With Election Day now behind us and the benefit of some time to digest the news, we reflect on what it has meant for the stock market and share our views on some of the most politically sensitive asset classes and sectors.
There were two big surprises for investors: one was of course an election outcome few predicted, and the other was the market’s reaction to it. We are not surprised that stocks recovered, but rather how swiftly. Not even the market’s surprisingly fast recovery from the unexpected Brexit “leave” vote in the U.K. back in June prepared us for this. After Dow futures were down over 800 points after the result became clear late on election night, the blue chips reversed course the next day to end more than 250 points higher, before adding another 218 points on Thursday and 40 points on Friday. The Dow was down all five days the prior week before rising each day election week – a wild ride to say the least.
Several factors may be behind the rebound:
The certainty of the outcome.A prolonged legal battle to determine our next president would have damaged investor confidence. Some cash on the sidelines was likely waiting for a definitive outcome.
Optimism regarding a peaceful transition.President-elect Trump seemed to strike the right tone for markets in his acceptance speech and appears willing to work with Republicans and Democrats to get things done.
Favorable election year pattern.Stocks have tended to do well late in election years due in part to the policy clarity provided by the winner. Since 1952, the S&P 500 is up by a median of 3% between Election Day and Inauguration Day (the average, at 1% is skewed by sharp drops in 2000 and 2008), with gains 69% of the time. Though policy uncertainty remains high, the likely path is becoming clearer each day.
Anticipation of market friendly policies.The odds that many of President-elect Trump’s market-friendly policies are implemented following the Republican sweep are high and include tax reform, infrastructure spending, and rolling back regulations in areas such as financial services and healthcare.
Negative sentiment.Heading into the election, sentiment readings based on derivatives were among the most negative that we have seen in two decades. Equity flows have been negative this year. The S&P 500 had just ended a nine-day losing streak the day before the election. That bearishness set up some buying on the news.
Sector dispersion has been notable. Sectors and industries expected to benefit from President-elect Trump, such as healthcare, financials, and infrastructure, all soared. Those that may be hurt by Trump’s policies sold off, including emerging markets and interest rate sensitive sectors such as utilities.
Here are our views on some of these areas following the election:
Emerging markets.Emerging market (EM) stocks have been hurt by Trump’s skepticism on foreign trade, with promises to terminate or renegotiate trade agreements and add import tariffs. Look no further than the Mexican peso, which has come under heavy pressure since the election, falling more than 10%. But changing policies can take time. Many of the things we import are simply not produced in the U.S., including commodities and relatively low value-added manufactured goods, suggesting less near-term impact than feared.
Rising interest rates are another concern. The post-election spike in interest rates has made funding overseas investments with U.S. dollars more expensive on top of the appreciation of the U.S. dollar that has eroded overseas returns for U.S. based investors.
EM assets are caught between two tensions. A more robust U.S. economy, especially one driven in part by infrastructure spending, may benefit EM. However, potential changes in trade policy have created uncertainty whether these benefits will ever accrue to EM economies and companies. While near-term caution is prudent, we sense potential longer term as better than feared trade relationships develop.
Energy.Trump is likely to be positive for fossil fuels. He has promised less regulation on drilling, along with expansion of drilling areas. Should oil and natural gas prices hold up, some pipelines may get built that would not have under Hillary Clinton’s leadership. Refiners may see easing ethanol requirements, and the segment of the industrials sector that services the energy sector may also benefit.
The risk is that increased production sends oil prices down and hampers sector performance, although master limited partnerships may be less sensitive to that risk than the oil and gas producers.
Financials.The election outcome has put upward pressure on interest rates and steepened the yield curve, helping bank profitability. The Trump administration has stated its desire to roll back financial regulations, including the Dodd-Frank financial reforms created to reduce risk in the financial system following the financial crisis. Implementation of the Department of Labor’s fiduciary standard for retirement investment accounts, slated for April of 2017, could now be delayed, benefiting asset managers and mutual fund and annuity distributors. Finally, the deregulation and infrastructure spending could lead to increased bank lending.
Healthcare.Trump has stated his desire to repeal and replace the Affordable Care Act (ACA), which would have a negative impact on those segments of healthcare that rely most heavily on those that are insured under the ACA. However, lowering drug prices through regulatory actions is unlikely to be a priority for President Trump, as it would have been under Clinton’s leadership. As a result, we expect a Trump Administration to be friendly to pharmaceuticals and biotech stocks. Managed care, which has been experiencing widely reported profit pressures through the ACA exchanges, may also benefit under an overhaul.
We think healthcare stocks may have overreacted to perceived policy risk prior to the election, suggesting the group could still play some catchup after the recent outperformance.
Industrials.Trump has put infrastructure spending at the top of his agenda, throwing out numbers of as much as $1 trillion in additional spending. Within industrials, construction and engineering firms are poised to benefit (as will related materials companies). Industrials are poised to benefit from increased defense spending, another priority of the Trump campaign. Additionally, some of the big global industrial companies have a lot of cash trapped overseas that could come back should tax reform include repatriation of overseas cash, as we expect. Less energy regulation may also support the segment of industrials tied to oil and gas infrastructure. A restrictive trade policy would represent a threat to that positive outlook.
Small caps.Policies aimed at bringing manufacturing jobs back to the U.S., a key campaign goal for Mr. Trump, are positive for small cap stocks. More bank lending is also positive because small companies are generally more dependent on bank credit. Technical analysis suggests small caps have the potential for a relative performance run given they broke above a downward sloping trend line.
Conversely, favoring large caps over small is the likelihood of tax repatriation, which benefits larger companies with the most cash parked overseas. Valuations for small caps relative to large are rich, in our view. And although we do not expect a recession as early as 2017, the latter stage of the business cycle tends to be friendlier to larger caps. Bottom line, although small caps may experience a short-term run of outperformance on the election results, the strength may not be sustained beyond the near term.
The election results were surprising as was the stock market’s immediate reaction. While the market is forward looking, it is important to remember that as of yet nothing has changed. It will take time to implement policy initiatives and even longer for the effects to manifest themselves. The forces affecting a slowing global economy are still in place. Yet, there is reason for optimism as the stock market is indicating prospects for growth, with some sectors benefiting more than others.
The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. To determine which investment(s) may be appropriate for you consult your financial advisor.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Investing is stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.
- Data provided by LPL Financial.
- Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly cross many sectors and companies.
- All indices are unmanaged and may not be invested into directly.
- All investing involves risk including loss of principal.
- International investing involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards. These risks are often heightened in emerging markets.
- The fast price swings in commodities and currencies will result insignificant volatility in an investor’s holdings.
- Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments.