The 2016 U.S. Presidential election turned out to be another Brexit: the predictors got it wrong. On the eve of the election, Hilary Clinton was ahead by some 5% in the popular polls (Post-ABC, NBC). A November 7 report by Bloomberg News claimed that betting websites placed the probability of a Clinton victory “near or above 80 percent.”1 Moreover, asset prices performed almost exactly the opposite of what was predicted to occur on the day after Donald Trump’s victory: stock values appreciated and bond values declined. Investors were supposed to seek a safe haven for their assets and turn off any appetite for risk – they didn’t. Within the equity market, securities of heavily regulated sectors such as health care and finance jumped while those potentially harmed by rising interest rates, such as utilities and consumer staples, underperformed. While some repositioning of portfolios may be in order, the markets adjust swiftly and we suggest reflecting on the following before making any bold moves.
5 Factors To Consider:
- Be careful about placing too much trust in professional forecasters of any type, before or after elections. According to the Financial Times, “Hundreds of state and national opinion surveys consistently predicted that Mrs. Clinton would emerge victorious with a margin of 3 or more percentage points in the national popular vote, and with her possibly winning 300 or more Electoral College votes.”2 Instead, she was ahead by some 1% in the popular vote and garnered only 232 electoral votes, which will be formalized on December 19.
- The fact that the Republicans won the Senate and now control both Houses increases the likelihood of enacted legislation in contrast to the more gridlocked characterization of the past. President-elect Trump has favored lower corporate (15% from 35%) and personal (33% from 39.6% for the top earners and elimination of the estate tax) tax rates and greater infrastructure spending, which may result in a larger federal deficit. A report by BCA Research reminds us that the effective U.S. tax rate for non-financial corporations has been in the range of 25%, well below the statutory rate of 35% and near its low since 1950.3 It will be important to gauge if increased deficit spending is matched by higher corporate profits.
- A November 9 report by Stifel Nicolaus & Company reviewed research that showed “the market’s initial reaction is seldom the one that persists.”4 Since the administration of Theodore Roosevelt, which began in 1901, the annualized return of the Dow Jones Industrial Average under Republican administrations has been 3.0% compared to 7.0% for Democratic administrations. The Wall Street Journal points out that while the Dow Jones Industrial Average plummeted nearly 5% on the day after the 1932 election of Franklin Roosevelt, the broader equity market as measured by the S&P 500 index gained 141% during his more than three terms in office.5 In assessing future returns, valuation levels at the start of a new administration are perhaps more important than which party is in power. U.S. equities continue to trade at above average valuations and, up until recently, interest rates had hovered near historic lows.
- Like it or not, President-elect Trump read the groundswell of populist sentiment better than any candidate. According to two reports from the Economist magazine, “Over 70% of America’s population believes the economy is rigged in favor of vested interests,”6 and from 1970 to 2014 the ratio of the top 10% to bottom 10% of household incomes has increased from just over 8 to 1 to more than 12 to 1.7 In the end, the Trump administration may be measured on how well they address this perception of inequality of opportunity and income disparity. Interestingly, an outside review of Trump’s tax plan concludes that the highest income earners, the top 0.1% of the population, would receive a 14% tax cut compared to a modest 0.8% cut for the bottom 20% of income earners.8 We remain a much divided country.
- The U.S. economy is holding steady and corporate profit growth is beginning to improve. Prior to the election, third quarter profits were showing a slight upward progression of 2%-3% compared to the single digit declines of the past several quarters. Earnings gains are closer to 5-6% excluding the energy sector; sales have exhibited similar rates of growth recently. Indicators of manufacturing activity in the U.S., Japan, China, and the Eurozone countries were more favorable in October compared to September. If a gradual normalization to somewhat higher interest rates is matched by a healthier environment for corporate profits, and the administration's new agenda becomes clearer, volatility should ease and returns should not be unusually distorted.
1 Bloomberg News, “U.S. Election Guide to Markets: What to Watch With One Day to Go,” November 7, 2016
2 Financial Times, “Republicans defy forecasts to take both houses,” November 10, 2016
3 BCA Research, “U.S. Election: Outcomes & Investment Implications,” November 10, 2016
4 Stifel Nicolaus & Company, “Special Edition: Thoughts On The Results,” November 9, 2016
5 Wall Street Journal, “Clearly Afraid: Read This,” November 10, 2016
6 The Economist, “Special Report: Companies,” September 17, 2016
7 The Economist, “An Open and Shut Case,” October 1, 2016
8 Financial Times, “Trump’s false promises to his supporters,” November 16, 2016