Trump win spurs huge market shift

Mike Loewengart, VP of Investment Strategy

E*TRADE Capital Management, LLC

12/05/16

The facts:

The news of Trump’s victory reverberated across world markets in November. U.S. equities went up, other markets went down—and many of the shifts were dramatic. We’ll show you what it means.

The impact:

  • U.S. stocks surged in November, as small caps posted double-digit gains.
  • Both developed and emerging international markets lost significant ground.
  • Bonds fell sharply on a rapid reassessment of future inflationary pressures.

What it means for investors:

Depending on one’s perspective, dramatic months like November can be either thrilling or nerve-racking. But they can also remind us of some elemental and often-overlooked portfolio tasks. Read on for more.

 

A closer look

November was a month for the history books. Following the election of Donald J. Trump, domestic equities rallied, international stocks slipped, and bonds sputtered. And all of this happened as the U.S. dollar moved sharply higher. Pundits argued that market action was driven by a sense that Trump’s policies would spur domestic economic growth, challenge the trade dynamics between countries, and contribute to intermediate- to long-term inflationary pressures.

  • The element of surprise: One of the main reasons market action was so pronounced in November—across a variety of asset classes—may have been that many analysts and investors saw a Trump victory as a lower-probability event. So when it came, they may have found themselves scrambling to catch up. As it turns out, Trump not only won the presidency, but Republicans also secured a majority in both houses of Congress. This doesn’t necessarily mean Trump will have the support he needs to pass all his policy proposals (and some may be left behind on the campaign trail), but he could make significant changes in a number of key areas.

  • Higher rates for the holidays? The U.S. Federal Reserve (the Fed) held interest rates steady in November, but gave hints throughout the month that a rate hike would most likely occur at its December meeting. As a result, some outlets have estimated the odds of a December rate hike at close to 100%. With a strong housing market, solid employment numbers, and GDP increasing at a 3.2% annual clip in the third quarter, the environment the Fed has long been waiting for may have finally arrived.
major asset class trailing returns graph as of 11/30/2016

Domestic equities

In the U.S., stocks finished sharply higher in November. This was especially true of U.S. small caps, which surged by double-digit percentages.

The large-cap-oriented S&P 500® rallied 3.70% during the month, and is now up 9.79% year to date. According to many market observers, the month’s big gain may have been driven by the expectation that President-elect Trump’s stated policy aims toward lower individual and corporate taxes, additional government spending, and reduced regulation would boost growth prospects, while also fanning inflation fears. This view may be reinforced by the makeup of Congress, which—with full Republican control—may be supportive of many of Trump’s proposals.

If large caps rallied in November, small caps roared. The small-cap-oriented Russell 2000 Index jumped 11.15% on the month, its best performance in more than five years. The index is now up 18.00% so far in 2016.

Post-election, the case for small caps may be somewhat less obvious than for their large-cap counterparts. Small-cap stocks tend to be more reliant on debt to fund operations and growth, and with bond yields rising so sharply over the past month, this may become a more expensive proposition. However, because small caps are more focused on serving the U.S. market, they’re somewhat shielded from the rally in the U.S. dollar. U.S. multinationals aren’t quite as lucky, as they need to convert foreign-made profits back into dollars from weakening foreign currencies.

As one might guess from November’s headline numbers, there were major moves in the sectors that make up the U.S. equity markets (based on the S&P 500 sector indexes). Thanks to the anticipated Fed hike, an increase in interest rates, and Trump’s commitment to lower regulation, financials were the strongest sector for the month, up almost 14%. Next in line were industrials, which benefited from the prospect of increased infrastructure spending. On the downside, utilities and consumer staples (both dividend-focused sectors) were the weakest, losing ground on increased competition for investment from higher bond yields.

On a year-to-date basis, energy continued to be the top performer, followed by industrials and financials, while health care, consumer staples, and consumer discretionary were the weakest. Health care is the only sector in the red so far this year.

According to the Russell 3000 Growth and Value Indexes, value was a significant outperformer in November, leading growth by more than 3½ percentage points. For the year, value remains the leader—now returning more than nine percentage points more than growth.

International equities

International stocks were substantially lower in November, with emerging markets bearing the brunt of the losses. Market observers believe weakness outside the U.S. was likely a reaction to what many see as the isolationist tendencies of President-elect Trump, including his desire to end or renegotiate international trade agreements.

Let’s take a look at developed markets first. The MSCI EAFE Index, a widely followed measure of developed market performance, fell 1.99% in November, and is now down 2.34% so far this year. Among the index’s component regions, Europe (outside the U.K.) was particularly weak, perhaps due to continuing concerns about growth in the region.

