Winter Quarterly Commentary

“We are not enemies, but friends. We must not be enemies. Though passion may have strained it must not break our bonds of affection. The mystic chords of memory, stretching from every battlefield and patriot grave to every living heart and hearthstone all over this broad land will yet swell the chorus of the Union, when again touched, as surely they will be, by the better angels of our nature.”

- Abraham Lincoln, 1809-1865 16th President of the United States

There was a lot of drama behind the scenes of the S&P 500 Index’s solid 12% return in 2016. The year began with a sharp 14% market drop into mid-February, on worries of a China crisis and a U.S. recession, then everything reversed in a great “pain trade” whereby 2015’s losers mostly become 2016’s winners. The surprise election victories by President Elect Trump and congressional Republican’s kicked these trends into overdrive with a year-end stock market flurry.

We mostly spared our readers political commentary during the exhausting and demoralizing 2016 race, but we can refrain no longer given the incredible gyrations in financial markets since the election. As a Trump victory appeared increasingly likely, stock futures were down some three percent in the middle of election night (a massive move)... but the collective market quickly changed its perception of the implications of a GOP victory. Stock market futures ended about flat by the time the market opened and the stock market finished its first full day of trading strongly up (a massive four percent reversal).

However, movement in the overall stock market doesn’t even begin to match the drastic movements in other financial markets and the “under the hood” divergence of the individual stocks that make up the broader market. Inflation expectations and interest rates both soared amid anticipation of lower taxes and increased military and infrastructure spending. Expectations of a robust economy due to lower taxes and a rollback of business regulations resulted in soaring consumer confidence and economically-sensitive stocks taking off while previously sought-after defensive stocks were jettisoned in the rush to jump aboard the Trump Train. The chart below shows the extremely sharp divergence of different stock sectors in the days following the election.

Stock Market S&P 500) by Sector Performance

July 8, 2016 – December 31, 2016

The markets, anticipating the effects of new government policy, have been pricing in a sea change. We are not ready to fully accept the market’s preliminary conclusion, and expect many of these trends to stall or reverse.

Consider what we refer to as the “Trump Enigma”: what exactly Trump wants to do is unknown; what exactly Trump will attempt to do is unknown; what exactly Trump is able to do is unknown... and only a future unraveling of that enigma will determine how much governmental change we actually get (to say nothing of the effect such change will have on markets). Meanwhile, many industries seem to be expecting regulatory changes which will consist of... whatever changes they have been wanting. Many are likely to be disappointed, as we simply cannot all have it all. Hope is abundant and we fear it exceeds available realities.

Perspective here is important, as political promise is not always reality. A few years ago, expectations soared on the election of Japanese Prime Minister Abe with his positive “can-do” attitude and promise of stimulative “Abenomics”. Many of the proposed policy changes were not realized and economic performance has been underwhelming.