I know this was a very emotional election so, as always, I preface this post by saying that my comments are purely from an objective point of view regarding the impact on the economy and investment markets. I realize there are many other very important social ramifications beyond just finance but I’ll leave those topics for others to discuss.
I’m not surprised that Donald Trump won the election. I also would not have been surprised if Hillary Clinton won because I thought the race was much tighter than the polls and media were leading us to believe, so I went into the election ready for either possibility and had portfolios positioned in a much more neutral fashion. That hurt certain investments in the weeks leading up the election as the markets started to price in a Clinton victory, but much of it reversed afterwards creating a nice bounce in a lot of stocks that had been driven lower.
I’m not surprised that Trump was elected because there is a clear change occurring right before our eyes. I don’t think Trump “won” the election. I think all the other candidates lost it because they were too much of your typical career politicians that people are sick of. Most people know the system is not working but I don’t think they necessarily understand why and simply have different views on what the solutions should be. Regardless, the masses are clearly saying that they’ve had enough with the crony bureaucrats and elitists. Domino #1: Brexit. #2: Trump, the outsider that pledged to “drain the swamp.” Next in the chain? Italy, France, and Germany. Then probably referendums in the Netherlands and Spain. One of the biggest implications of Trump winning, in my opinion, is that it’s yet another nail in the coffin of the whole bureaucratic euro project. I think this gives a lot of momentum to the populist movements which means more “unexpected” outcomes and more volatility in the investment markets. I remain bearish on the Euro and euro-related investments.
Our political leaders have been tied at the hip with economists and central bankers for a long time, relying on these central bankers to try to patch over the issues so they don’t have to be dealt with until they get past the next election. They’ve delayed dealing with issues for so long that the imbalances have built up to become structural headwinds that the Fed can’t just “fix” and all they’re meddling continues to make things worse – economically and politically. I can argue that you can trace every economic frustration shared by the lower and middle class on all sides to the Fed’s policies over the last 20 years and people don’t even realize this. It’s not about Republicans vs Democrats (or Libertarians or Socialists…). While there are many issues that the Fed is not directly responsible for, the secondary effects of their policies have exacerbated just about every issue. They have meddled with and distorted currency exchange rates, trade, interest rates and asset markets since the 1980’s and all it has done is create asset bubbles, a more fragile system and a greater political divide between the “haves” and “have nots.” Capitalism hasn’t failed; we haven’t had a system of true capitalism for a long time.
I’m sure you just want to hear how this affects the stock market but I started this post with the comments above because this is the key to understanding the markets in the years ahead. The potential unwinding of the establishment system, as it has been, greatly affects portfolio positioning and the tactical approach one should use to manage risk. It appears we are on the cusp of some big geopolitical changes in the world which could mean big changes in monetary policy if the central banks begin to lose their influence on the markets. The good news is that I believe these changes will ultimately be better for the real economy and the lower and middle classes. This does not necessarily mean it will be better for the investment markets in the near term though. The investment landscape has been upside down since 2009 where bad economic news is good news for stocks because it means more central bank Quantitative Easing. We’ve been in the weakest economic recovery since World War II but it hasn’t mattered for stocks. If we see a shift in policies that actually leads to a real boost by providing companies with the clarity to invest and expand, could this impact financial asset prices as the Fed steps aside?
The Federal Reserve’s policies distorted the asset markets in an attempt to create a “wealth effect” that they hoped would feed through to the economy in the form of higher spending. This did not happen because we’ve been stuck in a balance sheet recession (too much debt). It doesn’t matter how low you take interest rates; people are not going to borrow more money if they’re trying to pay down debt. What did happen is that an even larger disparity has been created between those that have financial assets and those that do not. The rise of Bernie Sanders and Donald Trump? From my perspective, it’s all the same. They’re the result of the secondary effects of the Fed’s policies making the rich richer and hollowing out middle class America through financial repression and policies that encourage financial engineering over actual investment. Globalization, outsourcing of jobs and technology have all had effects but these have been exacerbated by Fed policies.
If, and it’s a big “if,” we’re actually on the verge of seeing central bankers losing influence, then investment markets might revert back to tracking “reality” which would mean we need to go through a transitional period where prices reset (meaning they would fall a little). Much of the movements in the markets since the election have been portfolio repositioning. It’s still too early to know if we’re seeing major trend changes. Some markets are reflecting the potential that things could change but nothing has actually changed yet. Tax rates haven’t changed, infrastructure spending bills haven’t been signed, trade agreements haven’t been renegotiated and past policies haven’t yet been repealed. There’s a strong chance that a lot of things do change over the next year but these things take time to implement and funnel through.
I’ll give you my overall thoughts on things moving forward. You’ll see it’s not so cut and dry for long-term investors as “A will do well, B will do poorly, so I’ll just own A and not own B for the next couple years.” There are many ebbs and flows in markets so it all comes down to timing. This has been a terrible investment environment (i.e. holding long-term positions) but a great trading environment (i.e. short-term tactical maneuvering) for the past year and a half so I’ve found myself being much more tactical in portfolio positioning lately and will be moving more in that direction moving forward.
