Stock market gets "Trump bump"
Reaction in the U.S. was driven by two primary factors. First, the clear result and the prospect of a unified Republican government substantially reduced the political risk that had been feared from a disputed result or divided government. Second, the president-elect's proposed reforms, which include decreasing the corporate tax rate and increasing government infrastructure spending, were seen as positives for future growth but also as signs of higher future inflation. Outside the U.S., however, the reaction was less positive, as Mr. Trump's perceived antitrade platform was seen as a potential threat.
Surprising almost everyone, the major news in November was the election of Donald J. Trump as the 45th president of the United States. Almost as surprising was the market reaction, as U.S. stock markets rallied and bond markets sold off, the exact opposite of what had been predicted.
Looking at the numbers
U.S. equity markets finished November with big gains. The Dow Jones Industrial Average led the way, rising 5.88 percent. The S&P 500 Index also posted a healthy 3.70-percent return, while the Nasdaq was up 2.59 percent. Much of the gains in these indices occurred after the election and reflect the factors noted above.
The month was not, however, just about the election. Another major catalyst for U.S. equity outperformance was the long-awaited return of corporate earnings growth. Per FactSet, with 98 percent of companies reporting, the blended average earnings growth rate for the S&P 500 in the third quarter was 3.2 percent. This represents the first quarter of year-over-year growth since the first quarter of 2015 and is noticeably higher than the 2.2-percent decline forecasted at the end of September. Encouragingly, all 11 sectors had higher earnings than the September forecasts. This return to widespread earnings growth is supportive for equity markets and indicates that continued positive returns may be achievable.
Technicals remained strong during November, with all three major indices staying well above their 200-day moving averages. Additionally, the three indices achieved all-time highs.
International markets had a far more negative reaction to the U.S. election results. Both the MSCI EAFE and MSCI Emerging Markets indices were down in November. The EAFE, reflecting developed markets, recorded a 1.99-percent loss, and the emerging markets index fell 4.60 percent. Emerging markets were hit especially hard by the election outcome, as Mr. Trump's antitrade rhetoric and the strengthening dollar worried investors in this asset class.
Technical numbers for both developed and emerging international markets were also weak in November. The EAFE spent most of the month under its 200-day moving average, ending below its trend line. This could indicate future weakness. The emerging markets index performed slightly better, only dipping below the trend line for two brief periods before finishing the month above its 200-day moving average. Nevertheless, the technical performance of both bears monitoring going forward.
U.S. fixed income had a similarly turbulent month. The Barclays Capital Aggregate Bond Index was down 2.37 percent, and the Barclays U.S. Corporate High Yield index lost 0.47 percent for the period.
The major catalyst for the sell-off in fixed income was a dramatic rise in rates spurred by the election. The yield on the 10-year Treasury bond rose from 1.61 percent at the start of November to 2.37 percent by month-end. This represents one of the largest single-month increases in history and caused Treasury debt to have its worst monthly performance since late 2009. The increase in rates was due to concerns about potential increased government borrowing under a Trump administration and the potential for increased global inflation.
Economic news points toward accelerated growth
The consumer arena was far from the only encouraging sector of the economy in November. Housing continued to spur overall growth. Housing starts and existing home sales were up more than expected, while the survey of home builder confidence remained high. Notably, housing prices reached all-time highs, breaking record levels set before the recession (see Figure 1). The only negative among the housing numbers was a slight decrease in new home sales, but this decline can be partially explained by constrained supply.
Although the election was the big news of the month, we also got surprisingly good economic news. Consumer confidence rose sharply in November, with large increases in consumer views on the present situation and future expectations. Additionally, the October report of retail sales showed stronger-than-expected increases in the headline number and core report. This growth in spending was reinforced by a greater-than-expected increase in personal income in October. The combination of higher income, confidence, and spending bodes well for retailers heading into the critical holiday-shopping season and could be the engine for increased growth in the fourth quarter and beyond.
Figure 1. S&P CoreLogic Case-Shiller U.S. National Home Price Index, 2005−2016
Another bright spot for the economy in November was manufacturing. The ISM Manufacturing Index posted a stronger-than-expected gain on the heels of similar outperformance in October. Durable goods orders—a reliable gauge of business confidence—also rose more than expected, with both the volatile headline number that includes aircraft and the core number that excludes transportation surprising markets to the upside. This increased business confidence and investment are positive signals for the economy and markets.
Hiring continued to support growth, as solid gains in private employment were recorded for the month. The overall healthy increase in hiring points to strong job growth heading into year-end. Unemployment fell to 4.6 percent in November, the lowest level in nine years, and average hourly earnings continued to rise year-over-year.
Risks remain domestically and abroad
Although the initial reaction to the election was positive for U.S. markets, there are still risks domestically and abroad. Focus in the U.S. will be on the upcoming inauguration and the potential for differences between what candidate Trump said and what President Trump can accomplish.
Some differences, of course, are to be expected. One key issue to watch will be the relationship between Congress and the White House. Some of Mr. Trump's proposed policies are not consistent with those of the Congressional leadership, which will have to be resolved, and there will also be the usual negotiations over priorities and time frames. Overall, however, the major components of the Trump platform—decreasing business and consumer taxes, decreasing regulation, and increasing infrastructure investment—all appear reasonably achievable. In addition, the generally more business-friendly character of a Republican administration is expected to be positive for the economy.
More concerning are the risks again grabbing headlines in Europe and Asia. The rising tide of populism continues to threaten the stability of the European Union (EU), and elections in Italy, France, and Germany within the next year will likely serve as important barometers for the region. Pressure from the continent's ongoing refugee crisis and the increased representation of nationalist parties in local legislatures point to uncertainty in the EU. There are real political and economic risks here.
In Asia, China continues to weaken its currency, with the yuan hitting an eight-and-a-half-year low against the dollar during November. China's central bank has been trying to support the yuan by selling foreign exchange reserves and imposing capital controls on Chinese companies. This situation also bears monitoring, as the potential for antitrade rhetoric from the U.S. and slower-than-expected growth in China could lead to further volatility in currency and equity markets, with potentially serious consequences.
U.S. growth likely to continue
In the U.S., the combination of increasing economic growth, a return to earnings growth, and improving consumer confidence signal that we may be entering a period of accelerated growth. These factors, in addition to the potential for decreased regulation and tax rates under a Trump administration, have supported both the domestic economy and equity markets and could do so for quite some time. The outlook here remains positive.
With that said, the uncertainty surrounding the ongoing transition for the Trump administration and the previously mentioned foreign risks may lead to volatility. But despite the risks and any attendant volatility, the solid fundamentals and improving sentiment mean that optimism is warranted here. As always, a well-diversified portfolio matched to your time horizon provides the best potential to meet financial goals.
Authored by Brad McMillan, senior vice president, chief investment officer, and Sam Millette, investment research associate, at Commonwealth Financial Network®.
All information according to Bloomberg, unless stated otherwise.
Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Barclays Capital U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below.