compasspoints

When Pigs Fly: Making Sense of the Post-Election Markets

Compass Points December 04, 2016

When Pigs FlyLast month's presidential election outcome stunned most of us—regardless of whom you voted for—and called into question the reliability of political forecasting. In the days that have followed, we have also seen that the financial markets have not gone into free fall, as many predicted.

 

Stock markets declined in the hours immediately following the declaration of a winner, but the overall trajectory in subsequent weeks has been a positive one for equities. On the fixed income side, bond values have declined as interest rates have increased.

 

While the turn of events in our country—both political and financial—may feel like a "when pigs fly" moment, it does reinforce a point we try to make repeatedly in this newsletter: Trying to predict what markets will do in the future is not a prudent strategy for making investment decisions.


But what we can do is try to understand what may be happening with the markets in real time. So, here is our assessment of the market action in recent weeks ...

 

What's behind the stock market's surge?

 

With regard to the stock market's healthy advance after November 9, the main areas of gain have been in the industrial, financial and healthcare sectors—the industries which stand to gain the most under the new administration's espoused policies, which are expected to be heavy on infrastructure spending and deregulation (financial and healthcare).

 

Some of the timing of the rally may be coincidental, however.

 

First, we have just emerged from five quarters of declining corporate earnings. Most experts believed this to be the low-water mark in the "earnings recession," suggesting that stocks were poised to rally over the next several quarters—regardless of the election outcome. The president-elect, true to his nature, may have simply been the accelerant that caused this fire to burn faster.

 

Second, we are emerging from a long period of monetary policy marked by historically low interest rates (the response to the 2008 recession). Central banks in the U.S. and Europe have signaled that the limits of this monetary stimulus have been reached and are calling for governments to engage in fiscal stimulus through increased government spending. The stock market reads this shift toward fiscal stimulus as a new influx of investment and a growth opportunity.

 

Why the downward effect on bond markets?

 

The new administration's policies, as far as we can surmise, are likely to be inflationary. If it follows through with a massive infrastructure spending plan, an increase in the cost of goods and services is a fairly certain byproduct.  Increased government spending in conjunction with trumpeted tax cuts may expand the federal deficit. Additionally, promises to abandon trade deals and take a more protectionist stance may cause a decline in the United States' credit rating, which increases the cost for us to borrow money.

 

All of this together creates the conditions for higher interest rates, which in turn depresses bond values. Since the election, we have seen the interest rate on the 10-year Treasury Bond (generally considered a proxy for interest rates) rise to a high of 2.28%—a significant increase from its 1.36% low in July. This rapid movement in rates could be in anticipation of the new administration's positions.

 

It could also be attributed to expectations—already in motion before the election—that the Federal Reserve Bank will raise interest rates at its next meeting in December and possibly again next year. As described above, the Fed and European Central Bank believe the anti-recessionary effects of keeping long-term interest rates low have been fully played out. They have shown intent to allow long-term rates to increase more than short-term rates—and in doing so, hopefully re-inflate their economies and help their financial sectors.

 

Whatever the nature of the causation, bond markets are reacting accordingly by falling in value.

 

What now?

 

We are still confident in the underlying strength of equities in the near term and believe the earnings upcycle would have happened regardless of who won the election. The stock market remains the best tool for preserving the purchasing power of our savings over the long run.

 

We anticipate bond markets will begin to settle down—and, indeed, this may already be happening. Many experts feel interest rates have completed their near-term adjustment and that the pace of increase may be unsustainable. The expected interest rate hikes from the Fed are most likely already factored into the equation. Possible risks to this scenario are two-fold: 1) The Fed continues to increase rates beyond what many experts are expecting; or 2) Inflation with sub-par growth moves the economy into a period of stagflation, as last seen in the 1970s and 1980s.

 

However, all of this is purely speculation, as we really have no clear idea what the immediate future holds with this new president and his advisors. This brings us back to our original point that, while it may be interesting to try to prognosticate about the future, the safest (and possibly most rewarding) path for investors is to follow an asset allocation strategy that emphasizes diversification.

 

As you wonder how to respond to the extraordinary events of this election year, we encourage you to take this opportunity to review your holdings. Are you sufficiently diversified? Do your investments still correspond with your time frame and objectives? As your advisor, these are things that I monitor on an ongoing basis. Together we can ensure that your financial plan remains on track.

 


 

Estes Wealth Strategies is an independent firm. Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC.
 

Any opinions in this newsletter are those of Estes Wealth Strategies and John Estes and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.

 

Diversification and asset allocation do not guarantee a profit nor protect against loss. Investments are subject to risk including the possible loss of capital. Certain conditions may apply.  
Rebalancing a non-retirement account could be a taxable event that may increase your tax liability.
 
The information provided does not purport to be a comprehensive description of securities, markets, or other developments. This information has been obtained from sources considered reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information provided is not a complete summary or statement of all available data necessary for making an investment decision, nor does it constitute a recommendation.