After the U.S. election: Exploring a new investment landscape
November 17, 2016
The U.S. electorate surprised markets globally by voting Donald J. Trump into office on Nov. 8. The ensuing transfer of power in the White House could be among the most significant in U.S. history. Fiscal policy, monetary policy, infrastructure spending, trade relations — these are but a few of the economic levers that could ultimately be pulled in new directions. In the following sections, investment staff across Delaware Investments share their thoughts about possible implications for the asset classes they cover.
We think investors should keep in mind that Donald Trump’s surprise victory does not automatically mean his policy ideas will be completely implemented. With Republicans now in control of the executive and legislative branches of government, one could be forgiven for assuming that legislation will flow smoothly and follow a party-line agenda. But we should not lose sight of structural challenges that could temper the legislative pace. Stubbornly low productivity, relatively slow gross domestic product (GDP) growth, a big debt overhang, demographic shifts, and a growing level of wealth inequality are among the real challenges that must be addressed. Another significant uncertainty is the fate of the Federal Reserve. As a result, the order and magnitude of policy changes remains uncertain.
In the immediate aftermath of the election, markets adopted a risk-on posture — the opposite of what professional investors had expected. The Treasury yield curve has steepened, with the longer end selling off to a higher degree than the shorter end. Overall, selling of Treasurys has been widespread, and we are using it as a chance to add duration in this sector.
Municipal bonds have seen softer bids as well, in sync with their Treasury peers, in a relationship that is not uncommon. The incoming administration has put tax cuts at the top of its agenda, which could lessen the appeal of tax-advantaged investing. What’s more, we could see heavy selling if Congress passes a cap on the tax exemptions allowed for municipal income. It’s fair to say that this is one of the bigger possible threats to the asset class. We think municipals will see consistent bids eventually. It’s likely they will indeed find a steady level when proposals for a new tax code are better understood, which will probably be some time next year.
In corporates, meanwhile, demand has remained strong, driven in part by overseas investors who are taking part in the global hunt for yield. Liquidity is in good shape as well.
One factor that can influence performance across all fixed income sectors is inflation. Investors are asking, will there be an inflation scare? Won’t the new administration’s deficit spending tactics be inflationary? We think the structural problems listed above are more important than any immediate threat of inflation. We also remind investors that details on any deficit spending program are in short supply this early in the game.
Donald Trump’s victory carries a high degree of uncertainty across numerous policy fronts, and it could provoke periods of volatility as his administration gets under way. However, it should be noted that from a practical perspective, the new president will probably have little leeway in advancing his proposals. Any president’s ability to intervene in the country’s economic trajectory is severely constrained by constitutional checks and balances.
One notable exception, however, is the power to conduct foreign policy, including the negotiation and administration of trade agreements. As president, Mr. Trump’s anti-globalization rhetoric may have significant ramifications globally, depending on how aggressively his administration chooses to pursue them. Even if the specter of economic disruption ultimately hinders U.S. withdrawal from global trade, the mildest effort could reverberate significantly across other players in the global economy.
We note a few additional points that are top of mind:
- The new administration may pursue policies that have uneven effects across different parts of our investment universe. There may be periods of indiscriminate selling or buying because of this. This can create opportunities for us to find value by looking past the headlines and actually understanding how a company’s competitive positioning and long-term prospects may (or may not) change.
- A Trump administration or Republican Congress doesn’t change the fact that emerging market equities have attractive qualities. Valuations are collectively much cheaper than in developed markets, currencies are reasonably valued or inexpensive, major countries are already in the process of making structural adjustments, and secular opportunities for growth are high. We believe markets will recognize these developments in time.
- The fact that one party will have the majority in Washington should open the way for structural reform, which could be a net positive for the U.S. economy in the coming years. There could be complications, however. To begin with, a global trade war triggered by hasty measures against Mexico or China could likely affect growth in many countries around the world. Furthermore, the vote for Mr. Trump is emblematic of the populist movements making themselves heard in major European countries, which are themselves a source of market anxiety.
- Eventually, markets will shake off the uncertainty surrounding the election and focus on the underlying policy proposals, which might well be supportive of U.S. companies. (The infrastructure sector offers a good example. Mr. Trump has spoken repeatedly about making infrastructure spending a significant catalyst for GDP growth.) For global markets, particularly currency markets, it will be important to see if there are staffing changes at the Fed. Already, there has been discussion of Fed Chairwoman Janet Yellen stepping down, perhaps delaying the next rate hike.
- For companies on the smaller end of the capitalization spectrum, periods of volatility could be particularly challenging. With so much uncertainty swirling throughout markets, small-cap stocks could very well lag their larger-cap peers.
Focus and discipline amid unknowns and distractions
Many analysts and political scientists are interpreting the election results as a backlash against the status quo, and in many ways, we believe they are right. The U.S., as they see it, is now an official participant in the wave of populist activity that has been spreading globally. Income disparity, joblessness, immigration, and other concerns are informing the global conversation, and we now have a seat at that particular table.
As professional asset managers, we are responsible for taking a holistic view of the markets we cover, seeking to understand the probabilities of potential changes in asset prices. We believe we are also responsible for being flexible and avoiding thoughtless reactions. In the coming quarters, we will therefore adjust to market conditions as they unfold, always keeping in mind that there are bound to be differences between campaign promises and actual policy results.
The views expressed represent the Manager's assessment of the market environment as of Nov. 17, 2016, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
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IMPORTANT RISK CONSIDERATIONS
Investing involves risk, including the possible loss of principal.
Past performance does not guarantee future results.
International investments entail risks not ordinarily associated with US investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations. Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
Investments in small and/or medium-sized companies typically exhibit greater risk and higher volatility than larger, more established companies.
Duration measures a bond's sensitivity to interest rates, by indicating the approximate percentage of a change in a bond or bond fund's price given a 1% change in interest rates.