Election Results
Nov 06, 2024What is the difference between a political pollster and a weather forecaster?
The weatherperson sometimes gets it right.
Yet again, the political pollsters got it wrong. Donald Trump won the U.S. Presidency, convincingly, defying the pollsters, who forecasted a neck-and-neck race. The Republicans also regained control of the Senate. The House race is close, and at this point, too close to call.
What impact will these political outcomes have on the economy and the markets?
Generally, the economy and markets favor lower taxes and fewer regulations. Since President Trump and Republicans generally favor lower taxes and fewer regulations, this should be a net plus for economic growth.
Trump's promises of tariffs are more challenging to forecast. If the proposed tariffs are enacted, they will be at their highest level since the 1940s. As proposed, China would feel the brunt of the tariffs. Whether tariffs are enacted as proposed or merely a negotiating tactic remains to be seen. However, arguing that tariffs would not cause a pickup in inflation is challenging. It would take time and abundant financial resources to produce goods domestically that are currently being imported. Furthermore, certain low-cost items like apparel and cheap electronics would be nearly impossible to manufacture at a reasonable price domestically.
The U.S. dollar soared in response to the news. Tariffs and a strong dollar would likely be a headwind for emerging markets. Recall that we do not own any Chinese-based companies and are significantly underweight emerging markets relative to the MSCI All Country World Index.
Lastly, the changing political landscape poses a dilemma for the Federal Reserve Board (the Fed). The Fed just began its rate cut cycle, with a 50 basis point cut in September. The Fed's justification for the beginning of the cutting cycle was that the inflation battle was being won, coupled with fears that the economy was slowing. Less regulation and lower taxes would stimulate the economy, lessening the need for aggressive rate cuts. (Remember that the markets forecast a couple hundred basis points in cuts for this cycle.)
As we have opined in previous webinars and thought pieces, the Fed's runway to cut interest rates is not as long as many believe. Tuesday's outcomes will probably shorten this runway. At the same time, we believe that the rate cuts forecasted in 2024 and early 2025 are still likely to come to fruition as the Fed will not want to appear political and instantly pivot upon Trump's election/inauguration.
As we addressed in our August 15, 2024 thought piece: “A Murder Mystery: What Kills the Economy?”, periods of economic expansion do not end because of old age but rather because of an event. COVID, the housing collapse, the tragedies of 9/11, the bursting of the dot-com bubble, a dramatic spike in oil prices, etc., have all been triggers of previous recessions. There will be a trigger at some point, but for now, the economy continues to chug along and may very well pick up steam.
Remember, markets are not Red, they are not Blue, they are Green. Do not let personal political views cloud your views and make hasty moves. The day after the election in 2016, we had some clients call, asking to sell everything, as Trump had won. Four years later, some clients called asking to sell everything, as Biden had won. In both cases, markets were higher four years later.
Nonetheless, there are risks out there, the increase in debt being one of those. Unfortunately, we do not hear politicians talking much about "balanced budgets" these days. At some point, the financial markets will impose financial discipline. In 2022, Liz Truss was voted as Prime Minister of the U.K. A combination of proposed aggressive tax cuts and spending increases caused turmoil in the U.K. financial markets. The bond market, in particular, had its worst one-week performance in over 300 years. In two weeks, yields on U.K. government bonds went from just under 3% to over 4.5%, and the pound fell to a record low versus the dollar. In less than 50 days, Liz Truss was replaced as Prime Minister.
Source: FactSet
If politicians are not fiscally prudent, the markets will eventually do their jobs for them. Accordingly, we do not see the attraction to long-dated bonds (10 years and greater). We prefer to own equities that we believe can outperform in an environment of sticky inflation and are likely to favor higher interest rates over the longer haul.
As for how markets are reacting, investors' initial response to news of the Trump victory can be summed up by American Exceptionalism. Many U.S. stocks soared, and most foreign names weakened. The dollar rallied, and many other currencies shed about one to three percent. U.S. financials led the rally with hopes of reduced regulations. Stocks offering high dividend yields were sold in sympathy with the weak bond market/higher interest rates. We really see three ways this can play out over the next two years, assuming the Republican sweep.
First is that Trump is unbound by the political winds that made Trump 1.0 a somewhat mainstream Republican and that he goes through with the extremes of his policies: stringent immigration policies, extremely high tariffs, and then using that tariff revenue to attempt to offset some cuts to corporate and individual taxes. We believe this scenario leads to high inflation and an initial pop to GDP growth because of the stimulus of tax cuts. However, over the long term, it leads to a global trade war, interest rates rising unsustainably, and a hit to GDP due to all these factors converging.
The second is that Republicans get the trifecta, but Trump utilizes his political intuition, which has led to his surprise victories. He cuts taxes and regulations, implements border control but not mass deportation, and uses tariffs strategically. We believe this is almost a status quo situation for the next one to two years, with above-trend GDP growth but inflation that keeps the Fed from cutting rates back to neutral or easing territory.
The third scenario is some combination of the two paired with a sense of fiscal responsibility driven by the increased role of people like Elon Musk in the campaign, who has reckoned that he could remove $2 trillion from the Federal Budget (more than the Federal government spends on discretionary spending). Honestly, this seems like the least likely scenario because it would combine some of the most unpopular policies, and the Republican party still has to get reelected despite Trump being termed out. In the end, Trump is a seasoned businessperson and a politician with a good pulse on what large swaths of the country are feeling. We believe that the most likely scenario is outcome number two, and the market apparently agrees.
Given this shift, we would not be shocked if we added a bit more cyclicality to the portfolio in the form of industrials, consumer discretionary, or even a financial or two. However, at the same time, we also believe that the secular trends we have talked about for a decade are still at play, which is why we will maintain an overweight to Consumer Staples and Health Care. While there has been strong economic growth recently, and there are the ingredients for that to continue, the foundation of the global economic engine is not healthy. It is the equivalent of driving a car with the check engine light on. Slowing birth rates in developed countries, flattening real incomes, and increasing government debt set us up for a challenging decade. When that takes place, it is much harder to say, and that is why it would be irresponsible to pull out of the market and sit in cash. There are still good opportunities in the market and companies with great products or services. Identifying stocks that will benefit from some of these thematic trends while also seeking to protect your portfolio on the downside is what you pay us for. We do not take that for granted and plan to navigate this cycle just like we have in every presidential cycle since 2001.
Managed Asset Portfolios Investment Team
Michael Dzialo, Karen Culver, Peter Swan, Zachary Fellows, John Dalton, and Nicolas Vilotti
November 6, 2024
Certain statements may be forward-looking statements and projections which describe our strategies, goals, outlook, expectations, or projections. These statements are only predictions and involve known and unknown risks, uncertainties, and other factors that may cause actual results to differ materially from those expressed or implied by such forward-looking statements. The information contained herein represents our views as of the aforementioned date and does not represent a recommendation by us to buy or sell this security or any other financial instrument associated with it. Managed Asset Portfolios, our clients and our employees may buy, sell, or hold any or all of the securities mentioned. We are not obligated to provide an update if any of the figures or views presented change. Past performance is no guarantee of future results.
