Donald Trump retook the White House in a strong election showing for the Republican party, which also regained control of the Senate and maintained control of the House of Representatives, completing a GOP sweep. Much ink has been spilled in the aftermath of this momentous result over what drove the electoral results. For equity investors, however, the most important considerations are what comes next and have less to do with how we got here.
The initial impacts are likely to be directionally consistent with 2016, albeit to a lesser degree given a more mature economic backdrop and lofty embedded expectations. Trump’s pro-business approach could once again rekindle animal spirits and buoy capital spending, M&A and other forms of investment. For example, the National Federation of Independent Business Small Business Optimism Index jumped by 11.7 points during the fourth quarter of 2016, the largest 3-month bounce since 1980. When combined with a more favorable corporate and individual tax regime along with a lighter regulatory touch, the outlook for corporate profits appears healthy. These catalysts helped power equities higher both ahead of the election as the chances of a GOP sweep increased, as well as in the immediate aftermath.
Not all of Trump’s agenda is market-friendly, however. Potential headwinds exist, notably from the prospect of increased tariffs, reduced immigration and the potential for higher long-term interest rates. The previously mentioned tailwinds have so far been viewed as outweighing the potential headwinds from an economic and corporate profits perspective, but ultimately the specific policy details will have the most influence on the trajectory of earnings and growth.
Which policies get advanced, the order in which they do, and the degree to which they are implemented will all be important for equity investors. For the overall market, the degree to which stronger corporate profits can offset the risk to valuations from higher long-term interest rates will be crucial. Within the market, however, we believe the leadership rotation that began in early July is likely to continue in the coming months. Stocks’ initial response supported this notion, with further gains for many of the recent leaders including value over growth, small cap over large, the equal weight S&P 500 Index over the cap-weighted version, along with cyclicals over defensives. While the rotation lost steam in the first full trading week following the election, it could resume as Trump’s policies and cabinet picks gain more clarity.
Over the longer term, the economy tends to trump politics (pun intended) when it comes to what drives equity returns. The Federal Reserve’s steps to begin normalizing short-term interest rates in recent months have helped bolster the chances of a soft landing. Pronounced rate cuts typically come as the economy is decelerating but that is not the case today with third quarter GDP coming in at 2.8%, in-line with the average over the prior three years. This development, coupled with a raft of positive or improving macro indicators, has further emboldened our optimism on the economic front.
A resilient economy – that could well be further bolstered by pro-growth policies – should prove beneficial for equity investors, given the strong linkage between the economy and corporate profits. Historically, equities have delivered solid returns under leadership from both parties, with eight of the last 10 administrations presiding over positive U.S. equity performance ranging from 7% to 15% annualized. The two presidents with negative returns during their time in office had the misfortune of recessions occurring both early and late in their terms: 1969-70 and 1973-1975 for Richard Nixon (in office 1969-1974), and 2001 and 2007-2009 for George W. Bush. With a recession unlikely in the near term, history suggests robust U.S. equity performance during the second Trump administration.
Jeffrey Schulze, CFA, is Director, Head of Economic and Market Strategy at ClearBridge Investments, a subsidiary of Franklin Templeton. His predictions are not intended to be relied upon as a forecast of actual future events or performance or investment advice. Past performance is no guarantee of future returns. Neither ClearBridge Investments nor its information providers are responsible for any damages or losses arising from any use of this information.