Here are my thoughts on the investment markets in no particular order:
- I’m hopeful that the markets can break away from this policy controlled environment and asset prices might slowly revert back to reality of tracking fundamentals. While I believe this to be long-term positive for the economy, it could ultimately mean asset price adjustments in the short-term.
- The stock market went through its initial “shock” and subsequent “relief rally” in less than 24 hours. While this is potentially the least gridlock we’ve had in years with Republicans holding all 3 branches of government, and thus highest amount of clarity on the potential direction of policy, it’s important to keep in mind that big changes usually take a long time to implement. While I’m much more optimistic regarding the business environment and investment, I don’t think the stock market immediately starts a climb higher from here and will certainly face some big bumps in the road over the next year. A lot of positives but also a lot of new negative effects.
- Bonds have by far been the worst performers since the election. However, I’m still not convinced that interest rates have completely bottomed (although it’s looking increasingly so that they might have) and view this drop, especially in long-term bonds, as a nice buying opportunity. The reason is the difference between cyclical (short-term) and structural (long-term) outcomes. Anyone can boost GDP and inflation in the short-term by “buying growth” through deficit spending on things like infrastructure, but this does little to fix the longer-term structural issues which imply lower growth and lower interest rates, especially if the money is not spent wisely. To be fair, Trump has been talking about making changes that would hopefully improve some of the structural headwinds (i.e. less regulation and a cleaner tax code) but even if implemented it still might not be enough to overcome the anchoring effects on growth of poor demographics, too much debt already in the system and technological change.
- With interest rates currently moving higher, this puts pressure on asset valuations as a whole (lower discount rates) but especially all of the yield-sensitive stocks (i.e. Staples, Utilities, REIT’s, etc.) as bonds now start to compete against these stocks for investment dollars. While I was very bearish on all of these stocks earlier this year, I’ll be looking for buying opportunities as they get thrown out.
- The US dollar has been climbing and will probably continue higher against most currencies. This is positive for US consumers but, by nature, puts disinflationary pressures on prices and the economy. It’s also negative for the very large multinational corporations, as we saw in 2015, but doesn’t hurt smaller US-centric companies as much.
- A rising dollar and Trump’s rhetoric on China being a “currency manipulator” gives them an out for no longer playing nice and opens the door for a larger currency depreciation which would cause another deflationary shock like we saw in August, 2015 and January, 2016. This has been my largest concern for the last year and I believe it’s only a matter of time before it hits the markets again (the Chinese yuan has been sliding almost every day since the election…).
- Banks should perform well in the short-term but face longer-term headwinds if rates move lower again. Plus, they‘re basically just public utilities and a source of government fines at this point so I’m still not a long-term fan despite the Trump victory.
- I think this remains a favorable long-term environment for the defense contractors whether the US increases defense spending or not
- Drug/pharma companies remain attractive as a stable, non-cyclical business given the aging populations in most developed nations and now have much less pressure on drug prices hanging over their heads. I still think they face their challenges and most drug price increases have gotten out of control, but they won’t be targeted as aggressively.
- I think the ACA (“Obamacare”) will be repealed. I know this is controversial but it is becoming a very large burden on consumers and small businesses and major changes or repeal would be positive economically speaking for new investment and spending. Obviously not positive for the millions of people who might lose healthcare so we’ll have to wait and see how this plays out.
- Companies with a lot of cash overseas could benefit if able to repatriate it but also could face headwinds if the dollar continues to rise. The biggest winners might be smaller US-centric companies that could be takeover targets from this potentially new cash pile.
- Some positives for small caps could be cancelled by rising interest rates as over half of the debt held by small cap companies is in the form of floating rates. I think it’s important to be company specific here and pay attention to balance sheets.
- If Trump goes after trade agreements, it will have obvious negative effects on multinational companies currently benefiting (i.e. business in Mexico) and shipping/transports.
In summary, I think there will certainly be some beneficiaries of a Trump presidency but stocks as a whole still face some serious challenges. The potential positives of less regulation and lower tax rates could just as easily be cancelled out by rising interest rates and a rising US dollar. Starting from a base of high valuations leaves little room for error. Some of the strongest areas of the market over the last year (yield sensitive) will remain under pressure if rates continue to rise but eventually I’ll look for new buys in this area as I expect yields to remain lower than historically “normal” levels for a while. This means I also view long-term bonds as a buying opportunity as they come down and will slowly be adding to them. The macro environment isn’t going to change overnight so I largely am not making changes to our stock holdings but I have trimmed exposure quite a bit over the last year. When selecting stocks to invest in I try to use a 3 year outlook so we already owned companies positioned well for this environment and fortunately things just got easier for a handful of them. The biggest change will be in looking for new companies to invest in and what price I’d be willing to pay. I’m largely incorporating more short-term tactical positioning as a way to benefit from market volatility without leaving money invested and at risk of larger shocks.
Thanks for following!
-Nick