Trumponomics may promise more than it delivers, says Morgan Stanley, while investors steering clear of Europe may find it delivering more than it promises.
The dollar's surge to 14-year highs against the euro, while the S&P 500 Index scales new records, shows traders are underestimating the risk that Donald Trump will adopt more protectionist policies if U.S. economic growth fails to live up to his campaign pledges, according to Morgan Stanley's head of cross-asset strategy Andrew Sheets.
"Most investors have assumed a base case that is Trump doing some of the friendly things and none of the unfriendly things," said Sheets, who recommends buying European and Japanese stocks on expectations they will beat American equities in 2017.
Sheets sees the MSCI Europe Index gaining 6% next year, while the S&P 500 will plateau at 2,300, about 1.3% higher than current levels. The outperformance will be driven by improvements in European corporate earnings and the likelihood that populist candidates won't prevail in German and French elections next year, one of the concerns that's clouding the outlook for the region's assets.
Even if Trump deploys fiscal stimulus and avoids large-scale protectionism as predicted in Sheets's base case, economic growth could still disappoint. Gross domestic product will expand by 2% in 2017 and 2018, according to Morgan Stanley's predictions, below the median estimate of economists surveyed by Bloomberg.
"The surprise for next year could be that the U.S. has a hard time living up to expectations," said Sheets, who advises switching equity allocations out of America and into Japan as his top trade recommendation for 2017. "Investors may be overlooking low potential growth and headwinds from tighter financial conditions."
One indicator that supports a bullish stance on European stocks in the coming 12 months is that the earnings potential of companies listed on the STOXX 600 Index has climbed to a one-year high, according to data compiled by Bloomberg, after falling to a six-year low in July.
In addition, elections in France and Germany are more likely to either maintain the status quo or bring to power more market-friendly leaders, according to Sheets, who doesn't think far-right parties such as Marine Le Pen's National Front have any chance of succeeding.
"Last year we favored the U.S. over Europe and Japan, and this year I see that as being flipped around," he said. "Europe actually has a lot of things going for it. There's a lot of potential for European earnings to rise next year because the base is so low."
