- We do not anticipate a significant change to long-term U.S. GDP growth.
- Infrastructure spending could slightly boost growth and Trump has indicated his support.
- We still believe the Fed will increase interest rates in December.
- We think financials, health care and defense will stay in focus.
The 2016 U.S. presidential election put Republican Donald Trump in the White House as the 45th president and gave his party control of both the Senate and House of Representatives. As expected, financial markets initially reacted negatively to the election outcome and the uncertainty it generated.
Dow Jones futures contracts — considered a proxy for the U.S. stock market — fell more than 800 points in late evening trading on Tuesday, Nov. 8. But the decline in stocks was short lived, with major indexes up nearly 1.5% by the market close 24 hours later. There was similar action in the fixed income market; the yield on the 10-year U.S. Treasury note exceeded 2% that day.
“The initial reaction was what we often see when everyone is positioned for an expected outcome and then it turns out to be the opposite, so that wasn’t too surprising,” says Phil Sanders, CEO of Waddell & Reed Financial, Inc. and CIO of Waddell & Reed Investment Management Co. “But if this market has been anything over the last decade or so, it’s been amazingly resilient.”
Economic Policies and Trade
We do not anticipate a significant change to long-term U.S. gross domestic product (GDP) growth, which is forecast to average 2.5% in 2017. However, there are short-term risks to the economy and there has been speculation that Trump’s policies could be potential obstacles to economic expansion.
President-elect Trump has been very vocal on his anti-trade views, but the question is how he will turn those views into policies. “For example, is it just a token increase in tariffs on a particular good from Mexico or China and maybe a soft rework of the North American Free Trade Agreement? If so, I don’t think we need to worry about trade policy,” says Derek Hamilton, Waddell & Reed’s Global Economist. “However, if we see across-the-board tariffs on many goods from many countries, that would be negative for growth in the U.S. and other countries as well.”
U.S. GDP forecast to accelerate in 2017
In particular, the Trump administration approach to trade also could have an important impact on emerging markets. If trade policies became restrictive or protectionist, “we would have a big problem,” Hamilton says, because emerging markets are heavily geared toward trade. If changes in trade are modest and don’t become detrimental to growth, emerging market economies may continue to perform well, he says. “Longer term, we think global growth and company performance will continue to be the key drivers for the emerging economies,” Hamilton says.
Within the U.S., infrastructure spending could slightly boost economic growth and Trump has indicated support for such spending, including major improvements in things such as bridges, highways and the nation’s energy infrastructure and electricity grid. We think such projects may have bipartisan support in Congress. Trump went further during his campaign, promising upgrades in areas such as railroads, tunnels, airports, schools, hospitals, ports and waterways.
In addition, we think positive growth initiatives could result from having a single political party — in this case, the Republicans — in the White House and in control of both houses of Congress.
Infrastructure spending has languished at lowest levels in 50 years
Potential for Rate Hikes
While the performance of the stock market in the coming weeks could be a factor, we still believe the Fed will increase interest rates at its December meeting.
Trump has made several critical comments about current Fed policy and Fed Chairperson Janet Yellen. He has not called for Yellen’s resignation, but he has made it clear he would not reappoint her when her term expires in early 2018. There also are two vacancies on the Fed’s Board of Governors and there could be other openings timed with, or leading up to, the expiration of Yellen’s term. Trump’s criticisms of Fed policy were somewhat ambiguous during the campaign, but we anticipate changes to Fed leadership in the future and think a more “hawkish” approach and higher interest rates are likely as a result.
As noted, we believe the economy will continue to strengthen over the longer term and that is likely to mean additional rate hikes in 2017 and thereafter. If economic growth recovers strongly and inflation returns, the Fed may be forced to make more rate hikes than many now expect.
