Given both the unusual tone of last year’s election campaign and its unexpected result, we have been more focused on addressing election-related questions than in the past. Most recently, client concerns have related to the impact of new policies and what they might mean for financial markets going forward. Below, we’ve listed some common questions along with responses from our Research Team.
We believe the impact Trump could have on any one thing, let alone stock markets, is largely an unknown. There are just so many variables affecting markets and investor sentiment in the short term, particularly given no one can really predict what Trump will do, what policies he will be able to implement, and what the timing might be.
There’s also uncertainty concerning the impact his policies could have on economic growth, interest rates, and budget deficits as well as what financial markets may or may not have already priced in. Just to illustrate the futility of making short-term forecasts, prior to Trump winning the election the consensus view had been that in the unlikely event he won, stocks would crater and gold would rise. Instead, the opposite happened.
Trump has promised significant spending on infrastructure. That could lead to higher economic growth, which in turn could result in better sales and earnings growth for companies. But it would also likely increase prices and inflation, putting pressure on companies to increase wages, and exert upward pressure on interest rates. That’s all in the context of a U.S. budget deficit that is likely to be increasing, which could raise government debt servicing costs.
Since the financial crisis and recession, stock price-to-earnings (P/E) multiples have expanded despite sluggish economic growth and, lately, company earnings that have largely disappointed. That’s been mostly due to the Federal Reserve keeping interest rates near zero. If rates rise, as is generally expected, we view falling P/E multiples as a significant risk, especially given some metrics show stocks are close to their 1999/2000 peaks.
Looking at another potential impact, expectations of higher economic growth and rising interest rates led to a consensus prediction the U.S. dollar would strengthen. Indeed, that was the case in the post-election period (the dollar hit a 14-year high in December). But a rising dollar hurts the earnings of multinational corporations, as well as ultimately, their stock prices. We saw that in 2015.
Lastly, Trump’s protectionist rhetoric on international trade, if actually implemented as policy, might hurt U.S. stocks more than foreign ones. U.S. corporations have benefited tremendously from free trade and globalization via access to cheaper labor as well as more efficient and cost-effective global supply chains. This can be seen in the historically high margins U.S. companies achieved in the past decade-plus. They bet big on globalization and open trade and may have more to lose as a result.
So, while higher economic growth might lead to higher company earnings, which in turn could result in our optimistic scenario for U.S. stocks playing out (i.e., returns close to double digits), several factors could put downward pressure on margins, and in turn, earnings.
Two managers saw and/or made opportunistic purchases of health care stocks following the post-election selloff. One manager added a couple of small positions in pharmaceutical stocks. However, none have had substantive comments about the investment landscape.
That said, this isn’t a question we are regularly putting to fund managers given the amount of speculation and uncertainty it entails. They (and we) are certainly not spending much time thinking about, let alone making investment decisions or portfolio changes based on speculation. As one manager stated, “We do not know what to expect with the new administration, but it should be interesting.”
Our view on the range of economic scenarios has not materially changed. While the possibility that our optimistic scenario for U.S. stocks will play out might have increased slightly, we continue to view it as unlikely. We think the likely outcome is returns in the low single digits or less for U.S. stocks.
As former President Obama said in his farewell speech, “Reality has a way of catching up with you.” Investing is a marathon, not a sprint. Assuming Trump can and does pursue his policies as he has laid them out, and gets them through Congress, there is still a range of economic and market scenarios that could unfold.
We believe confidently pointing to one or two possibilities and predicting how they will play out in the face of so many uncertainties would be both disingenuous and a disservice to our clients. In the long term, fundamentals such as earnings and valuations matter. They are what we use as a basis for making investing decisions.
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