Election Aftermath — January 2017

January 19, 2017

Dow Jones Average: 19,732
S&P 500 Index: 2,264

Election Aftermath

The election of Donald Trump as president of the United States came as a shock to most political pundits, pollsters, and much of the public. While there were many factors that produced the unlikely election outcome, in the final analysis it came down to a positive narrative versus a negative narrative about the state of America. The positive case was based on the strength of the U.S. economy, an expansion of health care access, and a substantial reduction of U.S. involvement in foreign wars. The positive narrative seemed strong, particularly with respect to the economy, as America has experienced seventy-five straight months of net, new job growth, low inflation, low unemployment, rebounding real estate values, a record high stock market, and cheap fuel prices. But the negative narrative of wealth inequality, the decline of certain industries such as coal, rising health care premiums and deductibles, and the possibility of terrorist attacks, swayed voters in key swing states. The positive narrative was strong enough to give Hillary Clinton a popular vote victory of close to three million votes, but the negative narrative gave Donald Trump the all-important win in the Electoral College.

Even though the party in power usually retains the Presidency if the economy is strong, an examination of regional, economic differences sheds light on why that did not happen in 2016. It was telling that Clinton never had a polling lead over Trump in Iowa, a state that Obama won handily in 2008 and 2012. The voters in Howard County, Iowa gave Obama the win by more than twenty percent in 2012, and this time around they chose Trump by more than twenty percent over Clinton. That astonishing swing of over forty percent was indicative of weakness for the Democratic ticket in the heartland. In August 2012, right before Obama’s re-election, the price of corn reached a record $8.49 a bushel, making Iowa farmers very happy. By the fall of 2016 the price of corn had fallen by 60% to $3.30 per bushel, making the farmers very grumpy. Iowa farmers alone saw their revenue from corn drop by more than 12 billion dollars, money that was no longer available to sustain other businesses in rural America. It would not be farfetched to say that the election of 2016 turned on the plunging price of corn, along with the steep decline in coal prices, milk prices, and oil prices. Essentially all the commodities produced largely in rural America have suffered price declines in the past four years. The pronounced weakness in the farm economy, combined with the long-term decline in manufacturing jobs, created fertile ground for Donald Trump’s message. When people are not doing as well economically, when they are feeling marginalized, they often blame outside forces such as immigration, trade agreements, or simply the government, for their troubles. Meanwhile, a state such as California has benefitted from almost all socio/economic trends. Many of the companies that people associate with modern day success, i.e., Facebook, Google, Apple, Netflix, Tesla, Uber, Airbnb, etc., are headquartered in California. The coastal states in the U.S. have benefitted as intellectual property (computer code, databases, and medical research) has gained in value, while hard assets such as coal, oil, and farmland have declined in value. It is not entirely surprising that Hillary Clinton won California by over four million votes, while losing by razor-thin margins in the upper Midwest.

One of the great ironies of the 2016 election was that Donald Trump won the White House for the Republicans by running against the Republican establishment, which included a Congress dominated by Republican House and Senate members. Even though Obama is ending his second term with very high approval ratings, that did not translate into a win for Clinton. On the contrary, voters chose to give the Republicans control over all branches of government, even though those same voters expressed frustration and contempt for the Republican controlled Congress. We live in strange times.

It will be interesting to see how the Republican Congress and the Trump administration decide to rule a polarized nation and their own divided party. We cannot envision policies that will appeal to a majority of Americans, are philosophically Republican, and serve the needs of Trump’s core constituency. Donald Trump ran as a populist, someone who was going to make life better for people who are struggling financially in the era of economic globalization. But if initial indications are correct, the first acts of Congress in 2017 may be a major cut in corporate taxes, deregulation of banks, and a repeal of the Affordable Care Act, moves that would not seem to benefit Trump’s constituency at all. The Republican Party has long represented upwardly mobile people, small business owners and entrepreneurs, figuring that as the “job creators” prospered so would everyone else. With Donald Trump’s election, the Republican base, along with many independents, have rejected that premise. We are curious to see what a Republican Party, now turned on its head, will do for what Trump calls “the forgotten Americans”.

We do expect that Donald Trump will follow through on his signature campaign theme of tougher trade agreements. In legislation from the 1970’s, Congress granted presidents wide latitude when it comes to trade agreements and tariffs. If his recent tweets are any indication, we expect Trump to use that power liberally. He has been chastising companies that produce products in other countries, and then sell those products to U.S. consumers. While his initial thrust has been directed largely at auto companies, many other multi-nationals could eventually be subject to the same criticism, and threatened with punishing tariffs. Wilbur Ross, who is Trump’s pick for Secretary of Commerce, says there will be no trade wars, but Trump’s words do not mirror that assertion. Financial markets have done well in an era marked by the free movement of capital, people, and goods around the world. If that changes in a major way after the Brexit vote in England and Trump’s ascension to the Presidency, we would expect a decline in share prices. So far the markets are taking Trump’s comments in stride, figuring that he is posturing more than planning to launch trade-killing tariffs.

Current Strategy

The stock market shuddered in the morning after Trump’s win, but then it turned around sharply and embarked on a two-month rally of about five percent. We thought the odds of Donald Trump winning the election were small, and we thought that the stock market would fall if he did happen to win. We were wrong on both counts, as Clinton’s solid, popular vote win did not translate to an Electoral College victory, and the major stock indices gained ground after Trump’s win. In retrospect it is easy to see why our predictions were off the mark. Hillary Clinton’s popular vote win was too concentrated in a few big states, leaving Trump with a thin advantage across much of America. And the stock market rallied when investors quickly decided that the Republicans were likely to take their foot off the economic brake, and apply the accelerator, now that they can take credit for the growth that may ensue. A vision of Reaganomics redux danced in investors’ heads, with big spending, tax cuts for all, and higher growth rates, which trumped fears that Donald Trump may initiate trade wars. Expectations have cooled a bit in recent days, as investors have come to the realization that some Congress members do care about paying for all the projected spending, that Trump may unilaterally impose trade tariffs, and that the economy may be hard to stimulate further as it is already running quite fast. Some of the knee-jerk reactions that took place in various stock groups have begun to moderate.

Our portfolio was not particularly designed for a Trump victory. The financial stocks surged after Trump’s win, on expectations of higher interest rates and less government regulation. While we did have some exposure to financial stocks, the gain in that part of client portfolios was somewhat offset by declines in medical companies and foreign holdings. The medical stocks have actually done fine in the Obama era, as access to health care increased, and initiatives were put in place to improve health outcomes. Investors are fearful that may change with the expected repeal of the Affordable Care Act. Foreign stocks have been hit by a rising U.S. Dollar, which has gained value on expectations of a higher rate of economic growth and higher U.S. interest rates. We have made some modest changes in the typical client portfolio since the election, paring back on financial holdings as prices surged, and actually putting some money into large, stable foreign companies that pay sizable dividends. Going forward we will be increasing the allocation to somewhat smaller companies, where we think the particular product trends at the company can drive growth in a variety of economic scenarios. Our overall allocation to stocks is on the conservative side, which still seems appropriate to us given the generally high stock valuation level, and the political and economic uncertainties at this time.

We continued to fill out the fixed income side of portfolios, at better yields thanks to the rise in interest rates following the election. Our bond buying had been concentrated in corporate paper for much of 2016, as it was the only sector offering decent returns. But after the election there was a sudden rise in municipal bond yields so we resumed our purchases of tax-exempt, municipal bonds.

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