The initial equity market reaction to President-elect Trump’s victory has been positive, driven by expectations for stepped-up stimulus initiatives and regulatory reform. Stocks were also buoyed in November by encouraging economic data, as well as OPEC’s production cut agreement, which boosted energy sector shares. While we believe the degree of political risk globally remains elevated, we do see several factors which should support corporate earnings, and we therefore currently hold a constructive outlook on the market.
Though the S&P 500 has moved up by just a few percentage points since Election Day, sector rotations occurring beneath the surface and moves in other asset classes have been pronounced. Broadly speaking, a reflation trade characterized by rising bond yields and weakness in certain high-dividend stocks had already begun prior to the election. We believe this was the result of market expectations for a pickup in economic activity as well as some indications of firming inflation. The election’s outcome appears to have intensified these shifts, as investors have begun to account for the “Trump Triad” of lower corporate taxes, relaxed regulations, and increased fiscal spending. As a result, 10-year Treasury yields jumped by more than 50 basis points in just two weeks, the largest such move in 15 years. As of this writing, the 10-year Treasury is currently yielding 2.57%, a 17-month high and far above July’s 1.35% post-Brexit low. In addition, shares of banks and industrial companies have appreciated in the aftermath of the election, while in general higher yielding sectors such as utilities and REITs have lagged. Financials have been boosted in large part due to expectations for a steeper yield curve and a less onerous regulatory environment, while industrials have benefitted from anticipation for stepped up infrastructure spending and the possibility of improved economic growth ahead. However, questions remain as to how many of Trump’s policy initiatives will ultimately come to fruition, and the specific details of those that do. Moreover, to what extent might his positions on trade and immigration negatively impact growth? These questions give us pause as we consider the sustainability of some of the moves we have seen in interest rates and stocks.
Of the various proposals that have been put forth during the campaign, a reduction in the corporate tax rate is among the most likely to move forward in our opinion, given its support across much of the Republican Party. Depending on where the new tax rate falls, this change could give a sharp and immediate boost to corporate profits, particularly for those companies that generate much of their earnings domestically. We also expect that a shift towards a more business-friendly regulatory environment is likely. While much investor attention has been focused on banks, we anticipate that other industries are also likely to see a relaxation in their regulatory climates. We believe that many companies have faced headwinds to growth due to regulatory burdens, and even a partial relaxation of regulations may boost corporate earnings.
We understand the concerns that certain of Trump’s views, particularly on trade and immigration, could potentially be negative for the economy. Certainly if he were to act on his proposals to withdraw from NAFTA and initiate tariffs on imports, we would expect the global economy to take a meaningful hit. However, he may instead take a softer approach, such as his recent deal with Carrier whereby tax incentives were provided in exchange for the company keeping jobs in the U.S. In addition, we view certain of his cabinet picks as being more market friendly than might have been expected prior to the election. Generally speaking, we do see risk to the market should the incoming Trump administration attempt to make good on the more dramatic measures bandied about during the campaign, but are heartened by the somewhat softer tone that Trump has taken post-election.
Elsewhere, OPEC made news with its agreement to cut production by approximately 1.2 million barrels per day starting in January of next year. We view this move as quite positive for U.S. energy producers, as we would expect them to take advantage of the reduction in output by increasing their own production. Moreover, earlier in the year when crude prices had fallen into the $20’s, there were concerns over the potential for widespread bankruptcies in the energy industry, and the impact that soured loans might have on banks. In our view, the OPEC agreement largely takes concerns about a price retrenchment back to those levels off the table for now.
We currently hold a cautiously optimistic view on the market. In addition to the potential for Trump’s initiatives to provide a meaningful boost to corporate profits, we also see reasons to expect a healthy holiday shopping season. Wages continue to move higher, as evidenced by the 2.8% year-over-year growth rate achieved during October, the best since 2009. Moreover, consumer spending appears to be gaining momentum. Retail sales grew in September and October at the fastest two month pace in over two years, and the latest revision to third quarter GDP was boosted in large part due to personal consumption, which came in at 2.8%, up from a prior estimate of 2.3%. Consumers increased their holiday season spending by 3.2% last year, and projections that we track are calling for a slight acceleration this year, which we view as reasonable.
That said, we are cognizant of several risks which could change our positive view of the market. On the political front, if Trump pursues a hard line on trade and immigration, economic growth could stall and stocks may be at risk. In Europe, the populist wave continues to gain strength, with the latest example taking place in Italy, where voters rejected Prime Minister Renzi’s proposed constitutional changes, leading him to tender his resignation. Other votes will take place across the continent next year, and investors are concerned that more populist gains could lead to a breakup of the Eurozone. While we certainly view this as a risk factor which bears watching, in our view a continuation of the populist wave is unlikely in itself to bring about dissolution of the Eurozone, which has already survived numerous other crises over the last several years.
Lastly, equity market bears note that rising interest rates tend to compress valuation multiples and lead to lower stock prices. While there is some credence to this view, we believe that one must consider the context of today’s economic environment. Specifically, we believe that stocks are more at risk when yields are rising due to inflationary concerns, as opposed to yields rising due to expectations for stronger economic growth. In our view, the recent move in yields has been driven more by the latter than by material inflationary concerns. Furthermore, the absolute level of yields is also a key factor. Our research has shown that when yields are moving up from unusually low starting points, as is the case currently, the impact on stocks is not as meaningful as when yields are moving higher from more normalized levels. Nevertheless, we will continue to monitor these and other risks as we seek to preserve and grow capital over time.
This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Please contact us at 646-452-6700 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions, or if you would like to request a copy of our Code of Ethics. Our current disclosure statement is set forth on our Form ADV Part II, available for your review upon request, and on our website, www.rooseveltinvestments.com.