U.S. equity markets closed higher both days after the Donald Trump victory and Republican sweep of Congress. The positive reaction stems from the possibility of corporate tax reform, repatriation of foreign cash, and increased deficit spending. We’re hesitant to take the initial reaction as an “all clear” signal.
President-elect Trump has been clear about his desire to renegotiate trade deals and impose tariffs on foreign goods. He can accomplish these objectives by executive order; therefore, implementation of protectionist policies is a real possibility. Protectionism would be inflationary, and will likely lead to lower corporate margins and reduced consumer purchasing power.
Higher inflation will also lead to higher interest rates. The President-elect has been critical of Federal Reserve Chair Janet Yellen. It is likely that he will replace her in 2018, and other members sooner, favoring those with a more hawkish bent. The bond market is already beginning to discount this possibility with 10-year government bond yields rising 8% today to slightly above 2%. We expect interest rates to continue to climb. This will be a negative for consumers and consumer stocks, and will likely exert pressure on market multiples.
The sectors most likely to benefit from the election’s results include healthcare and financials. Proposition 61, the drug pricing initiative in California, was soundly defeated and a Republican Congress is less likely to focus on the pharmaceutical industry. The financial sector may benefit from some strategic clawbacks of Dodd Frank and from higher interest rates.
Our long-term, balanced, thematic approach to equity investing and our focus on relatively short duration bonds enable our client portfolios to withstand market gyrations from exogenous events, like political elections, better than many others. However, these are uncertain times. From a risk management and opportunistic standpoint, we are selectively raising cash reserves, reducing foreign exposure in favor of a more U.S.-centric portfolio, reducing some consumer oriented holdings, and potentially increasing holdings in the healthcare and financial sectors.