The Trump Rally

Clinton wasn’t the only loser in November. Conventional wisdom also took a beating, as the market plunge expected in the wake of a Trump victory failed to materialize. Instead we have had a sharp advance that persists a month later. What happened?  What do we make of this rally?

Those of us that stayed up late on election night learned that Trump would win the Electoral College, and that US stock futures had plunged 5% on the news. By the time we stumbled out of bed the next morning, the decline had been reversed. It was already dawning on investors that maybe some Trump policies were stock market-friendly.

The pre-election chatter from experts had been all about fear. As the predicted stock market collapse didn’t happen, those who had not taken Trump seriously had to reconsider the pro-growth policies likely from the new regime: lower taxes, higher construction spending, reduced regulation, and repatriation of offshore profits. A new story of hope quickly emerged – the Trump initiatives will boost the US economy and corporate profits. Stock market strategists quickly adjusted their messages; raising price targets and identifying the key beneficiaries. Game on!

But wait a minute! Aren’t we overlooking the negatives and the uncertainties?  The US 10-year yield has moved from 1.9% to 2.6%. The biggest borrower of them all is the US government, and higher rates will lead to a larger budget deficit – unless spending in other critical areas is slashed. Higher interest rates have already pushed up the dollar versus other currencies, and forty percent of large US company profits are earned abroad. That hurts corporate profits.

How will tax cuts and increased infrastructure investment be implemented? Will they be viewed as long-lasting reforms, or just temporary stimulus? How much of the agenda will survive congressional horse-trading? None of this seems to matter at this point.

The Trump policy narrative has gained momentum as investors, including some who “lightened up” before the election, have gained comfort in the common belief that the new policies will be effective. The rising stock market seems to validate that view, further emboldening investors. They are buying the story and the market.

The thoughtful investor focuses on the difference between the story and the underlying reality. Starting with a market where many stocks appear to be close to fully priced, interest rates that had nowhere to go but up, high levels of debt, and an aging population, it is hard to expect a miracle in the form of a rapidly growing economy. It’s our opinion that today’s higher interest rates and higher stock prices may already reflect the scenario where the best version of the Trump agenda makes it through Congress.

Are we implying that it’s time to sell? No. Even the most brilliant analysis of economic, political or market factors cannot predict what the markets will do next.

Take Mr. Trump for example. In August, candidate Trump revealed that he sold all of his shares two months earlier, warning of “very scary scenarios” that lay ahead for investors. “I did invest and I got out, and it was actually very good timing,” Trump said in a phone interview on August 2nd. Trump may have had good reasons to be scared, but he was wrong about the markets, which have gained about 7% since June. Those scary scenarios are always out there, always trumpeted as reasons to sell.

Many studies have shown that the average investor underperforms by 1 or 2% a year, regardless of how he invests, because of poorly-timed decision-making. The careful investor has learned this lesson, and employs a strategy that does not attempt to time the market. A commitment to being in the market bypasses the stress of guessing about in-or-out, and enhances one’s ability to discern the story and then take advantage of that perspective.

It pays to stick with the process. Portfolio managers trim holdings as favored stocks move higher. Researchers look at what’s been left behind – and there are plenty of laggards in the current market. It is possible to judge whether one should buy or sell an individual stock. It is necessary that investment risks be managed in relation to client objectives.

Throughout history, the most powerful market moves have occurred when least expected. A surprise event catches a sufficient number of investors leaning the wrong way, and prices move until balance is restored. The magnitude of the move is determined by the power of the story, as well as the degree of prior over or under investment. This current combination of factors has already sparked US stocks to a record five-week post-presidential election gain, and it’s still going.

As we close out 2016, we will be observing how both the markets and the narrative evolve. Before the election, we (and many others), said that a Trump win would come with a wider range of market outcomes. That was a safe sort of conventional wisdom, and of course most were thinking about downside risks. We are thankful for the rally – and we are mindful that rallies can turn into rollercoasters.