Elsewhere, the MSCI Emerging Markets Index finished 4.60% lower (the worst performance of any major index we track), while maintaining a year-to-date gain of 10.94%. Latin American stocks were hit the hardest. Given Trump’s campaign trail rhetoric toward Mexico, investors in the region are likely concerned about how future U.S. trade policy will affect our neighbors to the south.

It may also be worth noting that emerging markets tend to experience weakness on gains in the U.S. dollar, which—among other things—can negatively affect the borrowing costs of emerging market governments and corporations.

Fixed income

November was a challenging month for U.S. bonds—and that’s putting it mildly. Bonds were essentially hit on two fronts: A sharp increase in the likelihood of a December rate hike from the Fed, plus expectations for significantly higher inflation due to President-elect Trump’s proposals. The Barclays U.S. Aggregate Index fell 2.37% for the month, its lowest monthly performance in more than 12 years. Year to date, however, the index is still hanging on to a gain of 2.50%.

In the U.S. Treasury arena, the yield on the benchmark 10-year note jumped an astonishing 53 basis points, the biggest monthly increase since 2009, and is now up 10 basis points for the year so far. (A basis point is one one-hundredth of a percent.) At month’s end, the 10-year yield stood at 2.37%. The yield curve steepened as well, with the biggest moves taking place at the intermediate section of the curve.

Except for ultra-conservative T-bills, all U.S. fixed income sectors were negative for the month. Short-term U.S. Treasuries showed the smallest decline in November, followed by high-yield bonds (also known as junk bonds). Long-term Treasuries were the weakest, as investors quickly reassessed long-term inflation assumptions post-election. Intermediate-term Treasuries and corporate bonds were also weak. Year to date, high-yield bonds continued to lap the competition, followed by corporate bonds and TIPS. T-bills and short-term Treasuries have lagged.

The bottom line

As we approach the end of 2016, the S&P 500 is currently up almost 10% year to date, which is quite a leap from January, when many investors were heading for the hills. (The S&P 500 was down 4.96% that month.) As we now know, the markets ultimately recovered, and U.S. large caps are now up more than 20% from their February lows.

But what does this mean for one’s investments? Basically, well-diversified investors who didn’t flinch at the start of the year may now be seeing favorable year-to-date returns. Those who panicked and sold, however, may have missed out on the gains. This, of course, underscores the importance of maintaining a long-term perspective.

To that end, as the year draws to a close, there are several important steps each investor should consider no matter what transpired during the year, all described below. It’s sometimes easy to lose sight of tried-and-true portfolio upkeep in the face of dramatic market movement. And please keep in mind that it’s always a good idea to consult with a tax or financial advisor before making any big portfolio changes.

  • Look into the benefits of tax-loss harvesting. Investors who have securities that have lost value in taxable accounts may be able to sell those securities to offset any realized capital gains and distributions, and possibly up to $3,000 of earned income.

  • Contribute to an IRA. Investors have until April 15, 2017 to make IRA contributions for the 2016 tax year. That allows plenty of time to continue saving for this year’s contributions. But keep in mind that making a contribution early, if funds are available, may allow more time for potential gains to accrue.

  • Review and rebalance. Investors who regularly review their portfolio can proactively determine if their allocations still align with their personal investment goals and objectives, and then rebalance if necessary. Case in point: An investor who rebalanced back in February may have automatically added to U.S. equities, thus grabbing additional shares when prices were lower.

In closing, while the election’s now behind us, there’s still a lot of uncertainty in the air. Will the Fed raise rates? How will Trump’s term start? What policies will he and Congress pursue and ultimately agree on? And how will those policies affect the markets? Of course, no one knows for sure. In our view, in spite of all the noise and uncertainty, maintaining a well-constructed, broadly diversified portfolio—in keeping with one’s time horizon and risk tolerance—is one of the most important elements of long-term investing.

 

Thank you for reading.

Mike Loewengart

Vice President, Investment Strategy

E*TRADE Capital Management, LLC

 

Additional contributor:

Andrew Cohen, CFA

Director, Investment Strategy

E*TRADE Capital Management, LLC

 

Mike Loewengart is the Vice President of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Mike started his career as a research analyst and an investment manager due diligence analyst for the consulting divisions of several high-profile investment firms. He is a graduate of Middlebury College with a degree in economics.

Andrew Cohen is a Director of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE, Andrew was the Director of Investments and Operations for a large Registered Investment Advisor, where his responsibilities included investment manager research, asset allocation, and portfolio construction. Previously, he was a Senior Research Analyst and Team Leader for a leading wealth management platform. He is a CFA charterholder and a member of both the New York Society of Security Analysts and CFA Institute. He is a graduate of Virginia Tech with a B.S. in Finance.