John Gorlow
| Dec 05, 2016
U.S. stocks rallied in November as Trump’s victory fed optimism about a new Reagan-like era of growth fueled by tax cuts and spending. The Dow Jones Industrial Average rose 5.4% for the month, its best performance since March, crossing the 19,000 mark for the first time while setting eight new records along the way. The S&P 500 ended at 2198.81, returning 3.4% for the month. The Nasdaq Composite closed at 5323.68, adding 2.6% for the month.
Is that optimism justified? Does the comparison with “a new Reagan era” really make sense? There’s plenty of uncertainty about Mr. Trump’s administration and policy stances, and the market’s rally may soon give way to a more sober assessment. We’ll take a closer look at the Reagan parallels (or lack thereof) in this month’s feature section. But first, a look at the November numbers.
US Markets: The S&P 500 set four new closing highs, passing the 2200 mark for the first time, then closing the month at 2198.81 for a return of 3.70%. Year-to-date (YTD), the index returned 9.79%, which annualizes out to 10.71%. Small companies were among the biggest winners. The Russell 2000 index of small-cap stocks soared in November, posting a broad 11.15% return after last month’s 4.75% correction. This followed eight months of gains. The net result is an 18% YTD return for the index.
International Developed Markets: The unexpected U.S. election results were a boon to U.S. markets. But the news was not as good for non-U.S. markets as questions over policy and spending abroad swirled through the markets. Developed ex-US markets fell -1.60% after last month’s -1.94% loss. Spain did the worst, declining -8.61% for the month, and was off -11.02% YTD. Portugal fell -7.58% and was off -14.16% YTD. Italy dropped -4.7% for the month, ahead of the country’s constitutional referendum, and was down -22.72% YTD. YTD, developed ex-US markets as measured by the MSCI World Index were up 5.00%, but excluding the US they were in the red, off -0.50%. This lopsided monthly result was not new. For the three-year period, the annualized return for the MSCI World Index was 3.71%, but absent the U.S. 9.07% return, it was down -2.15% per annum.
Emerging Markets: Spooked by U.S. election results, emerging markets reversed course in November, falling -4.60%, with only 3 of the 22 markets rising. Greece did the best for the month, up 8.11%, but remained down -1.8% YTD. Russia added 3.97% for the month and was up 33.42% YTD. Egypt did the worst, off -30.84% for the month and off -26.72% YTD. Despite a rocky ride for the month, emerging markets returned 10.94% YTD (as measured by the MSCI Emerging Markets Index), outperforming both the S&P 500 U.S. benchmark and developed markets outside the US.
Yields, Rates and Commodities: November was brutal for bonds. U.S. government bond prices declined, capping their worst month in seven years amid solid U.S. economic data (the Commerce Department reported that Q3 gross domestic product had its strongest growth in two years), plus expectations that the Federal Reserve will soon raise interest rates. The yield on the benchmark 10-year Treasury note settled at 2.365%, its highest closing level since July 2015. That was up from 1.834% at the end of October, marking the largest one-month increase for the yield since December 2009. Some investors view this as a sign that the “lower-for-longer” interest rate theme has lost credence in the market.
Making Sense of It All
What happens from here? Analysts and pundits are uncertain (a rare event). But that hasn’t stopped them from guessing, offering opinions and analyzing countless potential scenarios.
For instance, on the issue of the emerging markets sell-off, Mohamed El-Erian (16-November Financial Times) notes inconsistency “with some of the important drivers of the U.S. equity rally.” He writes: “If the EM interpretation is the correct one [looming protectionism and higher interest rates], US stocks have some rough sledding ahead. If, however, emerging markets have misread the president-elect’s policy intentions, then these beaten down assets have more upside over the next year than that offered by US stocks.”
The outlook for continuing pressure on U.S. Treasury yields is just as murky. The Financial Times (OpEd, 27-November) writes that a loosening of fiscal policy “would be welcome if done in a way that delivered a swift boost to demand.” In the same article: “If Trump’s fiscal easing does not, in the end, do much to boost aggregate demand, US Treasury yields could fall back.”
Uncertainty over Trump’s policies is heightened by the question of how willingly the Republican-
led House and Senate will follow the new president. “Stock traders celebrating Trump’s election have bid up equity prices on a risky bet: that the new president will steer congressional Republicans in a U-turn away from their tightfisted fiscal policies — and bring Democrats along for the ride,” writes Jackie Calmes (29-November, New York Times). Has anyone consulted the Tea Party lately?
Others are attempting to explain the future by looking to the past, comparing the Trump presidency to the era of Ronald Reagan. Reagan cut taxes, went on a spending spree, and helped propel a soaring stock market (in the end, leaving the U.S. with a gaping deficit).
John Authers roundly debunks the idea that our current situation is parallel. “In early 1981, bonds had never been cheaper, yielding almost 15 per cent, while stocks were close to their cheapest of all time. These were perfect conditions for a stimulus to nudge the stock market into big gains,” he writes (Financial Times, 26-November), pointing to calculations by economist Robert Shiller. “Stocks were trading at a multiple of about 8 times their cyclically adjusted earnings (their average over the previous decade) when Mr. Reagan took office in 1981. Long-term bond yields stood at 12.5 per cent. Paul Volcker’s Federal Reserve was waging war on inflation. The economy was in recession.”
“The situation as Mr. Trump enters could not be more different,” Authers states. “Bond yields hit a postwar low of 1.6 per cent in the summer and are now rising. The Fed, after a period of unprecedented leniency, is raising rates. And stocks are far more expensive, at 26.5 times cyclical earnings. The economy is not booming — as made plain by the anger in the electorate — but there is far less slack than there was when Mr. Reagan arrived.”
He concludes that conditions under Reagan “were almost perfect for a fiscal stimulus, and higher stock valuations” while a “big Keynesian expansion at this point in the cycle is far more questionable. This could translate into higher rates when companies are heavily indebted and lower earnings multiples on stocks. It is hard to see how Trumponomics can possibly replicate Reaganomics starting from where Mr. Trump must start….”
Not exactly reassuring. Then again, it’s not reassuring that no one seems to know what Mr. Trump’s economic policies really are. They may not be Reaganesque after all.
Stay the Course
One thing is certain: we are living in an era of great uncertainty. Time will tell whether a President Trump will behave differently from a candidate Trump (so far, no one has managed to wrestle the new president away from Twitter). Will he unite Republicans? Will the Tea Party continue its revolt? Will Democrats make a comeback? What will happen if diplomatic gaffes upset U.S. relationships with China and other economic powers? Will Mr. Trump’s business interests have an impact on U.S. policies?
We have no answers. No one else does either. This is precisely why it makes sense to have a passively managed portfolio with broad index investing as its backbone. Trading on news and predictions works against long-term financial performance. Whether the market soars or plummets, you will be most successful when you follow a proven strategy, have a properly diversified portfolio, and stick to a plan that’s built around your own long-term goals. Our advice? Keep your eyes on the road and hands on the wheel. Stay disciplined.