November 14, 2016: Asset Trends After The Election

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Asset Trends After The Election

What a difference a week makes! The result of the presidential election defied many popular polls and predictions. The post election market behavior was even more surprising. US stocks only experienced a brief overnight loss in the futures market and have made a non-uniform ascent while other assets reacted to the election result negatively.

A week after the election

The following table shows some of the key major assets’ returns in the last one week:

Asset ETFs performance (as of 11/14/2016):

ETF	1 Week Return*	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR
VTI (Vanguard Total Stock Market ETF)	2.3%	8.6%	9.7%	8.5%	14.1%	7.2%
VEA (Vanguard FTSE Developed Markets ETF)	0.3%	0.1%	-1.9%	-1.0%	5.5%
VNQ (Vanguard REIT ETF)	-0.4%	1.2%	5.1%	9.5%	10.3%	4.9%
BND (Vanguard Total Bond Market ETF)	-1.9%	3.1%	3.4%	3.0%	2.1%
DBC (PowerShares DB Commodity Tracking ETF)	-2.0%	7.9%	-1.4%	-17.2%	-12.5%	-4.6%
VWO (Vanguard FTSE Emerging Markets ETF)	-3.6%	10.0%	4.8%	-1.8%	-0.3%	2.4%
GLD (SPDR Gold Shares)	-5.9%	15.4%	12.8%	-1.9%	-7.6%	6.5%
TLT (iShares 20+ Year Treasury Bond)	-7.4%	3.2%	5.5%	8.7%	3.8%	6.7%

Other than the near neutral reaction of the developed market stocks (VEA), US stocks (VTI) are the only major asset that rose strongly. In particular, the long term Treasury bonds (TLT) lost over -7.4% while so called safe haven gold (GLD) also had a great deal of loss. Investors retreated from emerging market stocks as US dollar rose strongly.

The above market action indicates the initial response to the Trump’s election win is more or less aligned with the his attempt to reverse globalization. Furthermore, it does seem that investors believe the US economy can be decoupled from the rest of the world.

However, even among US stocks, there is a great dispersion:

Description	Symbol	1 Week	4 Weeks	13 Weeks	26 Weeks	52 Weeks	Trend Score
Financial	XLF	11.11%	14.85%	-7.13%	-2.49%	-6.27%	2.01%
Industries	XLI	5.96%	7.41%	4.58%	11.23%	15.64%	8.96%
Healthcare	XLV	3.07%	1.27%	-5.83%	1.07%	1.34%	0.18%
Telecom	IYZ	2.77%	-2.16%	-4.98%	0.88%	6.94%	0.69%
Materials	XLB	2.44%	4.1%	-0.82%	4.3%	9.61%	3.93%
Consumer Discretionary	XLY	1.57%	1.9%	-2.59%	2.19%	2.95%	1.2%
Energy	XLE	0.9%	0.56%	1.48%	7.03%	5.45%	3.08%
Technology	XLK	-2.46%	-2.64%	-2.38%	8.5%	9.04%	2.01%
Consumer Staples	XLP	-3.87%	-3.2%	-7.62%	-4.68%	6.31%	-2.61%
Utilities	XLU	-5.72%	-4.19%	-7.45%	-5.43%	10.06%	-2.54%

The financial sector rose the most as investors believe that big banks and other financial service companies will benefit from Trump’s financial deregulation policy and the rising interest rates – mostly caused by the likely inflation. Industries and materials sectors were also in favor because of the talk of big infrastructure spending. A noticeable loser here is the technology sector: not only the tech industry was at odd with the Trump candidacy during the election, Trump’s anti-globalization stance will hurt the technology companies’ oversea business (based on Factset, technology companies in the S&P 500 index had the most international exposure, deriving more than half of revenue (58%) from oversea).

Finally, emerging market bonds suffered the biggest loss last week:

Bond ETF last week’s performance (as of 11/14/2016):

Bond ETF	1 Week Return*	YTD Return**	1Yr AR
TLT (iShares 20+ Year Treasury Bond)	-7.4%	3.2%	5.5%
EMB (iShares JPMorgan USD Emerg Markets Bond)	-4.7%	7.1%	6.0%
LTPZ (PIMCO 15+ Year U.S. TIPS ETF)	-4.1%	10.1%	11.2%
IEF (iShares 7-10 Year Treasury Bond)	-3.1%	2.9%	3.5%
LQD (iShares iBoxx $ Invst Grade Crp Bond)	-2.3%	6.4%	6.3%
JNK (SPDR Barclays High Yield Bond ETF)	-1.9%	8.6%	4.1%
CIU (iShares Intermediate Credit Bond)	-1.4%	3.6%	3.5%
TIP (iShares TIPS Bond)	-1.4%	5.5%	5.5%
SHY (iShares 1-3 Year Treasury Bond)	-0.3%	1.0%	0.9%
UUP (PowerShares DB US Dollar Bullish ETF)	2.1%	-0.2%	-0.7%

