RAA_Blog-Banner.jpg

The Blog

The New Administration and the Market

Posted by RAA on Dec 6, 2016 12:00:00 PM


administration-and-the-marketNow that the election is over, there is the potential for policy settings to flip from “easy money, tight fiscal” to “tight money, easy fiscal.” By “tight money,” we mean that interest rates are going higher, as we have already seen.

Easy fiscal means that the federal debt is going higher as we potentially embark on fiscal or government spending for infrastructure projects, modernizing the military and a host of other spending projects that are meant to be pro-growth, while lowering income and corporate tax rates. Just recently, the Dallas Fed’s latest Texas manufacturing report released on November 28, 2016 showed a sharp rise in business activity and optimism during November. One manufacturing executive described his expectations that the administration would “…reduce the regulation, taxes and government interference…” He went on to highlight the potential benefits to business expansion, hiring and investments.

So, this is all great you say, but how is that going to affect my portfolio? Let’s drill down a bit to see how the markets might digest a pro-growth, lower tax rate scenario.

EFFECTS ON THE MARKET

As many of you already know, the stock market can get ahead of itself at times. An example of this might already have happened in the last several weeks. Since November 9th, the S&P 500 has advanced 3.3% while the Dow has moved higher by 4.3%. Both ending values were as of November 25, 2016; a nice run in just 2½ weeks. Please remember that while this short-term stock market run was occurring, bonds were going down in value as money was exiting bonds and going into stocks. As a side note, the reverse also happens, which is why we have balanced portfolios.

The Republicans’ election victory has prompted what we call a risk-on rally. In other words, the green light was turned on for the stock market, but for how long is anybody’s guess. Their victory is largely based on the notion of their vision that fiscal largesse will be realized. Ultimately, it will only be clear what policy changes are on the table once they officially take office in January. We are of the feeling that the Republicans, like the Democrats in 2008, will be unbounded since both ends of Pennsylvania Avenue are in their hands, at least as far as having a majority in both chambers. Therefore, they have a good chance of implementing Trump’s policies in his first two years.

If the new administration is able to deliver even close to the size and scope of fiscal stimulus policies noted pre-election, it will boost GDP growth above what is expected in 2017. If this occurs, the dynamic that has existed since 2010 (tight fiscal and very easy money policy) will flip to easy fiscal and tighter money policy. For the bond market and the US dollar, the implications are clear: Treasury yields are likely to head higher (and prices lower), and there will be pressure on the dollar to rise, which makes goods and services produced by our domestic multinational corporations more expensive to sell abroad. Implications for equities are less clear. The rapid rise in bond yields may make investors somewhat uneasy about the stock market, valuation wise, in the short term. As a result, we are comfortable being slightly underweight equities.

ISSUES WE ARE MONITORING

We believe there are four issues that are especially important for us to monitor that could have an effect on the markets. Let’s briefly look at each one:

1. Trade restrictions or tariffs.

Trump has repeatedly signaled his intention to restrict American openness to international trade. He can revoke international treaties and he can impose tariffs, both of which are inflationary. Historically, the US economy falls into a recession for two reasons. The first is growth-restrictive monetary policy and the second is an adverse supply shock that acts like a tax on growth. This would include tariffs, which increase prices in the near term. We are hopeful that potential tariffs are just talk and will not become reality.

2. Fiscal stimulus.

Trump has called for significantly lowering both income and corporate taxes, although his primary focus has been on infrastructure spending. The latter has the highest “multiplier” effect, meaning that the spending affects more people, ie. contractors, suppliers, manufactures, labor, etc. Gridlock should not be a problem given that Congress and the White House are now in GOP hands.

3. Monetary policy.

Due to cyclical and structural headwinds, which we do not have enough space to write about in this newsletter, we do see interest rates moderating higher, but only gradually so. Slow wage growth, labor market slack and a continuing decline/stabilization in the labor market participation rate should act as a headwind so the Feds will move slowly and gradually.

4. Less regulation and lower taxes.

Without question, less regulation will help corporations move forward with respect to growing their businesses and helping contribute to corporate earnings and ultimately GDP. Lower corporate taxes will help bring back corporate profits that are domiciled abroad, which can be used for building new plants and expansion, hiring, increasing inventory and increasing dividends.

We feel that the 10-year Treasury might be in a trading range for now with the direction moving slowly higher. We prefer intermediate bonds with shorter durations than the Barclays Aggregate. In addition, we continue to like TIPS within the bond space. Thids approach will help against a backdrop of rising interest rates. For equities, as we stated earlier in this newsletter, we are still somewhat defensive since the trailing 12-months P/E ratio and other metrics are signaling that they are in the higher risk zone. We continue to like the mid-cap space and are reevaluating the small-cap space, as they should not be as vulnerable to a strengthening dollar, which will probably happen with rising interest rates and be an impediment to domestic multinational corporations.

Please contact us at (972) 684-5923 if you have any questions.

 

NOT SURE WHERE TO START? 

Request your FREE Final Approach retirement planning guide.

Final approach binder - 2017.png

This guide is designed to help you understand the decisions you will need to make as you approach retirement and the factors that go into a comprehensive retirement plan. It includes:

  • A checklist for transitioning into retirement
  • Common investor pitfalls
  • An outline of your retirement benefits
  • A retirement timeline to help you know what to expect
  • Key topics to consider in your estate plan
  • The importance of survivor assistance


Request the Final Approach to find out how prepared you are for retirement.

Request Your Guide

 

 

  

Disclaimer: This blog is intended for informational purposes only and should not be construed as individual investment advice. Actual recommendations are provided by RAA following consultation and are custom-tailored to each investor’s unique needs and circumstances. The information contained herein is from sources believed to be accurate and reliable. However, RAA accepts no legal responsibility for any errors or omissions. Investments in stocks, bonds, and mutual funds may increase or decrease in value. Past performance is no guarantee of future results. Any of the charts and graphs included in this blog are not recommendations for the purchase and sale of any security. 

Topics: Investment Updates