By: Jim Scheinberg – February 22, 2017
TRUMPeting in a New Era! (or Huge Error?)
Our last commentary was released hours after, as we put it, “the most shocking election in modern U.S. history.” What was even more of a shock is what unfolded in the days and weeks thereafter. Leading up to the election, markets were indicating that if Donald Trump were to upset Hillary Clinton, global equity markets would crash; and in the wee-hours of election eve, that’s exactly what appeared to be unfolding. Somehow, within one short day of the anointment of Mr. Trump as President-Elect, stock markets across the globe recovered and U.S. exchanges rallied. After our commentary was published, U.S. indices continued on to challenged all-time highs, shooting up nearly 10% in the five weeks that followed the pre-election lows. Yields on U.S. Treasuries, which are always a harbor of safety in uncertain times, reversed course and skyrocketed, as investors sold ‘security’ and embraced a new hunger for risk and appreciation. In my position, I am fortunate to regularly have conversations with peers who are some of the brightest portfolio managers, advisors and fiduciaries of pools of institutional capital in the world. There wasn’t one of them that wasn’t initially baffled by the rally.
Nonetheless, the financial ‘celebration’ has happened, regardless of its cause. What’s left is to sort out what a Trump Administration means for domestic and international capital markets and economies going forward… if it even means anything at all. As we sort through the massive amounts of data, policy and conjecture, I harken back to the most important thing I remember from the fog of the financial crisis: don’t speculate on the ‘what-ifs’… just continue to dig deep to find what it is that you are certain you know, and proceed accordingly. We attempt to do so in the following PIERspective.
How the Markets Fared
There were a lot of sparks in the bond markets after the surprising Trump win. Interest rates, which had plummeted on election night as election results came in, reversed course and skyrocketed over the next several weeks, spiking one full percentage point from where they started the quarter. The bellwether 10-year Treasury rose to 2.45% at year’s close after starting Q4 at 1.60%. The massive sell off in high-quality fixed income led to 3% net losses in most intermediate-duration indices. When the dust settled, interest rates finished the year almost exactly where they started, leaving net returns of just their poultry two-and-change percent coupons. Long-term government bonds saw double digit declines in Q4, which likely hit LDI fixed income portfolios in pension funds especially hard. The US dollar index, which had spent most of the year in negative territory rocketed up 6% following the election, leading to substantive losses in both developed and emerging international debt markets. These losses erased most of the recovery gains that were made during the year. The news was much better in the more credit sensitive areas of the bond markets, with high-yield posting modest gains for the quarter, capping a year that rivaled the returns of most equities. As confidence in the economy grew, so did appetites for risk.
Investors piled into equities here in the United States immediately following the surprise results of the election. With an expectation that a Trump administration agenda would lead to a near term acceleration in the economy, value stocks vastly outpaced growth names during the quarter. This was a continuation of a trend that we saw as we emerge from the depths of the sell-off during the beginning of 2016. Both situations resulted in building economic confidence, that typically bolsters more cyclically, value-oriented companies more than steady growers. Though the S&P 500 gained 12% for the year, value stocks outpaced growth stocks by 10 full percentage points. With the flood of new capital into equities, the effects of money-flow were much more magnified in the small cap space where gains nearly doubled that a large caps both for the quarter and the year. Here we saw even more lopsided performance from the value side of the spectrum, with value leading growth by 10 and 20 percentage points for the quarter and full-year-2016, respectively.
This dominance also played a factor in international developed markets, with value leading growth by 10 percentage points for the quarter and the year. Returns in the international markets were muted somewhat when measured in U.S. dollars, but realized gains similar to U.S. equities in their home currencies. Emerging market equities continued to be a tale of two cities (or rather continents) with Latin American stocks faring much better than those EM names in Asia. Latin America recovered handsomely from its 2015 commodity-based slide, adding nearly a third to stock values during the year. Asian EM equities gave back half of their gains in Q4, still managing respectable returns for 2016. This dynamic was logical due to the broad rebound in natural resources that occurred, which would play more strongly in Latin America than the manufacturing-based Asian economies.
Ultimately, that’s the crux of the conundrum. Clearly President Trump has policies that are likely to be near-term shots in the arm for the economy. A lowering of corporate tax-rates is likely in the first session of the new congress. That is always a near-term stimulus for growth. Repealing ACA mandates and creating more competition is likely to be additive as well. However, if President Trump starts a trade war, or incites a geo-political event (such as provoking a conflict near the Straits of Hormuz oil shipping lanes), all of the rosy present conditions that I have described above could evaporate very quickly. OR… perhaps Mr. Trump will bring savvy business efficiency to the bloat of government. It is impossible at this point to predict. What is most likely is that we will see grand examples of both. With a stock market that is trading at highly elevated valuations – valuations that are already pricing in uncertain future success, disappointments will surly lead to volatility. It’s bound to be quite a ride. I hope you packed you Dramamine.