As we all head into the Thanksgiving holiday in the wake of the historic election, we may expect some difficult dinner table conversations among differently-minded friends and family members. While we can’t ease that process, we can offer our observations and thoughts about what Trump’s election has meant and may hold for the economy and financial markets.
It’s early in Trump’s transition, and the nature of his campaign and the absence of any government experience means that uncertainty around policy choices is much higher than with past transitions. Regardless, based on market reactions described below, it appears that we may be at a point of departure-perhaps only temporarily-from the low-interest rate, low-inflation, low-growth path the economy has been on for several years.
Uncertainty and Diversification; Expectation of Faster US Growth. Considering the elevated uncertainty, it is more important than ever to remain diversified and to avoid rash reactions such as the selloff in US stock futures that occurred in Asia the night of the election and in Europe early the next morning. Those steep declines were quickly recovered when trading opened in the US due to recognition that Trump’s themes of infrastructure spending, tax reform, tax cuts, and regulatory reform, if implemented even in part, would likely boost near-term growth in the US. On the other hand, some of his themes pose short-term and long-term threats to the economy.
Prospect of Trade Friction and Effect on Foreign and US Stocks. With capital attracted to the US by expectations for faster growth and with concerns about Trump’s campaign rhetoric against trade agreements, foreign stocks and bonds declined following the election while the dollar gained against foreign currencies. At the time of the election, foreign stocks (and foreign US dollar denominated bonds) represented better value than those from the US. Although some markdown for the time being can be justified by uncertainty around Trump’s plans, we believe the selling of foreign stocks may be excessive when compared to the long-term opportunity. To be sure, as investors we need to be prepared for some near-term volatility as we find it highly likely that Trump’s campaign rhetoric against major trade agreements will eventually shape his presidential statements and actions on trade, although his policy choices will be partly constrained by Congress. Without fixed policy prescriptions on most topics, he seems adaptable and opportunistic, although on this key topic we will have to see.
Likewise, the US stock rally certainly does not reflect the hit to profits that US public companies (which obtain 40% of their earnings overseas) would experience if trade were significantly curtailed. We think this factor will help constrain Trump’s policy choices and diminishes the long-term appeal of US stocks over foreign stocks. In any event, growth in the developing world is a larger and more durable trend than just the US’s participation; already China has started enhancing its trading structures with Southeast Asia now that Trump’s victory throws the US-sponsored Trans-Pacific Partnership into serious doubt. Consequently, we maintain conviction that client investments in foreign stocks will continue to provide long-term benefits, and we don’t want to risk fundamental value by trying to time investments in foreign stocks to match changes in investor sentiment around Trump’s actions.
Jump in Interest Rates. Perhaps the greatest consequence for financial markets has been the quick jump in interest rates since the election as markets reacted to Trump’s plans to increase federal spending and cut taxes. We’ve communicated before about the turn in the major cycle of interest rates to an upward trajectory; Trump’s election has accelerated that process. We see the eventual normalization of interest rates as generally positive, although as we’ve said before, a rise in interest rates will be one obstacle to increased corporate profits and eventually become a threat to stock prices through the relative value of better paying bonds. In the meantime, the bond portions of our client portfolios are positioned for lower sensitivity to interest rates, and we’ve been pleased with their performance both since the election and all this year. Longer term, higher rates combined with ever-increasing federal debt are a threat to the public fisc (and Trump’s plans would boost the federal budget deficit, at least initially).
Expectations of Faster Inflation. Similar to expectations for faster growth, the markets seem to be anticipating faster inflation, which is an improvement of sorts given the struggle of central banks since the financial crisis to escape the threat of deflation. A related and important point is Fed Chair Janet Yellen’s recent description of running a “hot economy,” meaning the need to allow greater inflation than the Fed’s normal 2% goal in order to achieve full employment and sufficient economic growth. We’ve believed for a long time that the Fed’s unconventional policies would contribute to inflation, and we believe inflation may be used as a policy tool to ease the federal debt burden. Holding stocks that produce natural resources (i.e., commodities) is an important element in combatting the corrosive effects of inflation on client portfolios and spending budgets, although since the election, gains in the dollar have held commodity gains in check.
It is important to emphasize that the above are initial thoughts and reflections. We may be communicating in the coming weeks about portfolio adjustments as Trump’s administration takes further shape and as we and financial markets digest policy choices.
In the meantime, we wish you a peaceful holiday with your family and friends and safe travels for you and yours.
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