This week we reflect on Donald Trump’s surprising victory and the stock market reaction. With Election Day behind us and the benefit of several days to digest the news, we reflect back on what was quite a week for the stock market. Here we offer some perspective on the trading week and share our views on some of the most politically sensitive asset classes and sectors.
There were two big surprises this week for investors: one was of course an election outcome few predicted, and the other was the market’s reaction to it. We are not surprised that stocks recovered; but rather how swiftly. Not even the market’s surprisingly fast recovery from the unexpected Brexit “leave” vote in the U.K. back in June of 2016 prepared us for this. After Dow futures were down over 800 points after the result became clear late on election night, the blue chips reversed course the next day (November 9) to end more than 250 points higher, before adding another 218 points on Thursday and 40 points on Friday. The Dow was down all five days the prior week before rising each day last week; a wild ride to say the least.
By week’s end, the S&P 500 had produced a five-day gain of 3.8%, the best week for the index since October 2014. The 5.4% and 10.2% gains for the blue chip Dow Industrials and small cap Russell 2000, respectively, were the best since December of 2011.
We believe several factors are behind the rebound:
??The certainty of an outcome. A prolonged legal battle to determine our next president would have damaged investor confidence. Some cash on the sidelines was likely waiting for a definitive outcome.
??Optimism regarding a peaceful transition. President-elect Trump seemed to strike the right tone for markets in his acceptance speech and appears willing to work with Republicans and Democrats to get things done, an encouraging development for markets.
??Favorable election year pattern. Stocks have tended to do well late in election years due in part to the policy clarity provided by a winner. Since 1952, the S&P 500 is up by a median of 3% between Election Day and Inauguration Day (the average, at 1%, is skewed by sharp drops in 2000 and 2008), with gains 69% of the time [Figure 1]. Though policy uncertainty remains high, the likely path is becoming clearer each day.
??Anticipation of market friendly policies. The odds that many of President-elect Trump’s market-friendly policies are implemented following the Republican sweep are high and include tax reform, infrastructure spending, and rolling back regulations in areas such as financial services and healthcare.
??Negative sentiment. Heading into the election, sentiment readings based on derivatives were among the most negative that we have seen in two decades. Equity flows have also been decidedly negative this year. Most recently, the S&P 500 had just ended a nine-day losing streak (on November 7, 2016), the day before the election. That bearishness set up some buying on the news.
Key Market Implications
The strength in the broad stock market indexes this week was notable, but the dispersion in the sectors also stood out. Sectors and industries expected to benefit from President-elect Trump,such as healthcare, financials, and infrastructure, all soared, while those that may be hurt by Trump’s policies sold off, including emerging markets and interest rate sensitive sectors such as utilities.
Here are our updated views on some of these areas following the election:
1. Emerging markets. Perhaps nowhere is the impact of Trump’s election felt more acutely than in overseas markets and currencies. Look no further than the Mexican peso, which has come under heavy pressure since the election, falling more than 10%. Emerging market (EM) stockshave been hurt by Trump’s skepticism on foreign trade, with promises to terminate or renegotiate trade agreements and add import tariffs. But changing policies can take some time, and changing economic realities can take even longer. And many of the things that we import from emerging markets are simply not produced in the U.S., including certain commodities and relatively low value-added manufactured goods, suggesting less near-term impact than feared.
Rising interest rates are another concern. The post-election spike in interest rates has made funding overseas investments with U.S. dollars more expensive, on top of the U.S. dollar appreciation that has eroded overseas returns for U.S.-based investors.
Going forward, EM assets are caught between two tensions. A more robust U.S. economy, especially one driven in part by increased infrastructure spending, may benefit EM. However, concerns over U.S. trade policy have created uncertainty regarding whether these benefits would actually flow through to EM economies and companies. We think nearterm caution is prudent, with policy uncertainty high, but over the intermediate-to-longer term, we see the potential for improving earnings, attractive valuations, and better-than-feared trade relationships (compared with what was priced in immediately following the election) to support solid performance for EM equities.
2. Energy. Trump is likely to be positive for fossil fuels. He has promised less regulation on drilling, along with expansion of drilling areas. Should oil and natural gas prices hold up, some pipelines may get built that would not have under Hillary Clinton’s leadership. Refiners may see easing ethanol requirements, and the segment of the industrials sector that services the energy sector may also benefit.
The risk is that increased production sends oil prices down and hampers sector performance, although master limited partnerships may be less sensitive to that risk than the oil and gas producers.
3. Financials. The election outcome has put upward pressure on interest rates and steepened the yield curve (difference between shortand long-term interest rates), which is good for bank profitability [Figure 2]. The Trump administration has stated its desire to roll back financial regulations, including the Dodd-Frank financial reforms created to reduce risk in the financial system following the financial crisis. Implementation of the Department of Labor’s fiduciary standard for retirement investment accounts, slated for April of 2017, could now be delayed, which could benefit the asset managers and mutual fund and annuity distributors. Finally, de-regulation and infrastructure spending could lead to increased bank lending.
One risk, though unlikely, is that Trump would bring back Glass-Steagall, as he alluded to during his campaign. The law would separate traditional banking from investment banking, something that has populist appeal.
4. Healthcare. Trump has stated his desire to repeal and replace the Affordable Care Act (ACA), which would negatively impact segments of healthcare that rely most heavily on those insured under the ACA. However, lowering drug prices through regulatory actions is unlikely to be a priority for President Trump, as it would have been under Clinton’s leadership. As a result, we expect a Trump Administration to be friendly to pharmaceuticals and biotech stocks. Managed care, which has been experiencing widely reported profit pressures through the ACA exchanges, may also benefit under an overhaul.
We think healthcare stocks may have overreacted to perceived policy risk prior to the election, suggesting the group could still play some catchup even after last week’s outperformance. The healthcare sector gained 5.9% last week, ahead of the S&P 500’s 3.8% advance, continuing its historical pattern of strong postelection performance