The last two questions of AsianInvestor's Year of the Rooster predictions engaged with an old issue and a new one.
First, we took a look at the increasing concern among institutional investors that their investment returns would likely struggle to match up to historical rates. This was of particular concern given the tightening of fixed income yield spreads and the outright miniscule or negative returns offered in many bond markets, and the possibility that rising interest rates would reverse the concerted yield tightening that markets had enjoyed for years. This led to our penultimate Year of the Rooster question:
Will asset owners reduce their annual return targets this year?
Fund houses and chief investment officers had warned for years that the outlook for investment returns in the future did not look good. Rich valuations seemed to leave relatively little opportunity for better equity returns and the fact roughly $7.3 trillion of the global bond market offered negative yields meant there was also little prospect of strong investments to be had there — unless investors were prepared to ramp up their risk by heading down the credit rating ladder.
Our conclusion was that most institutional investors would begin to officially recognise that in their investment return predictions by lowering their return targets. In hindsight, we were too early to assume this, given the subsequent performance of markets.
2017 was a bumper year, in particular, for company shares as equity markets globally rallied hard. Led by the business-friendly policies and promises of the Trump administration, an already healthy global economy further improved, raising equity valuations in the US and Asia especially. With returns bolstered as a result, questions about tougher times in the future slipped down the investor agenda.
We still believe that a reckoning is coming. Bond yields have been widening as US interest rates inch back upwards, and a recession is likely to take place within the next three years. And as the market ructions of early 2018 showed, investors — automated and non-automated — were well aware that valuations in the US were high and vulnerable. Long-anticipated corrections have now taken place and performance this year is much more likely to be range-bound, reducing stock returns.
But an outright reduction of investor returns appears to be something for the future, not today.
Part of 2017's level of optimism stemmed from the belief that the Trump administration was very pro-business and finance, which would help to bring back the good old days of the mid-2000s. They had good reason to think this; Trump had spoken on the campaign trail of his desire to roll back regulation on the US banking industry, most particularly by undoing the Dodd-Frank Act.
So for our final question we asked:
Donald Trump has always been candid about his desire to get rid of the Dodd-Frank act, a set of rules enacted in 2010 after the global financial crisis that ratcheted up the requirements for banks to offer mortgages and loans, while also making those deemed 'too big to fail' to set aside extra capital.
His desire to do so appeared genuine and it was only underlined by Trump's appointment of the likes of former Goldman Sachs banker Steve Mnuchin as treasury secretary and former Goldman president Gary Cohn as chief economic adviser. Goldman Sachs has never been a fan of the regulations, which also banned proprietary trading.
For now, at least, this remains a partly achieved goal. The Trump administration has been beset by scandal almost from the beginning, while it has ended up focusing on other priorities such as immigration, a (failed) attempt to repeal Obamacare, and its successful introduction of a massive tax cut.
However, it made progress after Richard Cordray stood down as head of the Consumer Finance Protection Bureau (CFPB), the key agency created and tasked with monitoring much of Dodd-Frank's rules. Trump had often lambasted the agency for going too hard after banks in the country, and he took advantage of Cordray's departure to install Mick Mulvaney, his Office of Management and Budget director and an anti-regulation fan.
Mulvaney, who took the role leading the CFPB in addition to his existing responsibilities, has since focused mainly on getting the agency to step back from enforcing its rules, and asking that staff considering financial protection from the perspective of the banks as well as consumers.
For now at least, the Trump administration is working with Congress to ensure changes to Dodd-Frank while ensuring the banking industry remains safe.
One potential change being considered? Raising the Dodd-Frank definition of a bank that is considered "too big to fail" from $50 billion in assets, which captures about 35 banks, to $250 billion, which would encompass just the top 10.
Most recently, Trump has also talked about freeing banks up to lend to customers that are deemed too risky under Dodd-Frank rules. This push comes despite a booming economy and banks making record profits. The US senate is also pushing forward a bipartisan bill to increase the type of loan applicants that can be considered qualified borrowers.
But Trump continues to rail against Dodd-Frank with his rhetoric. Expect more parts of it to come under peril over the coming year.
Previous year of the Rooster outlook reviews: