The Presidential Election and Your Investments
A little over five weeks ago we had the second big election shock of 2016 (following the "Brexit" vote in June) when Donald Trump, a 3-to-1 underdog, won the US Presidential election. As the saying goes, "the markets hate surprises", and in my nearly 30 year career these are certainly two of the biggest surprises we've experienced.
In this post, we'll look at two important issues:
1. The lessons we can learn from how the markets reacted to this most recent surprise
2. How we might approach the investment world as it stands today
And before we get into this discussion, it's important to remember that we're trying to look at this from an unemotional perspective focused on the economic impact of the election. I fully understand that this election was about far more than economics, but it's long been said that emotions are the worst enemy of an investor, so the more we can try to set aside emotion and focus on the economic impact of this new administration on our finances the better off we'll be in the long run.
First, let's go back to the weeks leading up to the elections. Below are a few quotes (along with links to the full articles) capturing what the sentiment was among market "pros" heading into the election.
MIT Professor Simon Johnson on MarketWatch.com 10/31/16: "A big adverse surprise — like the election of Donald Trump in the U.S. — would likely cause the stock market to crash and plunge the world into recession."
From CNN Money article 10/24/16: "If Donald Trump wins the election, U.S. stocks (and likely many other markets overseas) will almost certainly tank. How big of a drop? Forecasting firm Macroeconomic Advisors predicts an 8% fall in the U.S. A new paper out Friday from the Brookings Institute projects a 10% to 15% nosedive. You get the idea."
Mark Cuban in Fortune magazine 9/7/16: “In the event Donald wins, I have no doubt in my mind the market tanks,” Cuban said.
This captures the prevailing wisdom at the time: a Trump victory would almost certainly spell doom and gloom for US stocks. Yet here's what actually happened post-election (November 8th close to December 16th close):
US stocks (S&P500) +5.94%
International stocks (EAFE Index) +1.38%
Intermediate-term US bonds (7-10 yr Treasury Index) -5.82%
Long-term US bonds (20+ yr Treasury Index) -10.32%
So Trump wins, stocks rally, and bonds get hammered. Pretty much the exact opposite of what Wall Street pros predicted...
Issue #1: what can we learn from this?
First, we once again see the fallacy of trying to predict short-term moves in the markets. While an entire industry is built around newsletters and websites that claim to be able to predict the future, not only is it a fools game, but this kind of investing mentality can cause long-term damage to your portfolio. Here's a good article from Kiplinger's on this issue. It's probably not a stretch to say that as the election results became clear the vast majority of investors would have jumped at the chance to spin the clock back 24 hours and sell all of their stocks, yet that would have been a very costly decision.
So what is a good way to approach situations like the elections where there was a large perceived risk to your portfolio? Adjust your risk on the margin, to a point where you're comfortable with whatever outcome there is. For example, heading into the election, it was entirely reasonable to go from having 70% of your portfolio down to 60% or even 55%. Take some risk off the table, turn the volume down a bit, to a point where you won't lose sleep worrying about the outcome but you'll also be positioned so that an unforeseen reaction (like stocks rallying on a Trump victory) will still benefit you. Market pros continually adjust their risk profile, particularly ahead of significant events that could impact markets. But adjust risk on the margin: going from 100% invested to 100% cash rarely works to your advantage. While you sacrifice some "opportunity cost" of not being fully invested if stocks rise more importantly you avoid the dangerous "knee-jerk reactions" that can come with being fully invested when negative surprises happen.
This brings us to issue two: with such an unexpected reaction in investment markets to the election of Trump, what should we expect going forward?
In the weeks since the election, markets have focused on the stimulative policies Trump has proposed: corporate and individual tax reform, infrastructure spending, less regulation, policies that generally help and economy grow. Much of the positive impact of these policies has rapidly been "priced in" to the shares of companies who stand to benefit. For example, bank stocks have rallied on average 17% since the election, and energy stocks are up 11%. So far it feels like a "honeymoon" period, where all of the positives capture the market's attention, and seemingly there are no negatives.
At times like this, it can be helpful to look back at why so many prognosticators thought stocks would "tank" if Trump was elected. Are any of the concerns people had back then still valid? Clearly the concern of the uncertainty in policy and approach to governing that a newcomer like Trump might bring to the White House seems valid. And the impact of protectionist policy (moving away from free trade) still seems valid. How the US relates to important world powers like China and Russia still is very much in question.
Taking some risk off the table pre-election was not flawed thinking, and with markets up since the election if you still have deep concerns about what the next four years might bring, if you still agree that some of the pre-election concerns are valid today, maybe this is an opportunity to adjust the risk in your portfolio to a level where you feel confident that whatever the markets do you'll be ok with the ride.
As always, I'm here to review your portfolio, goals, and risk, and I'd welcome the opportunity to help you ensure you're on track to meet your goals and still sleep well at night.