Louis P. Abel, CFA, CAIA
Chief Investment Officer, First Foundation Advisors - Member, Investment Committee
Our early take on the surprising presidential election result, the impact on the financial markets, and the implications for your investment portfolio.
President Obama was right: the sun still came up this morning! The surprising victory of Donald Trump in the U.S. presidential election initially caused global financial markets to drop sharply. As it became apparent that Trump was headed for victory last night, we witnessed an immediate flight out of risk assets and into so-called “safe haven” assets around the globe. The Dow Jones Industrial Average futures declined as much as 800 points as the election returns rolled in. Stock markets in Europe, Japan and the developing world suffered sharp sell-offs. The 10-year U.S. Treasury note, one of those “safe haven” assets, rose sharply, causing its yield to decline. The Mexican peso plummeted as much as 13% on the expectation of a Trump victory. Gold, the ultimate safe haven asset, shot up to above $1,300 per ounce. And, the U.S. dollar – another a safe haven asset - rose. Investors grappled with the uncertainty that a Trump presidency would likely bring.
But then, suddenly, as Trump began his acceptance speech, the markets seemed to turn on a dime and began to reverse course. Global stocks began to rebound from their earlier lows. U.S. stock market futures pared their earlier losses. And, the safe haven assets, including the dollar and gold, gave back some of their earlier gains. In a sharp reversal, the 10-year U.S. Treasury note sold off, causing its yield to rise. By the time the U.S. stock market opened this morning, the Dow Jones Industrial Average actually opened higher. The broader market was down, but only modestly. At the time of this writing, the Dow, the S&P 500, and the Nasdaq are all up. Not only did the sun still come up this morning, but surprisingly, even the stock market rose!
The Trump victory clearly caught financial markets off guard. Although the polls had tightened leading up to the election, Hillary Clinton maintained a lead over Trump and prediction models suggested an 85% chance that she would win the election. Stunned by a Trump victory, investors reacted in knee-jerk fashion. The market dislikes uncertainty. Trump represents uncertainty, and uncertainty means volatility. Investors brought out the usual playbook, which says, “When faced with uncertainty, and hence volatility, move out of risk assets and into safe haven assets.” A Trump victory reflects a rising tide of populism, much like the Brexit vote in the UK, which could be bad for financial markets. But, then, investors remembered what happened after the initial shock of Brexit. After an initial sell-off in global financial markets and a flight to quality, things began to settle down. Investors realized that Brexit might not actually be as bad as it seemed at first and markets eventually recovered. As Trump launched into his acceptance speech, which was much more conciliatory and unifying than he had been on the campaign trail, investors began to realize that things might not be as bad as they thought. This was a reminder to investors that the “sun would still rise in the morning.” Not wanting to miss out on the recovery, like many investors did who sold immediately in the wake of Brexit, investors piled back into so-called risk assets again and retreated from safe haven assets.
As investors reflected further on the implications of a Trump presidency, it became apparent that the usual playbook might not apply. A Trump presidency might actually be good for the stock market. If there’s one thing that Trump has talked about consistently, including bringing it up in his acceptance speech, it’s the idea of infrastructure spending. Trump could launch a fiscal stimulus program, with infrastructure spending at its core. This could help further stimulate U.S. economic growth. And, that would be good for the stock market. The core of Trump’s platform - more fiscal spending, lower taxes, and less regulation - could be a recipe for growth, which is good for the stock market. But, there is a downside to all this too. More spending and lower taxes mean higher fiscal deficits. And, faster growth might mean more inflation, potentially triggering the Federal Reserve to raise interest rates more aggressively. And, all of that is bad for bonds, especially long-term Treasury bonds, which is why we saw a steepening of the yield curve and subsequent sell-off in Treasuries after their initial rally. The view that seems to be shaping up is that the Trump victory is bullish for stocks (or at least neutral or slightly positive) while possibly bearish for bonds, especially long-term bonds sensitive to rising interest rates.
How are we positioning our client portfolios?
While investors seem to have moved beyond the initial knee-jerk reaction of selling risk assets and shifting into safe haven assets, and the financial markets have relaxed a bit, we would caution that we’re not out of the woods just yet. While we don’t think a Trump victory warrants a sharp sell-off and a flight to safe haven assets, there is still uncertainty that we need to grapple with. Trump’s policies on trade represent one of the greatest areas of uncertainty. At the end of the day, we don’t think his policies on trade will match the extreme nature of his rhetoric on trade during the campaign. But, nevertheless, trade is an issue to watch carefully.
We expect to continue to see periodic bouts of volatility as investors continue to grapple with the implications of a Trump presidency. However, we would view these as “air pockets” - likely shallow, and relatively short-lived. They could present potential opportunities. We are mindful that global economic growth remains relatively good, even if modest. Although the Fed is poised to raise interest rates in December, they are likely to hike rates gradually and modestly and global central banks remain mostly accommodative. Valuations for most asset classes, while not particularly compelling – and in some cases at fair value or even stretched a bit – don’t look extreme.
At the moment, we are taking a wait and see approach. We don’t see the need to react. On balance, more fiscal stimulus, lower taxes and less regulation is likely a positive for the stock market. However, the possibility that it could trigger inflation, add to the deficit, and trigger a more hawkish Fed is negative for bonds. We think we are already well-positioned for this environment. We own high quality large cap U.S. and international stocks. We don’t own emerging market stocks, which sold off sharply on concerns about the implications of Trump’s trade policies. We don’t have exposure to U.S. Treasury bonds and have largely avoided long duration bonds, favoring instead credit-oriented bonds.
Over the next few days, weeks, and months, we will continue to monitor and assess the situation and take any action that we think is necessary. For now, we are standing pat. We are looking for opportunities that may present themselves as we see volatility crop up.
We want to remind our clients to:
- Maintain a long term investment focus
- Look past short-term volatility
- Focus on fundamentals, not market reaction based on emotions
- Be prepared for volatility and we will look to take advantage of opportunities that it presents
We will be hosting a webinar on November 15th where will discuss the election results and their implications further. In the meantime, should you have any questions, please don’t hesitate to reach out to your wealth advisor.
As always, we appreciate your trust and confidence in us as stewards of your capital.
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