Talk about a crazy night / day today for the markets. As usual, when we get an event like this, we will address what happened and any implications Q&A style. Note that this will be a purely financial discussion; no politics allowed:
We know what happened in the election, what happened with the markets?
To say things were rocky would be an understatement. With Ms. Clinton’s initial lead in Florida the market took off positively. That was basically the highlight of the night with the market trending lower and lower until the futures went limit down 5%. Limit down is a circuit breaker in which the futures contracts on the S&P 500 effectively shut down giving everyone a chance to catch their breath. 5% is a very big move for the overall index.
At this point it was clear Ms. Clinton would lose and John Podesta, her campaign chairman was sent out to tell everyone to go home but that they weren’t conceding yet. We held our breath for two reasons, (i) a lack of concession would be even worse for the market and (ii) we had yet to see Mr. Trump’s victory speech.
These two concerns abated quickly with Ms. Clinton calling Mr. Trump to concede and Mr. Trump giving probably the speech of his life in which he was completely gracious with no off-the-cuff remarks. From there, the markets have recovered substantially from being down 5% to trading up currently. To be totally clear, this positive market reaction is completely unexpected by almost everyone.
What should we expect to see Mr. Trump focus on from an economic perspective?
It’s important to remember we now have a Republican President and a Republican Congress. While not an overwhelming mandate to go crazy, the Republicans certainly have a mandate to push through some of the policies they want to enact. If you recall in 2008 this situation was reversed.
What specifically will Mr. Trump focus on? A few big ones are obvious and some of these were discussed specifically in this speech last night.
· Infrastructure spending is coming and the good news is that the US drastically needs it. We rank towards the bottom of the “developed world” when it comes to the state of our infrastructure (roads, bridges, etc.). This will be very stimulative to an industrial base that has been in recession-like conditions.
· They will make a go at some sort of tax reform but who knows where exactly this plays out. At some point all of the things they want to do have to be paid for. But they will try and almost certainly the carried interest tax loophole for asset managers will be taken away.
· Repatriation of foreign cash owned by US companies. There is currently trillions (with a T) of cash being held overseas due to US tax laws that require it to be taxed if brought back to the US. Expect a holiday or some sort of new law allowing this cash to come back with some restrictions on how it can be spent.
· Fossil fuels get a new lease on life, especially coal. These industries will be supported once more. This doesn’t change the fact that there are market dynamics at work and supply and demand ultimately win, but these companies will no longer be on the regulatory defensive.
· Something will be done around the Affordable Care Act (Obamacare). This will be fascinating to watch because from a purely economic standpoint Obamacare is already in massive trouble with rates rising at a minimum 20%/year. However; remember that Donald’s support is widespread and he will be very cautious about taking away people’s insurance.
· Mr. Trump likely does not support repealing Dodd-Frank and other regulation that came out of the financial crisis. We would expect a lot of this to remain in place. The anger in this country against bankers, TARP, the elite, etc. is real and Mr. Trump fully understands this. Other regulation/red tape should be cut back somewhat.
What situations do we want to closely monitor from an economic perspective?
The market initially reacted negatively to Trump being elected primarily because of uncertainty. The market hates uncertainty and there are a few areas we will be closely monitoring because currently they are sources of uncertainty:
· Trade deals. Trump was very vocal about repealing trade deals during his campaign. Whether there will be follow-through, how intense they are renegotiated and how much Congress backs him up in this is still yet to be seen. Deals that would limit companies’ abilities to sell overseas or manufacture overseas and import to the US could have negative ramifications for some of the large US publicly traded companies.
· Changes in Federal Reserve leadership. Changes within the Federal Reserve tend to spook the market because investors no longer have a transparent expectation of how the Chair of the Fed will direct monetary policy. If Mr. Trump requires Fed chairwoman Janet Yellen to be replaced, we will be closely monitoring who the replacement is and their stance towards monetary policy.
As financial advisors and money managers what do we do with this situation?
First of all, that question had to be addressed before this morning. We touched on this in our last letter to clients, but a few reminders of how we think about this:
· At current market prices prudence and caution are imperative. Market valuations for both stocks and bonds are high. This requires us to take a more conservative approach to risk allocations.
· Bond exposure should be kept extremely short term (less than seven years at the longest). A 35-year bull market in bonds has lulled a lot of people to sleep. Remember if rates go up, bonds absolutely will go down in market price.
· Overweight cash for opportunities. Cash is optionality for the future. At expensive prices you hold more of it. At cheap prices you hold less. Currently it’s prudent to hold more of it.
· Utilize lower prices as buying on companies with little exposure to new policies. Many of the companies we own, while subject to daily fluctuations of the market, have very little business exposure to potential changes in government policy. If these companies’ stocks are sold off as part of the volatility it will be a good chance to buy at lower prices.
· Remain patient as volatility likely to continue for next few months. Even if the market rallies strong from here over the next few weeks, no one understands how gung ho Mr. Trump is going to be about certain changes he wants to make. As more of this comes to light, there is likely to be emotional market reactions that present us with good opportunities to buy cheaper.
As always, feel free to reach out with any questions.
Disclosures: Nothing above should be construed as financial advice. Consult your financial advisor before taking any action. Do your own homework.