MONTHLY FINANCIAL MARKET UPDATE
The summary below is provided for educational purposes only. If you have any thoughts or would like to talk about any other matters, please feel free to contact me.
Investors Play the Trump Card
It’s simply a formality at this point. On December 19, the Electoral College will convene and electors will cast their votes. Barring any surprises, Donald Trump will become the 45th president of the United States.
While December’s vote is expected to produce few surprises, the election day results that put Trump in the win column caught most professional pundits off guard. The subsequent reaction in the market came as quite a surprise, too, with the major U.S. indices claiming new highs.
Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC
*Monthly: October 31, 2016 – November 30, 2016
Wasn’t a Trump win supposed to send shares lower, perhaps much lower? Weren’t we going to get a Brexit-like reaction in stocks? Didn’t investors prefer a win by Clinton because she represented continuity, even if her professed policies weren’t always business friendly? The answer to each question is yes. Yet, we’ll never know how stocks might have reacted to a victory speech by Clinton.
What we do know is that stocks briefly plummeted in overnight trading as it became clear The Donald was about to trump Hillary (Bloomberg). A gracious victory speech by Trump, which was followed by a conciliatory concession speech by Clinton seemed to soothe concerns.
Then, rational investors did what rational investors do – they turned their focus back to the fundamentals and liked what they saw.
Data Source: St. Louis Federal Reserve Last Date: 11.30.16
Missing from Trump’s victory speech were the more controversial policies he advocated during the campaign. What did dawn on investors was the simple fact that voters had just elected a Republican president and a Republican Congress that seems intent on passing pro-business/pro-growth policies.
A cut in the corporate tax rate will aid corporate profits, encourage capital spending, and discourage “tax inversions,” i.e., companies relocate overseas purely because other nations tax their firms at lower rates, sometimes substantially lower rates.
Then there is the prospect of tax reform that may simplify the filing process and reduce the tax burden, putting more spendable cash in the hands of consumers. In theory, that means additional consumer and business spending, which would fuel economic activity.
There has been no shortage of talk that more burdensome regulations may be pared back, including a more business-friendly environment for traditional forms of energy production.
Finally, Trump promises to pursue additional outlays for the nation’s aging infrastructure and for defense.
All in all, it was a remarkable shift in investor sentiment that had been very wary of a Trump presidency.
A Trumpnado hits the bond market
Tax cuts and higher spending would likely bring about faster economic growth. But it could also boost the federal deficit. Moreover, we could see an uptick in inflation.
All three acted like a perfect storm for the bond market, sending yields sharply higher, as investors bailed out of bonds (bond prices and bond yields move in opposite directions).
Data Source: St. Louis Federal Reserve Last Date: 11.30.16
The impact on investment grade corporate debt has also been significant, with yields rising substantially (St. Louis Federal Reserve). However, the reaction in the junk bond market has been far more muted (St. Louis Federal Reserve).
The potential for a more robust economy acts like a tailwind for the cash flow of firms that sport lower bond ratings. In other words, the prospect for easier debt repayments typically reduces the risk of holding low-grade corporate debt.
Where to from here
Of course, there are always risks to the outlook. We’re hearing plenty of talk of tax reform, higher government spending, and less regulation. But the devil is always in the details.
While the Republican majority is likely to make headway on lowering the corporate tax rate, plans put forth by Trump and House Republicans that cut individual tax rates differ in various aspects, and compromises will be needed.
Republicans in the Senate could use the reconciliation process (a simple majority is needed) to pass a bill and avoid a Democratic filibuster. Any moves to reach across the aisle, gather bipartisan support and pass a bill with 60 votes in the Senate will require additional give and take.
Tax cuts can have a more immediate impact on the economy, but major infrastructure projects have exceedingly long lead times. Additionally, Republicans and deficit hawks have historically cast a very wary eye on large domestic outlays.
How the market performs over the longer term will likely be tied to the economy, Federal Reserve policy, and the perception of valuations.
We’ve seen a number of events at home and abroad that have had a temporary impact on stocks since the bull market began in 2009. Yet, prospects for an expanding economy have proved to be a tailwind for the market.
We will eventually enter a recession. That’s inevitable. But the odds of one occurring in the near term are currently low.
Warmest Regards,
Christopher J. Carroll, CIMA®
Founder, Portfolio Manager, and Managing Partner