2016 began with a thud and ended with a bang. After one of the worst-ever starts to a year, U.S. stocks managed to rebound and ultimately finish the year with solid gains. Much of the rise came in the final few weeks of the year, following the surprising results of the U.S. presidential election. Indeed, there has been an abrupt change in market sentiment, and asset prices have largely taken their cues from a recalibration of economic expectations in the wake of the surprising Trump victory and Republican sweep of Congress.
While policy specifics under the incoming administration are still being fleshed out, markets aren’t waiting around for the details. There have been sharp moves in certain areas of the market since the election, and we believe these moves are sending signals that are influencing asset allocation in a world where the political landscape has shifted dramatically. Below are some of our initial thoughts on how the election may impact the investment landscape in 2017.
A Roadmap Developing?
From a pure investment standpoint, the recent election seems to be creating a roadmap for macro developments and portfolio positioning under a Trump administration. The basic narrative out of the election is one of stronger growth, higher inflation, and less regulation.
Economic growth is expected to pick up through fiscal stimulus. From a big picture perspective, the idea that a sizable fiscal package could be enacted at this point in the business cycle is a big deal and comes at a time when markets were beginning to wonder if the monetary authorities were running out of bullets. In terms of the fiscal initiatives expected, perhaps the biggest change will come through tax cuts and possibly tax reform that would benefit both consumers and businesses. Some type of infrastructure spending also looks like a good possibility over the coming year, which should also support growth.
Higher growth, the prospect of tighter immigration policy, and possible protectionist policies should all be inflationary. For many years, the global backdrop has been highly disinflationary, but that dynamic may be changing, and the recent election may be the catalyst that unlocks this transition. If so, this could mark a significant shift in the bond market towards higher interest rates, after more than three decades of declining rates.
Heavy regulation has long been cited as a significant headwind by both large and small businesses in the current cycle. The incoming administration seemingly favors less regulation, which should produce a more business friendly environment and has the potential to boost confidence in those who control business investment.
Translation to the Portfolio
Using some of these broad principles as a starting point, the next step is to assess what these developments might mean for portfolio positioning. From our perspective, these are some of the likely winners and losers assuming the backdrop just described comes to be.
Winners
Stocks jumped following the election, and in general they should continue to benefit from a more pro-business environment that helps corporate profits grow faster. However, there’s been a large discrepancy in performance between the various sectors of the market, and that’s likely to continue, too. Specifically, the Financial sector appears poised to outperform due to positive factors like a steeper yield curve and the prospect of less regulation. In addition, mid cap and small cap companies may outperform multinational large caps due to less foreign exposure in the event that tariffs or other trade impediments are enacted, and they may disproportionately benefit if corporate tax policy is reformed.
The U.S. dollar appears poised to continue rallying, with ramifications throughout the portfolio. Within equities, that would suggest favoring domestically oriented sectors and industries over globally exposed areas, and overweighting domestic equities at the expense of international equities (since a stronger dollar erodes the total returns of U.S. investors due to currency losses). Another option is to hedge the currency exposure in certain international markets.
Within fixed income, the winners are likely to be positions that are less sensitive to higher interest rates, including inflation-protected bonds, credit-sensitive sectors such as floating rate debt, and fixed income alternatives.
