Several days removed from the conclusion of this presidential election cycle, we find ourselves revisiting the remarkably familiar themes that surrounded the 2016 election, and observations we shared at that likewise transitional time, many of which continue to be relevant today. As was the case then, and with a second Trump administration set to take office in January as part of a likely “Red Sweep,” it’s only natural to ruminate about possible paths forward (see an exploration of those in our pre-election newsletter), and further, how to calibrate for them in portfolios and plans.
Here we need to distinguish between the process that leads to financial planning adjustments and the process of investment allocation adjustments. For as much as we can brainstorm strategy, financial planning adjustments (e.g., changing the timing of distributions from retirement accounts) are inherently reactive: campaign promises evolve into legislative and policy agendas, and from there into actionable changes to regulatory regimes. We inevitably adjust to those changes as they are refined and handed down. Due in part to the market nearly instantly repricing developments, prudent investment action, by contrast, is best taken in advance, guided by enduring principles—adherence to an investment policy, foremost among them—and animated by and bracing for a variety of possible outcomes in the short term, with a focus on the long-term goal of a secure future regardless of what develops. Reactive investing has rarely been an enduringly successful approach.
Since before the Fed began hiking interest rates in 2022, we’ve been adjusting portfolios for a shift not just in the interest rate regime, which set off a massive repricing of risk, but also in the low-volatility market conditions that persisted generally from 2009 through 2021. Volatility can be ignited by a variety of sparks—interest rate U-turns, geopolitical conflicts, elections, corporate earnings surprises. (Donald Trump’s reelection fits in this broader context of uncertainty and volatility for which investors get paid through long-run returns.) But at a certain point, volatility is volatility, regardless of the proximate cause, and so it takes a multi-pronged effort to constrain it. That goal of containment is driven by a desire to avoid the corrosive effect that excessive volatility can have on portfolios, whether that be magnifying the effects of detractive forces (e.g. over-spending during a year of steep market decline) or tempting investors with unhealthy behavior (e.g. return chasing, excessive risk taking, unsustainable spending) when markets are hot.
There’s an important implicit caveat here: volatility works both ways, up and down, and so while we frequently calibrate to the risk of market decline, we must also allow for the unforeseen market lift. In other words, while bracing for the downside, we mustn’t forfeit too much of the upside, allowing for what might go right even as campaigns tend to highlight what in the given candidate’s or party’s view is going wrong. All of this has informed adjustments leading up to this November, in which we’ve been:
- Finding opportunity in higher interest rates. For some time, we’ve been rounding out the “core” (defensive or investment grade) bond allocation by adding higher-yielding “peripheral” (offensive or below investment grade) bond strategies in alternative credit (strategies other than bond mutual funds) that we expect to generate near equity-like long-run returns without taking the full risk of stock ownership. Apart from bonds, we’ve placed emphasis on higher-yielding money market and even equity funds that distribute cash, which offsets the need to harvest gain from more long-term growth-oriented strategies. This reflects the general greater opportunity in bonds that has become present since the end of the Federal Reserve’s prior “zero interest rate policy” and has given clients an opportunity to downshift in risk with limited cost in longer-run return.
- Bracing for interest rate surprises. Though the conventional wisdom since 2022 has been that rates would come back down reasonably swiftly, if not sharply in an economic “hard landing” scenario, we’ve maintained a defensive posture with respect to interest rates in the bond portfolio through “short-duration” (less interest rate sensitive) strategies without sacrificing yield, out of humility for forecasting the timing and degree of interest rate cuts. This posture is proving beneficial as interest rates rise and bond values decline, from recognition that rates had either fallen too far too fast or needed to come up to price in some projected consequences of President-Elect Trump’s signature ideas (e.g. tariffs and immigrant deportations).
- Removing higher-cost, concentrated strategies and added to lower-cost equity indexes, quality and yield. As other factors such as tax cost have allowed, we’ve trimmed out concentrated (volatile) strategies that can underperform for long periods before achieving brief, difficult-to-harvest periods of outperformance. In areas where active managers are most challenged to obtain information advantages , we’ve looked to reduce cost that can detract from returns by adding to stock index funds, whose broad exposure improves the likelihood of participating in the best performing market themes and likewise of not selling those winners too soon. The market fuel this year from corporate investments in artificial intelligence and the more recent sector swings in response to Donald Trump’s reelection (e.g. rally in financial stocks) vividly illustrate the wisdom of investing broadly in stocks to participate in whatever theme may drive the market at a particular time. We help clients mitigate the inherent volatility of these stock investments with their bond allocations and through limited investments in stock funds utilizing high quality (historically, low volatility) stocks and yield strategies. Thus, we believe clients have the tools in their portfolios to deal with a significant market retreat.
- Reducing exposure to Chinese equities. Out of concern for China’s path out of economic stress and in recognition of the growing technology and strategic schism between the US and China, we swapped the emerging markets index fund for an index fund that excludes Chinese company stock. While Chinese stocks may have rallies in response to government stimulus measures, we believe active management is the best method of navigating what will be a challenging environment for that market due to Trump’s re-ascendance and China’s longer-term structural adjustments.
- Rethinking Small-Cap Investments. More generally within equities we’ve favored the stock of large companies, which have experienced meaningful earnings growth, over that of small companies, a goodly portion of which (around 40% of the Russell 2000 small cap stock index) have negative earnings, adding to quality even as investors have demonstrated more appetite for risk, and seeking small cap exposure through private equity strategies, where earnings have been more durable than in public company counterparts.
Having made these adjustments, we feel confident that client portfolios are well-situated to weather whatever developments lie ahead, and we remain vigilant about opportunities to make either defensive or opportunistic adjustments as shifts in economic patterns emerge. Meaning, in the very short term we are not recommending any specific changes (i.e., moves in reaction to the election results).
Even as the election and the rhetoric around it has taken the recent spotlight, we’re reminded that the forces that animate economies and markets are larger than any single office (and often separate from our personal thoughts and emotions). The US economy is experiencing still-robust growth, corporations are generally in good shape, foreign country balance sheets are stronger than before the pandemic, and foreign company stocks, while vulnerable to adverse policy choices from the US, have already priced some of that in (i.e. the discount on foreign stocks is near record levels) and thus remain an important hedge over the longer term on developments in the US.. Finally, after planning for adequate cash reserves to meet expenses, both known and unforeseen, diversification remains the bedrock of balancing the market’s risks and rewards.
All that said, if the election, economy or markets have you considering greater action, we hope you’ll reach out. It may be that it’s time to explore a new investment policy—that is, a new target mix of stock and bond exposure—that better reflects the current investment climate or your personal situation. Or perhaps an infusion of cash, which can be held in higher-yielding money market funds with no cost to trade, would bring comfort amidst the market’s potential swings. In any event, we welcome the opportunity to talk further with you.
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