Contrary to expectations, since US Election Day, equity markets have rallied - with major indices reaching all-time highs - and interest rates rising sharply. What can we expect going forward? Aegon’s Tom Wald shares his thoughts.
We believe the stock market has discounted Republican control of the White House and both chambers of Congress as having certain favorable impacts. Specifically, these would be less government gridlock, reduced regulation, and lower corporate tax rates.
While many might argue these points, both in terms of whether they will come to fruition or be good for the markets, we feel these factors have quickly provided a silver lining to what the market had initially interpreted as a cloud of Trump uncertainty and nervousness.
Specific sectors given a boost
Individual sectors of the market have also reacted extremely favorably to potential industry specific changes under the new administration. This has included bank stocks (S&P 500® Banks Select Industry Index +15%) as the prospect of a steepening yield curve and less government regulation has certainly been well received, biotechnology stocks (NASDAQ Biotechnology Index +11%) as concerns of Clinton supported drug pricing constraints fell by the wayside, and defense stocks (S&P 500® Aerospace & Defense Select Industry Index +9%), which of course stand to benefit from increased military spending. As these sectors rallied hard, it has spilled over to the broader market.
In regard to the upward move in interest rates, future Trump economic policy is currently being interpreted as more inflationary than any we have seen in over a decade as the potential combination of lower taxes, higher infrastructure spending and perhaps larger federal deficits would likely result in higher price levels throughout the economy.
We also believe the Federal Reserve (Fed) now has "cover" it did not have before regarding the market impact of raising rates. It has been our feeling that ever since its lone rate hike of last December, and the stock market correction that immediately ensued during January and February, the Fed has been reluctant to raise rates for fear of negatively impacting the equity markets. Now they no longer have to worry about that as rates have increased materially since the election and stocks have rallied in the process. We believe this will make the Fed feel less hindered to increase rates throughout 2017. Strange as it may sound, it's almost as if the American voters did more for monetary policy in one day than the Fed had done in almost one year.
Interest rate hike
In our opinion there is a high probability of a Fed funds rate hike at the committee's December meeting next month and this is now priced into the fixed income markets. Despite the difference in rate expectations today versus those of pre-election days, we would caution that rates have come very far very fast and we most likely see them as being range bound from here through the end of the year, at approximately 2.25% on the 10 year Treasury, give or take about .25%. Needless to say, economic and inflationary trends will be a major area of focus for investors in the New Year.
The weeks ahead
Markets in the weeks ahead will clearly be centered on the perceived impacts of the new administration's economic agenda, complete with the inevitable debates as to its pending effectiveness or risk. Remember, little more than a week ago the markets were expecting pretty much business as usual from Washington and now we have anything but that. There could still be volatility comparable to what was believed to be the case in the immediate hours following the election, and if this does occur we believe investors would be well served to keep the following in mind:
- We feel this is still a market that continues to climb a "Wall of Worry" and whatever uncertainties the market may confront about a Trump administration can be added to the list of what investors have been dealing with over the past year and a half. This has included China's devaluation of the Yuan in August of 2015, recessionary fears during early 2016 (both of which resulted in double digit corrections in stocks), lower than expected gross domestic product (GDP) growth in 1H16, and of course Europe's surprise Brexit vote last June. In each of those cases, the market absorbed the "event" with some volatility and then moved higher.
- It has also been said that the market is "the great discounter of future events" and as it does discount those future events it fights through current ones. In this case the most important future events, present and accounted for prior to the election, are improving U.S. economic growth and corporate earnings trends as we enter 2017. Pertinent to this, the first estimate of 3Q GDP released on October 28 displayed 2.9% growth, better than twice the level experienced throughout 1H16. In addition, we believe 2017 could be a year of double digit profit growth for the S&P 500®.
- Finally, it is vital to emphasize that this is as important a time as any in recent memory to maintain a long term investment focus. While we have just experienced an election unlike any other since the days of our grandparents, history nonetheless has proven that markets ultimately follow economic and profit cycles rather than political ones.
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The information included in this article should not be construed as investment advice or a recommendation for the purchase or sale of any security. This material contains general information only on investment matters; it should not be considered as a comprehensive statement on any matter and should not be relied upon as such. The information does not take into account any investor's investment objectives, particular needs or financial situation. The value of any investment may fluctuate. This is a general perspective about market volatility and our market outlook and is not intended to predict future events.
Transamerica Funds are advised by Transamerica Asset Management, Inc. and distributed by Transamerica Capital, Inc.