Q1 2017 Market Commentary: Lowered Expectations: The First Seventy-One Days

 

April 10, 2017

Written by Nathan Erickson, CFA®, CAIA, Chief Investment Officer

While many of us are familiar with the concept of online dating, in the 1980s and 1990s the trend was video dating. Subscribers could peruse a video library of available singles describing themselves and why they would be a “good match”. In the mid-1990s, a sketch comedy show called Mad TV created a parody of video dating called “Lowered Expectations”. These videos featured less appealing, chronically rejected singles in classic late-night parody form. The message was… if one was having trouble within the traditional dating pool, perhaps he or she needed to lower his or her expectations.

The domestic stock market had high expectations for what was to come following the election of Donald Trump and the Republicans sweep of the House and the Senate. President Trump had an ambitious plan called Donald Trump’s Contract with the American Voter, which he published here: https://assets.donaldjtrump.com/_landings/contract/O-TRU-102316-Contractv02.pdf

President Trump’s plan was comprised of no less than 18 actions and 10 proposed legislative acts, including the Middle-Class Tax Relief and Simplification Act, and the Repeal and Replace Obamacare Act. This ambitious agenda, coupled with strong rhetoric, drove domestic markets, bond yields, oil prices, and the U.S. dollar higher at the end of 2016.

President Trump was sworn into office on January 20th and, despite a burst of executive actions in the first few weeks, the administration has failed to meet expectations both internally and externally. Very few of the proposed actions and legislation have been addressed, and there has been widespread media coverage of the challenges the new administration has experienced in staffing the cabinet positions. There may be no harsher critic than capital markets, where nearly all markets have reversed course in the first quarter relative to the final month and a half of 2016. The market’s biggest criticism may be the decision to prioritize repealing and replacing the Affordable Care Act (ACA) ahead of developing a comprehensive tax plan, given the relatively immediate impact a tax plan would have had on investor confidence. The subsequent failure of Republicans to bring a healthcare bill to vote has only weakened confidence in the administration’s ability to execute on the promises that won their party the election.

In our last market commentary, we cautioned that the market may have been ahead of itself at the end of 2016. Markets are always pricing in the future (e.g., Apple’s stock price is not based on how many iPhones it sold last quarter, but how many they are expected to sell next quarter). However, in the case of the new administration, markets appeared to be pricing in expectations that required many pieces to fall into place before they would come to pass. While optimism drove prices higher at the end of 2016, reality has lowered expectations in the first quarter of 2017.

Despite lowered expectations, markets overall remain relatively healthy. International markets in particular have had a strong first quarter, supported by a weaker U.S. dollar and strong fundamentals. At the same time, while oil prices and ten-year treasury yields have retraced, they remain in line with levels experienced last year. A strong parallel exists between what happened in Europe following the Brexit vote and what has happened in the U.S. following the Presidential election. Markets had an immediate response in both cases, but soon after they returned to pricing based on economic fundamentals.

This begs the question, does the president really matter? While the question may sound treasonous, the truth is that the president by him or herself can have little impact on the economy. A recent podcast from Freakonomics Radio, with the same title (How Much Does the President Really Matter?), compared a U.S. president to a co-pilot sitting in a seat on a plane that is already on autopilot. The economy was in relatively good shape prior to the new administration, and it remains in good shape regardless of the actions, or inactions, of the new administration.

We do agree that a comprehensive tax plan would support investment markets and expectations of stronger economic growth and inflation; however, such a plan cannot be enacted via executive order or Twitter. It requires support and cooperation from the broader congressional body. The efforts to repeal and replace ACA showed us just how difficult it can be to get such support and cooperation.

Whether one voted for Donald Trump or Hillary Clinton, we all want the new administration to exceed our expectations, just as the brave souls who explored video dating decades ago and who utilize online dating today hope to find a diamond in the rough. Although we are early in the days of the new administration, we are better served to lower our expectations and be realistic about what can be accomplished over the next several years. The longer-term markets have proven to be relatively indifferent to who holds office, both in this term and in previous terms, as the markets focus much more on broad economic trends.

As your advisors, we continue to look for ways to improve our clients’ portfolios. We will share our recommendations based on the outcomes of our annual portfolio evaluation process in the coming weeks. If Congress and the new administration make progress on their agenda and enact a new tax bill and/or healthcare bill, our portfolios should respond positively. However, the true value of diversification is experienced when markets have their worst moments, not their best. While all investors hope that the worst moments occur later rather than sooner, those moments will eventually occur. In the meantime, despite lowered expectations, we believe the global economy is relatively healthy and our client portfolios are well positioned to benefit from progress on the political front and to manage risk as it occurs.

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Written By

Mark Feldman

Nathan Erickson