If you’re reading this, the world didn’t come to an end last night with the U.S. election. However, underdog real estate mogul and reality TV star Donald Trump secured the presidency by capturing more than 270 electoral votes. Whether it was a late rally or systematic polling error, in the end, the Republicans will take back the White House in a surprise victory. Reminiscent of the Brexit vote, but on a much larger scale, a populist uprising has defeated the status quo. Down ballot, the U.S. House of Representatives predictably remained in Republican control. As of this writing, it appears the Republicans have also narrowly retained control of the U.S. Senate.
Uncertainty Reigns, For Now
As noted above, the Trump victory has thrown markets into chaos in the short term. This reaction is hardly a surprise – he is volatility personified. First, his victory has been considered a long shot since the beginning of his candidacy. Markets clearly weren’t expecting a Trump victory which by itself would cause a spike in volatility. Second, and more importantly, Trump has little-to-no policy history to assess and much of his rhetoric is contradictory. He has been antagonistic towards the Fed, arguing that super-low rates are artificially propping up a failing economy. He has floated comments about “negotiating” U.S. financial obligations and threatened to pull back from international organizations like NATO.
The hallmarks of Trump’s campaign were promises to curtail immigration and punish what he sees as unfair trade practices and currency manipulation. He has proposed a significant increase in infrastructure spending, but the budget math doesn’t add up, as his proposals to lower tax rates will dramatically expand the deficit and likely produce higher interest rates.
Thank You, Montesquieu
It is important for investors to recognize that this volatility won’t last forever, however. First, our system of checks and balances assures separation of powers. In spite of a maintaining majorities in both the U.S. House and Senate, Trump will not enjoy unlimited power.
Second, as we’re already seeing, markets will react to and digest this new reality very quickly. New equilibrium levels across asset classes will likely be discovered in a few days to weeks. While not of the same magnitude, it might be instructive to remember that risk assets regained their footing within 2-3 days after the Brexit vote.
Assessing Portfolio Implications
In the short run, we expect higher sustained levels of volatility and for risk assets to perform significantly worse with Mr. Trump en route to the White House as evidenced by the markets’ reaction already. We are also skeptical of sector-based strategies designed to profit from the occupant of the Oval Office. Most importantly, for all the hype and rhetoric, investors would be wise to remember that in many ways, this election has left most of the key investment variables unchanged. It is likely that the U.S. and global economy stumble forward at sub-par real and nominal growth rates and that poor demographics continue to drive a global savings glut. Central banks are largely tapped out in a world with almost zero fiscal latitude or leadership. Equity valuations, broadly speaking, remain at elevated levels. High quality/sovereign bond yields are paltry at best and near-0% cash rates still lose value after adjusting for low inflation. In this environment, the most interesting opportunities for investors are likely to come from alpha, mispricing within the indexes, as opposed to the returns on the indexes.
In the long run, perhaps a Trump presidency can achieve some sought-after economic goals. Trump, along with Republican leadership, will be keen to scale back or eliminate some of the regulatory burden that is hampering business. This could include looser constraints in the energy sector, banking industry (i.e., Dodd-Frank), and a full-frontal assault on the Affordable Care Act (ACA). Setting aside externalities (like safety, climate, or systemic risk issues), changes in these areas could act as a much needed boost to business productivity.
Finally, as we noted with Brexit, this surprise result can be instructive for investors. Markets are unpredictable and polls are often wrong. Investors can use this experience as a guide to their own risk tolerance. Accurately assessing your pain threshold is the only way for long-term investors to ride out short-term losses.
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Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only. There can be no assurance that developments will transpire as forecasted, and actual results may vary. Other industry analysts and investment personnel may have different views and make different assumptions. Accuracy of data is not guaranteed, but represents best judgment, as derived from a variety of sources. The information is subject to change at any time without notice.
Understanding current market conditions and what might be expected in the near term.
Understanding potential market trends in early 2017 requires a look at the market’s recent optimism.
During periods of market optimism, remaining mindful of risk is still important.