Broadly speaking, the past week made fools of professional forecasters. Heading into the November 8th election, Hillary Clinton was the consensus favorite to win the presidency, with most polls pegging her chances at greater than 65%. However, notwithstanding her slim victory in the nationwide popular vote, Clinton’s loss of several traditionally Democratic states in the upper Midwest gave Donald Trump the electoral votes needed to pull off a stunning upset.
Initially, overseas and futures markets reacted negatively to this surprising turn of events (overnight, the S&P 500 futures declined as much as 5%). Most investors (ourselves included) braced for a wave of panic selling when equity markets re-opened last Wednesday. Instead, stocks rallied, bonds fell, and speculators scrambled to place bets on the prospective winners and losers of a Trump administration.
Anyone who followed his campaign should grasp the difficulty of predicting Donald Trump’s policies as president. When not deliberately vague, his stump speeches were often contradictory, and by some accounts his victory surprised even himself. Indeed, Trump’s unpredictability was a large part of his populist appeal. Such ambiguity did not prevent the market from rapidly pricing certain expectations, which we can parse from a selection of sector ETF returns over the past week:
Leading the way, both Biotech (IBB) and Pharmaceutical (IHE) stocks reflected a decreased likelihood of significant healthcare reform in a Trump administration which has pledged to repeal the Affordable Care Act (and presumably is not interested in regulating drug prices, either). Financial stocks (VFH) received a boost on two counts: First, from the potential to roll back Obama-era regulation such as the Dodd Frank Act. Second, from an anticipated rise in interest rates and inflation which would accompany Trump’s ambitious fiscal stimulus plans (and concurrent budget deficits). Aerospace and Defense stocks (ITA) rallied based on Trump’s stated intent to increase military spending, while Oil Services companies (IEZ) strengthened on the expectation that Trump’s administration would be more friendly to the fossil fuel industries.
In the “losers” category, we can count long-term government bonds (VGLT). Interest rates spiked in the days following the election, given Trump’s campaign pledges of $1 trillion in infrastructure spending and a significant reduction in personal and corporate income tax rates. The combination of higher spending and lower taxes is very likely to increase the federal budget deficit, necessitating greater issuance (supply) of government bonds. Also among likely losers are Emerging Markets (EEM). Developing economies were some of the greatest beneficiaries of liberalized global trade over the past two decades, but could see that progress stalled if protective tariffs once again become fashionable. Moreover, a strong dollar (from higher U.S. interest rates and a potential repatriation of overseas corporate cash) could lure capital away from emerging markets, back to the U.S.
One might think that speculators would have been chastened by the events of last week, but all evidence points to the contrary. It’s worth remembering that while the assumptions outlined above are reasonable enough, they are certainly not foregone conclusions. Investors are better off sticking to a diversified portfolio, rather than making concentrated sector bets every time the political winds shift. This is certainly the path that we take on your behalf.
To further drive that point home, the Economist magazine recently highlighted an interesting behavioral finance study in which a pool of quantitatively-trained participants were offered the chance to wager up to $25 on the outcome of a succession of coin flips, in which the odds of a “heads” toss was 60%. Surprisingly, two-thirds of participants gambled on tails at some stage, and more than half of the participants failed to pursue the optimal betting strategy, which, according to the Kelly Formula, would have been to consistently wager 20% of their bankroll on each toss. Moreover, about 30% of the participants lost their entire bankroll by betting too much at a time, despite a significant “house” advantage! The takeaway from this, as it pertains to investing, is that even when long-term odds are substantially in an investor’s favor (annual stock market returns have been positive more than two-thirds of the time), the temptation to “gamble” on a quick gain proves irresistible to some investors, to the detriment of their wealth.
Are You Retired and Charitable?
If you are older than 70 ½, you are required to take a minimum distribution from your IRAs every year before December 31st. If you happen to also be charitably minded, there is a strategy that might keep you out of a higher tax bracket, qualify you for credits and deductions that you might not be eligible for with a higher adjusted gross income, and reduce the amount of your Social Security income that is taxable. It is called the Qualified Charitable Distribution.
It involves asking your IRA custodian (i.e. Schwab, Fidelity, etc.) to redirect a portion of your required minimum distribution (RMD) directly to the charity of your choice, rather than receiving it yourself and deducting it when filing your return. In doing so, your charitable contribution no longer flows into your taxable gross income, yet counts as part of your RMD. This is particularly useful if you don’t need all the money to live on. As usual, we recommend that you check first with your CPA or tax adviser.