Orlando's Outlook: American Brexit prompts increased equity allocation

11-11-2016

Bottom line In one of the most shocking upsets in the history of presidential elections, Donald Trump defeated the heavily favored Hillary Clinton to become the 45th president of the U.S. In our view, this was a “change” election, as voters ultimately rejected the status quo as represented by the seasoned insider Secretary Clinton. They repudiated the economic policies of the past eight years, taking a chance on the brash businessman outsider with no Washington experience and no Beltway connections. But as we witnessed this past summer with Brexit, the pollsters and pundits whiffed yet again, with few giving Trump or the Republicans—who ran the table—much of a chance.

Importantly, Trump’s election, with consolidated Republican control of Congress, removes a significant amount of fiscal-policy uncertainty overhanging the election and creates a more constructive outlook for economic and corporate-earnings growth and equity prices over the next year. As a result, Federated’s PRISM® asset-allocation committee held an ad hoc meeting, in which we shifted our equity allocation up to 52%, from a 2% underweight. To achieve this, we added a 1% allocation to each of domestic large-cap value and growth stocks, such as financials, industrials, materials, health care, technology and energy companies. We believe these will benefit from President-elect Trump’s fiscal-policy initiatives over the next two years. We funded this shift by removing 2% from benchmark 10-year Treasuries, whose yields are rising due to the market’s perception that economic growth and inflation will increase over time, and because of our expectation that the Federal Reserve will hike interest rates next month and perhaps twice more in 2017 in response.

How will stocks respond? From the S&P 500’s record peak in mid-August, we had been forecasting a 4-9% correction down to 2,000-2,100 through year-end, in part due to this election-related, fiscal-policy uncertainty. The S&P hit 2,084 last Friday, a 5% decline from peak levels, so we were in that range. 

We reasoned that if Trump could actually find a way to win the election—a long shot, to be sure, based upon the discouraging polls—stocks would initially trade lower in knee-jerk fashion, due to the uncertainty of his policies, much like we saw in the immediate aftermath of the shocking Brexit vote in late June. As we were watching the surprising election results, we saw the S&P futures plunge by a limit-down 5%, or about 100 points, to 2,029, close to a re-test of the Brexit bottom of 1,992.

Frankly, the strength of the S&P’s 2% rally over the past two days, and the 7% rebound in the futures market, was a little surprising to us. But we now believe that investors are starting to share our constructive longer-term view of stronger economic and corporate-earnings growth from Trump’s policies, which should drive share prices higher. The S&P could rally to 2,350 by the end of 2017 (up 10%) and to 2,500 (up 15% from current levels) by year-end 2018.

Clinton gets ‘Gored’ Trump clinched his presidential victory in the electoral college with a 290-to-228 advantage, with two states pending: Michigan (with 16 electoral votes) is leaning toward Trump, while New Hampshire (4) is leaning toward Clinton. So the adjusted final vote may be Trump 306, Clinton 232. But Clinton is actually narrowly winning the popular vote, 47.7% to 47.5%. How can this happen? Clinton won big in populous states like California, New York and Illinois, while Mr. Trump took many more states but with closer popular-vote margins. So Trump wins the election with a plurality, while Clinton actually wins the popular vote, much like the Gore-Bush hanging-chad situation in 2000. This has happened only three other times in history, all in the 19th century.

Like Brexit, where did the pollsters go wrong? President-elect Trump performed better among independents (48-42%), which we thought would be the key to the election as they are now the single largest voting block at 42% of registered voters. Mrs. Clinton garnered stronger support among women, millennials, minorities, city dwellers and single people, while Mr. Trump did better among men, whites, older voters, married people and rural inhabitants. Importantly, Trump did not perform as poorly as expected among educated voters and women. Trump supporters also appeared to be more enthusiastic, so weaker voter turnout for Clinton among millennials and minorities may have contributed to his victory.

  • Republicans run the table A possibility we had assigned only a 20% probability due to the polls, Republicans will maintain their current majorities in both the Senate and the House of Representatives.
  • Senate Remarkably, they lost only two seats, Mark Kirk in Illinois and Kelly Ayotte in New Hampshire, despite having to defend 14 more seats than the Democrats, so the Republican majority shrinks from eight seats to four.
  • House Republicans had a massive 60-seat majority ahead of the election (including three vacancies), but lost only six net seats, with two races not yet decided in California. They will still have a substantial majority.
  • Governorships Republicans also picked up three more governorships, in Missouri, New Hampshire and Vermont, increasing their national lead to 33 states. North Carolina is still pending.

What did voters care most about? The issues that most resonated with voters were growing the economy, combating terrorism and fixing health care, which are more traditional bread-and-butter issues for Republicans. But across party lines, the vast majority of Americans (70% according to some sources), thought America is heading in the wrong direction. 

What can we expect from a Trump presidency in 2017? With the mandate supplied by the consolidated Republican Congress, we expect legislative progress from President-elect Trump on several fronts:

  • Corporate and personal tax reform
  • Infrastructure spending from the repatriation holiday
  • Health care reform
  • Increased defense spending
  • Immigration reform
  • Filling the Supreme Court vacancy

Success on several of these fronts will support our forecast for stronger economic and corporate-profit growth and rising share prices.

To see Phil Orlando’s thinking in action, click here.