invested in global developed market equities (represented by the US-dominated MSCI World index) and our momentum-based model goes overweight the US by choosing the S&P 500 index for one of its other tactical indices.

This positioning is strongly influenced by the post-election rally and being so invested in the US market, especially given the concentration of the richly valued technology and semiconductor industries, is a risk. Our system uses the market cap weighted S&P 500 index, so we’re bound to it for measuring performance and tracking the tactically adjusted portfolio strategies, but investors may prefer to use an ETF tracking the equal-weighted S&P 500 for a more balanced exposure across US sectors given tech is already so well represented in the MSCI World.

Source: Investors' Chronicle, LSEG

The other major stock index our allocations favour is the FTSE 100, which with its old-world industry exposures provides more than just geographical diversification from the US market. Importantly, a portion of our strategic “max weight” to global equities allocation is defensively positioned in cash for the moment. This is because there is now negative correlation-adjusted momentum for equities in Europe, one of the core regions for our model. Risk signals from a variety of stock markets help our models take circumspect action and hold crash protection assets in case weakness spreads.

Mitigating natural drawbacks of our tactical asset allocation (TAA) system

Practically speaking, the problem with our system, which utilises protective momentum algorithms (based on the work of Dutch academics Keller and Keuning) to duck out of assets in decline, is the tendency to move in and out of non-core holdings and rack up charges while not having enough time to benefit from the investments. We won’t change this as these momentum models provide useful benchmarks for us as we try and diversify across more models and evolve a portfolio management system that is less prone to over-trading. Anyone practically following these benchmark portfolio models might wish to make their own calls on whether to hold onto some satellite equity holdings for longer, either because they have strong views or just to reduce churn.

Source: Investors' Chronicle

Furthermore, for portfolios below a certain size, some of the smaller holdings are just not worthwhile. For example, if you had £10,000 and were investing adventurously, it wouldn’t add anything to have bond holdings that would be worth £130 or £210. You’d be better off keeping that in cash.

Our current TAA system is most useful giving signals about when to start reducing risk in terms of equity holdings – i.e., guiding how fully invested to be vis-à-vis the strategic upper limit for your risk tolerance. It flags when to have portions (and of what size) of that strategic allocation in a crash protection asset – which will be cash, US Tips or short duration gilts depending on momentum.

Similarly, for the fixed income allocations, the TAA mechanism helps decide the level of exposure to corporate bonds (and hence credit risk) as well as the types of duration (interest rate sensitivity) that are appropriate in government bond holdings. This is valuable given the risk of inflationary bear markets where equities and longer duration bonds may be prone to sell offs at the same time.

It may be the case, given your personal objectives, that you choose to have a permanent minimum level of your strategic fixed income weights invested in gilts for the income in pounds. Still, it’s good to track when you might want to water down duration risk in the rest of the portfolio to sidestep and/or dilute some of the worst periods for capital markets.