Client Letter: Ending of 2016 and the Trump Honeymoon RallySubmitted by Alsworth Capital Management, LLC on December 9th, 2016
As of this writing, the US stock market has continued an upswing following the victory of President-Elect Donald Trump. The stock market has embraced the notion that the businessman President will be singularly focused on the economy and that he will help drive economic growth. Just as surprising as the Trump presidential win, was the fact that Republicans took control of both houses of Congress. We have grown accustomed to gridlock and obstructionism defining our political discourse in the last decade. Now with Republicans having the ability to push through legislation unimpeded, it appears certain that some significant and sweeping changes will be coming down the pike. Thus far, we have only received vague inferences to describe the pending tax cuts and deficit spending (“infrastructure spending”), but the market has cheered in anticipation none the less. In these early, pre-inauguration days, the Trump administration is riding a Honeymoon rally in the stock market and feeding off the jubilant crowds along their “Thank You Tour.” After the inauguration, the details will take precedence.
Winners & Losers: The strength of the US stock market has been driven largely by the Financial and Energy sectors. Big banks have benefited from the promise of lower regulations and higher interest rates. They make money by lending money at a higher interest rate than what they pay in interest for deposits. Ultralow interest rates have cut into their profit margins terribly and the promise of higher interest rates has been a boon for this sector. The energy sector is likewise benefiting from the belief that a Trump administration will be lighter on regulation, more open to drilling and pipelines and less concerned about environmental protection regulations. The early cabinet appointments have affirmed these early expectations. Trump appointed Scott Pruitt to the Environmental Protection Agency, a man who doesn’t believe climate change is influenced by fossil fuels and who has worked closely with the energy sector in the past. Trump has also appointed Steve Bannon as Chief Strategist, Steven Mnuchin as Treasury Secretary and is likely to nominate Gary Cohn as Director of the Office of Management and Budget. All three men are former Goldman Sachs executives, well known in the banking sector.
The Trump rally has not been good for bonds, high dividend paying stocks, consumer staples stocks, non-US stocks, emerging market stocks or managed futures. The expectations that Trump will be good for growth is also inflationary. We already have low unemployment and wages have been coming up recently, which causes manufacturers to pass on higher costs through higher prices for their goods. The expectations are that Trump will push economic growth through stimulus deficit spending programs and that his administration will use tariffs and legislation to keep companies from sending manufacturing overseas. These all point to higher costs for goods. Inflation pushes interest rates up, which is bad for bonds. If we are holding a bond that pays a 1.50% coupon rate and suddenly interest rates spike up to 2.5%, our old bond doesn’t look attractive anymore. In order to induce a buyer to purchase our bond, we would need to sell it for a lower price. Bond holdings have declined in value since the election, which is a large asset class for most investors. This same logic applies to stocks that pay high dividends.
Non-US stocks have sold off as well, as expectations are that Trump will throw out trade agreements and enact protectionist tariff programs. This has similarly hurt large US corporations that derive much of their sales outside of the United States, like Coca-Cola. Emerging Market stocks had done very well in the first half of the year, but sold off after the election in response to uncertainty about trade policies going forward and a strengthening US dollar. Many emerging market companies fund their high growth by borrowing funds in US dollar denominated debt. When the dollar goes up, the cost of this debt goes up, cutting into their profits. Managed futures positions have also sold off post-election, driven mostly by the spike in interest rates and commensurate declines in their bond holdings. While the Dow Jones Index and S&P 500 Index, representing large US companies, has been hitting new highs, most diversified portfolios have experienced offsetting declines in the bond and non-US holdings. Within US holdings, the gains have really been focused on certain sectors so the more conservative consumer staples and high dividend paying stocks have not kept pace.
As we get more clarity on the Trump administration in the coming weeks and as legislation gets defined post-inauguration, we will have a better sense of the likely impact to the various sectors of your portfolio. At this point, there is a lot of volatile jockeying around and I believe much of this is over reaction based on very limited data. I don’t like to make reactionary moves in the portfolio without data to back up and justify the decision. The comments, rally speeches and tweets that we are dissecting on a daily basis have been unprecedented in their vagueness. Soon we will start to get concrete proposals, we will have an administration team in place and we will get a sense of the level of unity in the Republican party. Once we have data, we can make reasoned adjustments in the portfolio, if needed and avoid emotion driven speculation. Despite all of the emotion surrounding this political season, all of the volatility surrounding the markets and the cloudiness of our crystal ball, we can still choose to maintain our reason. We will continue to be driven by investing reason and fundamental valuations rather than speculation and emotional reactions. US Stocks are trading at high valuations relative to just about any point in history. We may well get a shot in the arm from deficit spending projects, like we got a shot from the Fed dropping interest rates to near zero. However, the fact remains that US stocks are really expensive. Non-US stocks may well get hurt by trade policy changes, but they are trading at such low valuations that there is a good amount of cushion already built into current prices to account for these changes. There is also a high probability that the reality of governance forces the campaign proposals and promises to end up looking a little different in practice.
I hope you get a chance this Holiday season to untether from the noise of political news. We have much to be thankful for and much to be optimistic about. I’m looking forward to the opportunities that will present in 2017 and like many, I’m also happy to see 2016 come to a close. Please feel free to call, email or setup an appointment at any time. It is important that we stay connected and I’m happy to answer any questions. We relish the opportunity to be helpful!
Shane M. Alsworth, MBA, CFP®, CLU®, CIMA®
The views and opinions presented in this article are only those of Shane Alsworth and Alsworth Capital Management, LLC
Investments are subject to market risks including the potential loss of principal invested.
Asset Allocation does not assure or guarantee better performance and cannot eliminate the risk of investment losses.
Sources: Wall Street Journal, Morningstar/Ibbotson data