Post-Election, Will Markets and Portfolios Emerge Winners or Losers?
A new administration poses uncertainty about how markets will react. Given the expectations for a Hillary Clinton win going into the election, the outcome of Donald Trump’s victory may cause investors to question what lies ahead. We’ve assembled some thoughts you may find helpful in guiding your clients as they consider the impact of the election and its implications on their portfolios.
Markets are not terribly fond of unexpected outcomes, and the results of the U.S. election are indeed that, so it’s no surprise that markets initially reacted poorly to this surprise. Yet after a sharp decline in U.S. and global markets initially, stocks then reversed themselves and rallied, with a swing of nearly 7% from the overnight lows to the closing highs. Bonds were also all over the place, as yields dipped and then rallied. We witnessed nothing as dramatic as what we saw after the other most-recent stunner, the Brexit referendum in the United Kingdom in June. That too makes some sense. After all, from what can be gleaned from the little substance that emanated from this campaign, it is almost impossible to game out the precise market and economic policy implications of a Trump presidency. What there is to guess at suggests possible gains for the financial sector, companies leveraged to infrastructure, and healthcare companies, should there be dramatic reform to the Affordable Care Act.
What does seem relatively clear is that less regulation and more stimulus, either through government spending, tax cuts, or both, are the likely outcomes. Trade barriers are a wildcard for sure, and could roil markets come January. But the world is already in a jumble of conflicting tariff barriers and free trade initiatives, yet trade continues to chug along, especially after the dip in 2015 caused by plunging oil and commodity prices.
The global economy has been increasingly less dependent on the US and our leadership, which means that even negative scenarios of a Trump administration may have less effect on the flow of goods and services than some may anxiously anticipate. And that leaves open the other possibility: cutting through the thicket of regulations and removing some of the negative effects of government may potentially be a boost to national and global economic activity.
No one knows what the new president’s policies will be or how they will be implemented. But we can turn to history for guidance. Going back to 1928, new Republican administrations typically post low market returns for the first year (versus Democrats’ average returns of around 22%), as their attempts to reign in the effects of Democrats’ spending tends to put brakes on the market. But since the new president doesn’t fit the mold of the typical Republican president, he may not follow those same Republican policies.
This has obvious implications for a rate hike in December. To recap, on November 1, the probability of a December rate hike was 68%, reaching 86% on Election Day, with predictions for a Clinton win. After then dipping to 50%, the probability for a rate hike in December now hovers around 76%.
It also affects the outlook for the yield on the 10-year Treasury note. Going into the election, the consensus was that a Clinton win would cause yields to rise, and that a Trump win could result in falling yields, as investors sought safe-haven assets. Instead, yields spiked to more than 2.00%, as traders think Trump’s stimulus may cause growth to ignite and rising inflation to follow.
Credit spreads, which had contracted last year, have stabilized over the last two weeks, as investors (seeking yield and expecting Treasuries and government bonds to move higher) have adopted a ‘risk-on’ posture.
With this insight as backdrop, what changes should investors make to their portfolios? Actually, none—at least not at this time. Emotions are high for both the winners and losers, so making investment decisions when euphoric or angry can lead to a poor outcome. Investor goals and time horizons haven’t changed from the day before elections to the day after. Economic data and fundamental valuations are about the same as last week. And more politically sensitive sectors of the economy (healthcare, energy, and financials) already reacted to the new administration’s views within seconds of the market’s opening bell.
Although short-term decisions are rarely advised, consider a couple of factors over the longer term that might prompt a look at your portfolio. First, taxes are likely to be higher, especially at higher income levels, through either higher rates or elimination of tax loopholes. Second, new spending programs to help move the economy forward will require funding through taxes, so a portfolio strategy to maximize after-tax return will be increasingly important. Portfolio diversification also will continue to be critical, as the new president figures out how to govern. Stumbles are to be expected, and with an inexperienced president who is learning on the fly, we can expect volatility to remain high. Alternative asset classes that are not highly correlated to the stock market can help reduce volatility when these disruptions occur.
In summary, an unpredicted outcome can temporarily cause increased market volatility. Expect a December interest rate increase of 25 basis points. Spending on infrastructure, funded through either government stimulus, higher taxes, or a combination of both, should spur growth, and modest inflation will follow. A diversified portfolio, comprising low-correlated asset classes, should position investors to benefit from the changes ahead.
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