Only a strong economy can create higher asset values and sustainably good returns for savers.
— Ben Bernanke, former two-term Chair of the Federal Reserve
Uncertainty, the Trump agenda, and stocks
There was no shortage of angst in the investment community that a Donald Trump victory in last year’s election would send shares down sharply, at least in the immediate aftermath of a Trump win. In reality, just the opposite happened, with stocks surging in the wake of his surprise victory. The pre-election-day conventional wisdom didn’t pan out. Instead, investors quickly warmed to the idea that a republican president and a republican Congress would quickly enact a pro-business agenda that would fuel economic growth and, by extension, corporate profit growth.
It was an ambitious agenda that included a steep cut in corporate taxes, individual tax cuts, regulatory reform, and new outlays for infrastructure and national defense. Sure, Republicans have never been fond of boosting domestic spending, but tax cuts and regulatory relief have always been a staple in the conservative agenda. Even then, Trump could strike a deal with Democrats to boost much-needed spending on roads, bridges, and airports. Well, proposing policy changes during campaign season is one thing. Enacting those changes is another. Much like a UFC fighting match, things got ugly fast, at least from the vantage point of the Republican leadership and President Trump. However, we should view what happened on Capitol Hill through the eyes of a non-partisan investor who is invested in a diversified portfolio, one that includes a stake in the global economy and the major sectors of the U.S. economy.
Stocks and a political brick wall
If Republicans can’t enact their agenda, won’t that quash the so-called Trump rally? Won’t shares take a beating? We’ve seen a fair number of headlines that suggest such a scenario, so let’s address it. We believe the stock market reaction to the failed repeal-and-replace effort and the Russian situation sheds some light on how the market may react to the potential gridlock over tax reform. No longer do investors expect corporate and individual tax reform to sail through Congress – a stark contrast to market sentiment late last year.
While a cut in corporate taxes might be considered the “crown jewel” for the market, what investors want is respectable economic growth that produces respectable corporate profit growth. As we have seen, the markets hate uncertainty. Political uncertainty may create noise and temporarily dampen investor sentiment but, in the longer term, it’s a growing economy and expectations for higher profits that support stocks. It’s about the economic fundamentals and the long-term investment plan we recommend, which incorporates temporary setbacks. Investing is not without risks, but risks can be managed. Market timing rarely works.
But here’s the most important point: market uncertainty and volatility are exactly why there is an equity premium in the long term. One of the first things you have to realize as an investor is that to earn a respectable return on your capital, you have to be willing to lose money on occasion — sometimes a lot of money. Losses are a normal part of a well-functioning market. Without occasional losses, stocks wouldn’t earn a risk premium over safer asset classes such as bonds and cash.
Conventional wisdom suggests congressional gridlock and failure to enact business-friendly legislation will drive a stake through the heart of the Trump rally. While we can’t promise there won’t be some volatility, our focus is on a growing economy and rising profits. Strong corporate earnings, economic growth, and low bond yields still support a favorable environment for stocks. Yet, still stocks will fall at times. The reason doesn’t even matter. When you invest in stocks, you should go into that investment with the expectation that they will go down with regularity even when they give you gains over the long-term.
For the long-term investor, it all revolves around economic activity and earnings growth. We’ve hammered this theme home before. And no doubt we’ll bring it up again in future Monthly Insights. But our sincere desire is to see you reach the goals we’ve talked about in our many conversations. Getting sidetracked by the story of the month will only serve to delay the achievement of these goals. Once again, let us emphasize that it is our job to assist you! If you have any questions or would like to discuss any matters, please feel free to give us a call.
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