The Daily Difference: Thanksgiving Market Update
2016 Thanksgiving Market Update
First and foremost, we would like to wish all of our clients, friends, and partners a very happy Thanksgiving. We are thankful for the privilege of working with each and every one of you.
It seems that the reality of a Trump administration and a republican controlled Congress is setting in among investors. We continue to see a stronger Dollar, higher interest rates, and strength in U.S. equities. These reactions are an expression of the following high level narratives that are forming as the new administration begins to take shape.
Higher inflation & stronger growth
The themes of higher inflation and growth are largely being derived from the new administration’s stated policy objectives related to tax reform and infrastructure spending, and the prospect for higher growth that these policies may create.
Our View: So much is still unclear related to actual policies and how a republican controlled Congress will react to the deficit double whammy of tax reform and higher spending. The theme of stronger growth is distinctly tied to the Trump administration’s stated policies of tax reform combined with infrastructure spending. If we see stronger growth, higher inflation does seem like a likely outcome. The market is clearly interpreting the new administration’s proposed policies as pro-growth. We would agree that if the proposed policies are enacted, there would likely be some level of incremental economic growth. However, we are cognizant of the possibility that higher inflation and deficits could actually temper growth. With so many uncertainties, we are not making any dramatic moves yet, but are assessing some reasonable allocation adjustments based upon the current economic realities.
Please keep in mind that we have positioned most portfolios with a strengthening U.S. Dollar in mind. We have also positioned portfolios for the potential of a rising rate environment with the inclusion of floating rate loans and other absolute return and non-directional fixed income managers. We are currently considering how best to protect our clients’ portfolios from the potential for higher inflation, along with reassessing interest rate expectation and equity markets. Regarding inflation protection, many investors are quickly adding TIPS or other inflation protection securities into portfolios (TIPS provide principal protection on U.S. Treasuries). We are not looking to add TIPS at this time, as we believe they are simply not sufficient protection for a diversified portfolio in the current environment. In a portfolio made up entirely of U.S. Treasuries, an allocation to TIPS might be reasonable, but we do not own U.S. Treasuries and we do not want to as we believe the risk/return profile to be poor in the current low interest rate environment. Furthermore, while TIPS may protect part of the principal from higher inflation, investors still have significant exposure to higher rates. History has shown that the best hedges against inflation are equities, real estate, and certain commodities. Potential beneficiaries of lower corporate taxes, stronger domestic growth and a stronger U.S. Dollar might be small and mid-cap stocks that derive a larger percentage of their revenue from domestic sources, and may also benefit disproportionately from corporate tax cuts. We are in the process of assessing portfolio adjustments commensurate with this thinking.
Our investment committee continues to meet weekly and discuss the markets as they evolve. We maintain an open mind, but will continue to be focused on building well-diversified portfolios and focusing on the long-term. We believe our discipline has served our client portfolios well during volatile times and we will continue to keep you updated as our thinking evolves and changes. As always, please let us know if you have any questions or concerns.