During the eight days leading up to the November presidential election, the S&P 500 gained a total of 0.7%, including dividends. Post-election, the S&P index gained 3.0%, ending the month with total gains of 3.7%. There were concerns that a Trump win would result in a dramatic increase in uncertainty and chaos in the financial markets. For a few hours as the results were tallied, that appeared to be the case. Now, there seems to be a sense of relief that all the uncertainty about the election has finally ended.
The “Trump Bump” in stocks is arguably a premature reaction given the unknowns of how any of this will actually play out, but regardless of how one feels about the situation, the short-term results are positive, and demonstrate the strong baseline of persistent support for this market. Is it justified? Much of that support can be found in the economy we already have today, irrespective of new economic and tax initiatives. As reported last Friday, the U.S. economy produced 178,000 new jobs in November with the unemployment rate dropping to 4.6%, its lowest level since August 2007. 15.6 million jobs have been added since the post-crisis nadir in early 2010, and additional data last week indicated ongoing and sustained improvement in U.S. manufacturing growth. Along with a revision in gross domestic product growth (GDP) to 3.2% for Q3, these are solid confirmations that the U.S. economy likely turned an important corner in the months leading up to November.
While the U.S. economy has continued to improve, there are notable differences in the character of this particular recovery. The economy’s improving health has resulted in large part from monetary intervention, with both lower interest rates and quantitative easing playing significant roles. While the results are tangible, a disproportionate share of the benefits have accrued to those with the education and technical skills to land the new jobs, or to those fortunate enough to hold appreciating financial assets. The rest of the voting population, already feeling slighted by the uneven dispersion of gains from globalization, is hungry for their share, which the President-elect is promising to deliver through tax cuts and massive spending on infrastructure projects.
Will it work, or could massive new spending programs result in higher budget deficits and a reinflation of the economy without the desired higher growth? Many economists consider the ideal rate of economic growth, where unemployment and inflation are in balance, to be between 2% to 3%. Can the economy grow above 3% and unemployment fall below 5% without causing an increase in inflation? Even if 4% GDP growth is achieved with fiscal stimulus, will the economically discontented segment of the population benefit if they don’t have the education and skills for more technically demanding jobs? Obviously, there are more questions than answers. The financial markets will continue to evaluate these issues and react as we get more specifics about new policies. It’s not unusual for the markets to give a new administration a grace period; they can also quickly turn merciless and investors should not be surprised by more volatility ahead.
Near term, the shift in emphasis from monetary policy to fiscal policy has notably changed the internal dynamic of the markets. Bonds have been most affected by the “Trumpflation” trade that took hold after the election, as fixed income investors are betting that fiscal stimulus will grow the budget deficit, increase inflation, and force the Federal Reserve to more aggressively raise interest rates. The yield on the benchmark 10-year U.S. Treasury bond was at 1.4% prior to the election and now stands at 2.4%, driving a rapid decline in bond prices. The broad U.S. bond market (Barclays Aggregate) lost 2.4% in November while longer dated bonds are taking a bigger hit. The chart below shows the returns for long-term (20+ year) U.S. Treasury bonds and U.S. large-cap stocks since the November 8 election.
High dividend stocks that led the market until November have also retreated in the face of higher interest rates. Before the election, the telecom, utility, and energy sectors showed market leading returns ranging from 8.7% to 16.6%. Post-election, only energy firms have outperformed the broader index with 5.6% gains, while utilities have lost 1.3%.
Healthcare firms continue to underperform, adding 2.8% more in losses to a year already in the red. Beside the potentially negative impact on hospitals from a rollback of Obamacare, the market appears to believe that healthcare products will continue to be pressured. Banks have been the biggest beneficiaries of expectations for higher interest rates and deregulation with 8.0% post-election gains.
Higher U.S. interest rates are also driving the value of the dollar higher relative to other currencies. Higher priced dollars translate into lower profits for firms with foreign revenues, such as many companies in the consumer staples sector. Pre-election the staples sector showed gains of 6.1%, then lost 2.9% after November 8.
More broadly, the stock market has favored companies with higher domestic versus foreign revenues. Small and mid-capitalization firms, more likely to have less international presence and less U.S dollar exposure, are outperforming larger firms. Foreign stocks, gaining ground prior to the election, are again performing poorly, hurting overall returns for broadly diversified global stocks portfolios.
What It All Means
Can the stock market hold and potentially build on recent gains? How bad will it get for bonds? The best way to protect your financial future is to stay invested and focus on managing risk through broad diversification and rebalancing. We continue to monitor and evaluate these new developments and adjust accordingly. We also bear in mind that what is happening in the markets this quarter, this year or even this particular stock-market era is not as important to your future wealth as taking a disciplined, process-driven approach to investing over the longer-term.
We will discuss 2016 results as well as future portfolio allocations and strategies in more detail in our January letter. In the meantime, please contact us directly with any specific questions or concerns. As always, we appreciate the opportunity of working with you.
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The information provided in this letter is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal or tax advice. Proffitt & Goodson, Inc. makes no warranties with regard to the information or results obtained by third parties and its use and disclaim any liability arising out of, or reliance on the information. The information is subject to change and, although based on information that Proffitt & Goodson, Inc. considers reliable, it is not guaranteed as to accuracy or completeness. Source information is obtained from independent financial data suppliers (Interactive Data Corporation, Morningstar, etc.). The Market Categories illustrated in this Financial Market Summary are indexes of specific equity, fixed income or other categories. An index is a reflection of the underlying securities in a particular selection of securities picked due to a particular type of investment. These indexes account for the reinvestment of dividends and other income, but do not account for any transaction, custody, tax, or management fees encountered in real life. To that extent, these index numbers are artificial and cannot be duplicated in real life due to the necessity of paying those transaction, custody, tax, and management fees. Industry and specific sector returns (technology, utilities, etc.) do not account for the reinvestment of dividends or other income. Future events will cause these historical rates of return to be different in the future with the potential for loss as well as profit. Specific indexes may change their definition of particular security types included over time. These indexes reflect investments for a limited period of time and do not reflect performance in different economic or market cycles and are not intended to reflect the actual outcomes of any client of Proffitt & Goodson, Inc. Past performance does not guarantee future results.