Investors anticipate higher interest rates, which propped up US dollar (UUP). Virtually all bond segments fell last week. However, even though the 10 year interest rate has risen rapidly, it does look like it still has a lot to go:

Long shot anticipation trades

The strong reaction of stocks in the past week can be attributed to so called anticipation trades: investors believe that the Trump administration with a Republican controlled congress is pro growth. There have been many analysis on the Trump’s not so detailed policies including his tax cut, infrastructure spending, trade policies, Obama healthcare repeal, immigration policies and financial deregulation. In general, the public or at least the financial markets seem to agree that his policies will result in higher economic growth, higher inflation and higher debt. These analysis all make some sense under certain assumptions.

However, we believe that the recent market actions are more long shot anticipation trades than some sure bets. There are many risks involved with these anticipations: a conservative congress might not support higher spending and higher debts; the trade policies will impede the growth, at least at the beginning before the domestic industries can fully absorb the higher import cost and lower export earnings; the rising interest rates will further incur debt burden to both consumers and businesses; …, etc. Even assuming these policies will eventually result in the expected higher economic growth, the economy will surely go through many bumps, not only because the risks mentioned above are likely to occur, but also because the implementation of these policies will simply take time and the interim reactions will be painful.

Higher economic growth and higher interest rates do not necessarily support higher stock valuation. In fact, because of higher interest rates, investors demand higher returns from stocks (otherwise, they could have just invested in bonds for the full maturity). The election result does not change the fact that the valuation of stocks is at a highly elevated level by any historical metric. The associated risks mentioned above and the natural bull bear market cycles will again reign and affect the markets. For a reasonable analysis and warning, we recommend Hussman’s latest post.

We thus call the recent market reactions long shot anticipation trades. Markets will soon be back to face the reality and will then work through from there gradually with many ups and downs.

Takeaway

The takeaway is that both stocks and bonds will likely experience more volatile periods. We believe markets are more likely to make trial and error discoveries. Just like the euphoria before the election (that mostly anticipated a Democratic win which didn’t materialize), they soon will realize that the reality is not smooth sailing.

In terms of investments, the Strategic Asset Allocation (SAA) strategy recognizes the virtue of long term returns and should ignore the short term noise. the Tactical Asset Allocation(TAA) based portfolios, on the other hand, also should ignore the short term development and follow the intermediate trends in the next rebalance times.

Portfolio Review

The alternative portfolios listed on our Brokerage Investors page had a large loss, mostly due to the loss in long term bonds and gold:

Portfolio Performance Comparison (as of 11/14/2016):

Ticker/Portfolio Name	1 Week Return*	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR	10Yr Sharpe
Harry Browne Permanent Portfolio	-2.7%	6.2%	6.4%	3.8%	2.8%	5.9%	0.77
Permanent Income Portfolio	-2.0%	4.1%	5.3%	5.0%	5.0%	5.6%	0.84
My Simple Alternative Hedge Fund	-3.0%	3.4%	4.1%	2.5%	5.9%	8.5%	0.99
VWINX (Vanguard Wellesley Income Inv)	-0.2%	6.6%	6.6%	5.8%	7.4%	6.6%	0.9

The strong rise in stocks somewhat offset the loss in other sectors. This is the benefit of hedge among several strongly uncorrelated or negatively correlated assets.

Market Overview

S&P 500 companies’ earnings recovered and most likely had a positive earnings growth in Q3 – based on Factset, 91% companies have already reported their Q3 earnings and the blended earnings growth year over year is 2.9%. However, the great dispersion among US stocks and the retreat in other risk assets are definitely the cause of concern. Moreover, the rapidly rising long term interest rate will eventually increase consumer and business borrowing cost (mortgage, loans and corporate bonds). As stated above, we view the current election induced development will take a breadth before the reality sets in. As always, we will stay on course and respond based on our strategies.

For more detailed asset trend scores, please refer to 360° Market Overview.

As now we have a president elect who promised to challenge the status quo and make substantial structural change (such as infrastructure building), we are now in a wait and see period: as the nation is posed to invest, the most important factor to watch is how productive the investments will be. Simply put, productive investments will result in better return on investment (ROI), tangibly or intangibly. They should also increase productivity that in turns will improve our standard of living. Capital misallocation can result in a higher growth but might not improve the real standard of living, which is the ultimate goal of economic activities.

In terms of investments, U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future.

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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