Trump Wins – What’s Next for the Market? From the 11/13/2016 Client Letter
Wow. What an interesting week for the markets.
A quick recap, and then a brief summary of how I see events impacting markets over the next quarters:
Early Wednesday morning, market futures began selling off as a Trump victory began to look possible. As those odds increased, the futures markets began to sell off in earnest. At one point Dow futures were down more than 800 points. Other exchanges such as the NASDAQ saw circuit breakers triggered to slow the downward cascade. Overseas markets, which had gone negative as the electoral votes piled up in Trump’s column, also sold off more deeply.
For those that don’t know, when this happens the market usually opens where the after-hours trade left off. So it was looking like the markets were going to experience a very bad day.
Then something changed. Futures began to make up lost ground, overseas markets began to rise. Often, following a large directional move, the markets will retrace part of that move prior to reversing again to continue in the same direction as before. In this case, down.
But that’s not what happened Wednesday morning.
Markets opened slightly down from Tuesday’s regular session and then proceeded to rally the rest of the day. The Dow’s move from down over 800 points after hours to rally nearly 6% from the futures low and reach an all-time high the day after the election results may be as unprecedented as Trump’s come from behind victory in election.
Many of Trump’s campaign promises were slim on details and big on promise, as is often the case with politicians seeking election. But Trump had more unknowns than most and the markets dislike uncertainty.
This uncertainty helped drive the futures selloff. But what changed in the early hours of Wednesday morning?
Markets globally began to rally when it became clear that in addition to the Presidency, Republicans would also take the House and the Senate. Instead of a gridlocked DC with Democrats holding the Senate or Congress, real change suddenly became possible.
It didn’t mean that everything would change, but that some items of Trump’s agenda were suddenly probable, and without a term long fight with the opposition.
As a family member of mine expressed it, the Republican sweep is perceived as The Free Market Revived.
What exactly does this mean, and how might it impact markets in the near term?
First off, lower taxes. America has one of the highest corporate tax rates in the world. Lowering corporate taxes makes America more competitive as a home market for both our corporations and multi-nationals located in higher tax rate jurisdictions. Think of the tax inversions we’ve seen in the last couple years, when large US companies make an acquisition to get their corporate taxation domiciled in Ireland or elsewhere. It’s reasonable to expect multi-nationals elsewhere to start attempting American tax inversion if Trump gets his 15% corporate tax rate. More jobs.
Lowering the corporate tax rate also leaves more $ in private sector hands, which is traditionally much more efficient with capital than government. This could translate to more jobs, bigger dividends, continued stock buybacks, and accelerated M & A activity driven by tax savings.
He also aims to simplify individual taxes and lower rates across the board. In the near term, tax cuts are more effective than stimulus spending. Tax cuts hit the economy quickly.
He’s proposed a tax holiday for US corporations. Depending on what study you read, there are between $1.2 trillion and $2.8 trillion dollars being held by US companies overseas. At a 20% tax holiday or less, most if not all of those dollars will come home. Trump is proposing 10%. That is a potential steroid for US corporations.
Regulations will be rolled back. Many have been overly burdensome for several industries. This removes a major obstacle US companies of all sizes have been forced to deal with over the last decade. They can now look forward to an easing of regulations rather than more unknown regulations coming down the pipe. This allows management teams to become more effective in strategic planning and capital expenditures. These are probable positives for jobs and earnings.
Banking in particular will almost certainly see wide spread reduction in regulations. Dodd-Frank will be heavily streamlined if not gutted entirely. These are positives for bank earnings.
If Trump’s promises are to be believed, he will try to break up the big banks. I see this as an additional significant positive if it happens. It could pave the way for increased earnings sector wide while reducing systemic risk.
Interest rates are likely to rise. Also good for banks.
The energy industry is facing renewal, with administrative policies that favor American producers over global producers. This will begin to impact energy sector earnings within a few quarters, subject to what kind of protections actually come through and whether OPEC can get agreement at cutting production.
The Affordable Care Act will also be streamlined or perhaps completely restructured. Given the precipitous rise in cost to patients, providers, insurers, and tax payers that has occurred as a result of the program, it’s hard to think whatever changes come will not be financial positives in some significant way. This will take longer than the other initiatives, but reforming the ACA is on the agenda.
These are factors the market began to price in when it became clear Republicans were going to sweep the election.
It’s interesting to note these are the sort of structural fiscal reforms the US Central Bank has been calling on elected officials to implement for years in order to reduce the economy’s dependence on monetary policies (which are increasingly ineffective.)
Despite the sweep, many if not most of Trump’s ideas will be obstructed by opponents on both sides of aisle – he is an outsider and will likely remain so. But it’s clear the market is cheering lower taxes, lower regulation, and the probability of a renewed American energy sector.
How long will the honeymoon last? That’s impossible to say definitively, but the above gives the market something to think about, particularly if earnings continue to strengthen. There are no guarantees, but lower taxes + lower regulation + rising earnings + no recession should translate into positives for equity market prices in the near term.
There are downsides to many Trump proposals, including deficits risks and trade wars, and bonds seem likely to suffer, but for now the markets like what they think they see. Barring a change in recession status or a major disruptive event here or abroad, markets seem primed to hold their ground and perhaps even advance moving into year end and the first half of next year.
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To smarter investing,
ACI Wealth Advisors, LLC.
Process Portfolios, LLC.