Howard Marks memo for the month of November 2016.
Think back to just before last week’s election. What did we know?
- The polls were almost unanimous in saying Hillary Clinton would win the popular vote by about 3%.
- FiveThirtyEight, an analytical website whose forecasts had proved quite accurate in the two prior presidential elections, gave Clinton a 71% probability of winning, and almost everyone else was between 80% and 90%.
- Clinton was favored in most of the “swing states” that would make the difference in the Electoral College. Thus she was expected to win more than 290 electoral votes, leaving just 250 or so for Donald Trump.
- Clinton was the obvious choice of the people who move the markets. This could be seen in the fact that the markets went up when Clinton’s odds improved in late October (recovering from some unpleasant Wikileaks disclosures), and then they fell after the FBI’s James Comey announced the discovery of an additional cache of Clinton emails on October 28, lifting Trump’s chances.
- Thus there was a near-universal belief that a Trump victory – as unlikely as it was – would be bad for the markets.
So what happened? First Clinton didn’t win. There’s much soul-searching, particularly among the forecasting fraternity. Everyone knew intellectually that Trump had a non-zero chance of winning, but few people thought it could actually happen.
And second, the U.S. stock market had its best week since 2014! The Dow Jones Industrials rose almost 5% for the week, taking them to a new all-time high. The Dow was up every day last week. It rose on Monday and Tuesday, when Clinton was expected to win. And then it rose Wednesday, Thursday and Friday, after she had lost.
That behavior calls to mind my January memo, “On the Couch,” on the subject of the market’s irrationality. Clearly, the election was the biggest event last week, so it must have been the main influence behind the changes in stock prices. But how could the expectation of a Clinton victory make stock prices rise, and then the reality of her defeat make them rise further?
In that memo, I included a cartoon showing a newscaster saying, “Everything that was good for the market yesterday was no good for it today.” In the case of the election, it might have been, “Whatever was good for the market yesterday, its polar opposite was good for it today.” It just doesn’t make sense.
While people search the market’s behavior for logic, there really doesn’t have to be any. In “On the Couch,” I mentioned that sometimes the market interprets everything positively, and sometimes it interprets everything negatively. The market often fails to act rationally in the short run, primarily because of the role played by people in determining its course.
Thus two key observations can be made based on last week’s developments:
- First, no one really knows what events are going to transpire.
- And second, no one knows what the market’s reaction to those events will be.
These observations reinforce my belief that it’s a mistake to base investment decisions on macro forecasts. But you knew that.
Impact on the Markets
Of course there’s logic to the market’s rise last week, just a logic different from that which would have made it go up if Clinton had won. The reasons one might cite are these:
- As a businessman, Trump doubtless intends to be a pro-business president. In fact, he’ll probably make more of an effort to nurture business than Clinton would have (especially when being pushed to the left by Sanders and Elizabeth Warren), and more than I think characterized the Obama administration.
- Trump’s campaign promises have included tax reform; reduced income tax rates on corporations and big earners; some form of tax holiday to enable corporations to bring in profits stranded abroad; a reduction of business regulation (Carl Icahn tells me this will be huge); a big infrastructure program ($1 trillion announced); an end to bank-bashing; less pressure on pharmaceutical and health care companies to cut prices; and an end to the estate tax. That’s quite a pro-business agenda.
- The populist power of Sen. Warren will be reduced.
- Businessmen and Wall Streeters will be welcome to serve in the administration, not verboten as in recent years.
At the bottom line – if everything works as promised – there will be massive fiscal stimulus; big increases in GDP growth, corporate profits and jobs; higher inflation than otherwise would have been the case; a big increase in the national debt; and more of everything for everybody.
No austerity here!
Trump’s statements regarding business and the economy contain some real positives and are the best part of his platform . . . if he and his administration are up to the task of putting them into practice. However, some of his promises may test the limits of what can be accomplished under the limitations imposed by economic reality.
And there are negatives, including:
- Trump’s express disdain for Janet Yellen, and the resulting possibility that Fed independence will be reduced,
- his stance on international trade pacts (an area in which a president has unusually broad power to take unilateral action), his threat of imposing import duties on goods made in China and Mexico, and the resulting possibility of trade wars, and
- the possibility that this plus his unconventional positions on things such as climate change and defense treaties bode ill for international relations in general.
That brings us to the outlook for bonds. Just as the U.S. stock market has celebrated Trump’s election, the bond markets have been discouraged. Interest rates rose very rapidly last week following Trump’s election, bringing big losses to bond holders. The FT wrote the following, citing Henry Kaufman, the Salomon Brothers chief economist who correctly called the bond bear market in the 1970s:
I always feel it takes a degree of innate optimism to be a devotee of stocks (with their reliance on conjectural returns awarded by the market) as opposed to bonds (which bring contractual returns guaranteed by their issuers). Thus U.S. equity investors have exhibited an optimism regarding the Trump administration that virtually no one foresaw a week ago.
Equity investors like inflation because it pumps up profits. Bond investors dislike it because it raises interest rates, reducing the value of the bonds they hold. But the two can’t go in opposite directions