Manufacturing job losses were a key issue for many voters
Sectors in Focus
We think the financials, health care and defense sectos will remain in focus during the Trump administration. We think a Fed rate hike will provide a positive scenario for the financials sector, which was among the market leaders during the stock market recovery on Nov. 9. Financials tend to benefit from rising rates because interest margin expands, which is likely to create more profit, and improving economic activity typically points to more loan demand.
A less-intense regulatory environment may provide an added benefit to the financial sector. For example, new Department of Labor regulations related to fiduciary standards for financial advisors – set to be implemented in April 2017 – may be delayed, revised or dropped if not enacted before President Barack Obama leaves office. There also has been speculation that a Trump Administration will repeal the Dodd-Frank Wall Street Reform and Consumer Protection Act, which implemented what are considered to be the most significant changes to financial regulation since the Great Depression. The Act affects all federal financial regulatory agencies and almost every part of the U.S. financial services industry.
Health care has been hit in recent quarters by rhetoric about drug pricing and increased regulation. We’re seeing an initial relief rally in pharmaceutical sector stocks, since that industry was an area of scrutiny for Democrats and had absorbed pricing attacks. Similar factors have applied to biotechnology companies. But we expect pharmaceutical companies to adapt to a world of more scrutiny on their pricing.
However, Trump’s call to repeal the Affordable Care Act (“Obamacare”) could pressure health care services stocks, such as hospitals and other providers who have benefited in the past from Obamacare. “We would caution that there is likely to be volatility in these areas since any actual policy or legislative changes, and any fundamental changes to these companies, will take time to develop,” Sanders says.
From an economic perspective, a key question is what any change in, or replacement of, Obamacare would mean to health care premiums. “The increases in premiums in the last couple of years have been a fairly significant drag on consumer purchasing power,” Hamilton says. “If any changes result in a more modest increase in premiums on an annual basis, I think that would be a positive.”
We think defense stocks may perform well in the future because we believe Trump will want to show allies and adversaries that he takes a hard stance on national security. We believe it is likely the defense budget will expand, which bodes well for companies dependent on government-funded defense contracts. That said, any new demand could prompt pressure for lower contract prices.
Other areas to watch
- Aerospace and multi-conglomerates – If trade policies become protectionist, many mid- and small-cap companies could suffer.
- Consumer discretionary – Low inventories, increased wages, consumer sentiment could mean a strong holiday season for some retailers.
- Railroads – Any limitations on trade could have a negative effect.
- Automobiles – Concerns about production shifts outside of the U.S. could pressure these stocks.
- Internet – Vulnerable to strength in the U.S. dollar and foreign response to a new administration, given volume of business that is outside U.S.
- Semiconductors – Infrastructure focus on spending could be positive. Most production is in Asia and assembly is in Mexico; product is priced in dollars, which could impact demand. Any new moves to force repatriation of production or assets could encourage more mergers and acquisitions (M&A).
- Telecommunications – We expect a loosening in the M&A environment and perhaps easier approvals of pending proposed deals.
We reiterate our view that investors often underestimate the ability of companies to adapt to new policies or economic conditions. Strong companies with great products, services and market share tend to take advantage of opportunities and historically have done well under all presidential administrations.
We believe it’s important to stay focused on the fundamentals and merits of sectors, industries and companies when making stock market investment decisions. Those fundamentals historically tend to outweigh broad election outcomes. Government policies and regulations affect every business, but we think individual companies and innovators ultimately drive long-term success.
Past performance is not a guarantee of future results.
The opinions expressed are those of Waddell & Reed Investment Management Co. and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through November 2016, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
WADDELL & REED INVESTMENTS℠ refers to the investment management and investment advisory services offered by Waddell & Reed Investment Management Company, the investment manager of the WADDELL & REED ADVISORS FUNDS℠ mutual funds, which are distributed by Waddell & Reed, Inc.
Before investing, investors should consider carefully the investment objectives, risks, charges and expenses of a mutual fund. This and other important information is contained in the prospectus and summary prospectus, which may be obtained at waddell.com or from a financial advisor. Read it carefully before investing.
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