Handling the Post-Election Realignment

The last few weeks are evidence that market forecasters don’t know much. They said before the election that a Clinton victory would be good for stocks and a Trump victory would be bad for stocks. Some observers were forecasting sharp drops of 10% to 15% if Trump were to win.

Traders initially followed this view. In overnight futures trading, the Dow Jones Industrial Average declined about 900 points immediately after the Trump victory was apparent. That view quickly was overtaken by a new view that a Trump administration would be good for the economy and stocks because of fiscal stimulus through infrastructure spending, tax reform and regulatory relief. Within a week, the Dow gained about 1,000 points from its pre-election close. That’s almost a 2,000-point reversal from the lows of election night.

Other market effects in the week following the election included sharp rises in the dollar and interest rates and sharp declines in prices of bonds and emerging market stocks, especially Latin American stocks. T. Rowe Price Latin America is down 8.08% for the last week.

Markets re-price assets based on the changing perceptions of active investors. Be skeptical about overhauling your portfolio to capture these new trends and views. Instead, we look at the factors that matter to markets to position our portfolios and try to maintain balance and diversification.

Let’s review a little history. When Ronald Reagan announced his economic policy, high inflation was expected. Instead, inflation declined fairly steadily not only through his presidency but well beyond. When Barack Obama announced his fiscal stimulus plan in 2009, it was expected to generate both high growth and high inflation. Instead, inflation continued to decline and growth was very tepid. Likewise, when the Federal Reserve first implemented quantitative easing, high inflation was expected to follow. We’re still waiting for inflation to hit the Fed’s 2% target.

Most people who help form public perceptions don’t know what they’re talking about and change their views quickly. They can influence short-term market moves, but beyond that the economic fundamentals prevail.

As I wrote last week, the election doesn’t change prevailing trends. The U.S. economy continues to grow at a modest pace. There are modest pressures for higher inflation, largely because wages are rising and deflationary forces are abating. Most economies outside of the United States continue to struggle, but there are some attractive non-U.S. opportunities.

We saw that interest rates, inflation and commodity prices were rising well before the election. We made portfolio changes in line with that view last summer. I think this week’s decline in Latin American stocks is overdone. Those economies will continue to benefit from rising commodity prices. I’ll re-assess that view in the coming weeks as the policies of the new administration become clearer.

The Data

Consumers seemed to be positive going into the election. Last week’s Consumer Sentiment, as measured by the University of Michigan, rose to 91.6 from 87.2. The measure had been declining modestly since May but remains in the range it has been in the last two years.

Consistent with that, retail sales surged 0.8% in October. In addition, September’s sales were revised even higher to 1.0%. Even after subtracting autos and gas, the sales increases still were strong.

The Empire State Manufacturing Survey turned positive after months of negative numbers. The survey reading was a modest 1.5. But that was well above expectations and just might be an indication that manufacturing found the bottom.

In addition, the Philadelphia Fed Business Outlook Survey came in at 7.6, the fourth consecutive positive number and in line with expectations.

Industrial Production was flat, and last month’s number was revised lower to negative 0.2%. But the manufacturing component of the report increased 0.2% in each of those months. This is another piece of good news for manufacturing.

In housing, there was no change in the Housing Market Index from the NAHB. Home builders continue to be optimistic, and that optimism has been justified by new home sales.

Housing starts had a disappointing headline number of a 9% decline from last month. But that was due to a 38% decline in the overbuilt multifamily housing sector. Single-family home starts increased 8%, indicating the home market still is healthy. It will be interesting to see how the recent rise in mortgage rates will affect home purchases.

Consumer inflation appears to be taking hold, as we’ve expected. The headline for the Consumer Price Index (CPI) rose 0.4% in the last month, though after excluding food and energy it rose only 0.1%. Over 12 months, the headline consumer inflation number is up 1.6%. After excluding food and energy, it is up 2.1%.

New unemployment claims declined a sharp 19,000. That brings new claims to the lowest level since 1973. Continuing claims also declined to a 16-year low. And new claims have been below 300,000 for 89 consecutive weeks, the longest streak since 1970.

The Markets

U.S. stocks had a great week, but bond and emerging market investors suffered. The markets overreacted to the election. I expect some of this week’s action soon will be reversed.

The S&P 500 gained 0.69% in the week ended with Wednesday’s close. The Dow Jones Industrials popped 1.62%. Small company stocks had the best week, rising 5.71%. International stocks didn’t fare as well, at least partly because the dollar rose. The All-Country World Index lost 0.65%. Emerging market equities lost 4.30%.

Long-term treasuries lost 1.25%. Investment-grade bonds lost 0.58%. Treasury Inflation-Protected Securities (TIPS) lost 0.95%. High-yield bonds lost 0.61%.

The dollar gained 1.76%.

Energy-based commodities gained 1.26%. Broader-based commodities lost 1.90%. Gold tumbled 3.99%.

Bob’s News & Updates

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Some Reading for You

Medicare premiums will rise a bit in 2017, but higher-income beneficiaries see higher increases and could pay $10,000 in annual premiums.

India made a little-noticed move, abolishing a lot of currency in a stated attempt to reduce corruption and some crime.

Compensation is increasing at a faster rate, which should be good for growth and retail sales but increase inflation and reduce profit margins.

I comment and link to these and other items on my public blog at http://www.bobcarlson.net.