Do elections really matter to financial markets? Pt3

white-house Today is the first day after the election of Donald Trump. My earlier posts on this topic focused upon how a Hillary Clinton administration would affect the economy and the financial markets. I did not address how a Trump administration would affect them largely because I did not believe he had much chance of being elected. Now that he has been elected, I want to address this. Here is the editorial posted by the New York Times today: “Trump’s Revolt”.

Donald Trump opened his campaign with an attack on new immigrants to America; particularly Mexican immigrants. He claimed, without references that recent Mexican immigrants were “sent” by Mexico to this country and that Mexico was sending us “their worst”. Trump pledged that, as a remedy he would build a high wall the length of the US/Mexican border ostensibly to prevent more undocumented Mexicans and others from entering the USA without visas. This wall would be paid for by the Mexican government he said; threatening Mexico with adverse currency exchange rates if they did not. He stated that, if elected, he would mount an effort to identify and uproot the estimated 11 million undocumented immigrants and deport them to their country of origin. Trump has blamed these immigrants for displacing native and properly documented American workers. Donald Trump expressed alarm about the resettlement of war refugees; particularly those from war torn Syria and Iraq. Trump expressed much suspicion about Muslims living in this country.

On foreign policy, Trump claimed he knows more about the situation in Iraq and Syria than the US military commanders there. He stated he would “tear up” the multinational treaty to end the nuclear program in Iran. Regarding the war in Syria, he stated he would simply “bomb the s**t out of them”. During national security briefings he reportedly wanted to know why the USA did not use nuclear weapons more frequently. Trump depicted the current trade policy of the USA as being very unfavorable to the USA; citing the NAFTA for being “the worst trade deal in US history” and cited the US trade deficit as an example of government officials who “didn’t know what they were doing”. A regular theme of Trumps was to declare that Washington DC is a “swamp” of corruption and incompetence that he and he alone could fix.

Trump’s own business practices reveal a practice of lying and cheating his competitors, government regulators, his own employees, and those contracted to do work for him. His justification for these practices was that ethics really knows no place in business dealings; that the “art of the deal” is to win at any cost. He has displayed wanton disregard for the privacy and dignity of women and used his ownership of beauty pageants as a means to satisfy his sexual fantasies; bragging to other men about how he was free to intrude upon dressing rooms and even to take liberties with women without their consent; a practice many consider sexual assault. During the campaign more than 11 women came forward to assert he had sexually assaulted them; one of them a 13 year old at the time.

Trump is currently under investigation for fraud perpetrated upon thousands of students who enrolled in Trump University; saddling many of these students with massive debt with little to show for their money. There is evidence that he defrauded an insurance company of $17M claiming damages upon his Mar a Lago resort in Florida that was largely unscathed by a hurricane.  The US Dept. of Labor has issued three complaints against Trump for failure to bargain in good faith with a union representing workers at his Las Vegas casino.

President Elect Donald Trump will have Republican majorities in both the US House and Senate. Speaker Paul Ryan has already stated that his cohorts in the Senate are ready to scrap the Affordable Healthcare Act that has brought health insurance to more than 20 million uninsured Americans. They have no proposal to replace this program. This prospect suggests that those 20 million people will now have to return to waiting in emergency rooms when their ailments have reached extreme conditions. Hospitals; required to provide this care will now return to massive costs of uncompensated care. Here in Arizona, acceptance of the Medicaid portion of the Act brought an estimated $11B in insurance to hospitals and healthcare institutions saving many rural clinics from closing.

His suspicion of Muslim immigrants; particularly those war refugees led him to declare that he would no longer allow them to come to the USA.  I believe this suspicion could lead to a requirement that current residents from war torn countries in the Middle East would need to register with the Federal government and face an extended vetting process. The prospect of locating 11 million undocumented immigrants living in the USA would require massive investigations pitting community members against each other. Hillary Clinton depicted this process as likely to be “busloads and trainloads” of people forcibly removed from the country. I assert that it is likely that if Trump keeps this promise internment camps will have to be constructed as these people are processed for deportation.

Trump’s trade policy could cause the USA to attempt to renegotiate trade agreements decades old; causing constriction in trade between countries and possibly trade wars. The policies he has pledged to implement are likely to cause extreme uncertainty for investors in financial markets. I assert that the severe Market contraction of 2001 was more likely caused by investor uncertainty after the election of George W. Bush than it was from the so-called “tech bubble” or as some assert a “market bubble”. This contraction began a 10 year period in which the Dow produced no gain. The Trump policies are much more extreme than those of George W. Bush.

What vexes advisors in this extreme situation is that although we may believe there is a contraction coming due to this change in US leadership, there is no way to predict with accuracy when it will commence and there is especially no way to predict when the market hits the bottom. Systematically buying more shares of stock holdings as they decline in value will result in more shares ready to increase in value once the market turns up again. This “portfolio rebalancing” will produce better investment results over the long run but for those investors who are currently depending on their portfolios for income they face difficult times ahead. Election night saw S&P 500 futures slide 800 points until trading mechanisms closed the trading. Today’s 295 point Dow rally will be short lived, in my opinion.


Brexit and investment strategy

Brexit Cameron and MerkelAs I write this the Dow 30 is down almost 500 points due to the shock to world financial markets of the vote by the British to leave the European Union. Here is the transcript of Dean Baker’s analysis given on PBS’s News Hour.  Baker believes that this is, in part due to strong anti-immigrant sentiment. Among the (perhaps) unintended consequences is the ease with which young Brits were able to seek and take jobs anywhere within the EU. It will also adversely affect the 2.5M British expats living on the continent.

What I expect to see is what I predicted to my client this morning where we see each other poolside mornings. I told him the Dow could plunge as low as 500 points today. If you are an investor with a well diversified portfolio of stocks, bonds (both domestic and international) and other asset classes is that your holdings’ values will dip as their underlying prices dip but you will not lose the number of shares you own. If you sell during this downturn perhaps speculating that the slide will continue, you will lose your shares, as well as their value.

Smart investors (and their smart advisors) will not sell holdings during this downturn but will examine their asset allocation to see which of them have been affected. This will be evident in the change in their proportion to the entire portfolio. If you, as other smart investors do, hold cash as a distinct asset class, you will have the liquidity to buy more shares to bring those holdings back to their target allocation. In this process you will be buying shares that have a (hopefully temporary) market discount. Please consult your advisor for confirmation of this general outlook. If you have any questions, please don’t hesitate to call. (520) 623-3646. Thank you!

Rebalance your portfolio in the face of the storm

Calm in the face of the storm

Please find this very good article from the New York Times (via the Arizona Daily Star) that helps to put the current market instability into perspective. The article points out that retirement portfolios usually take years or even decades to come to fruition, so it suggests that impulsive moves to cut losses by selling stocks may hurt retirement portfolios that an investor may need to rely upon for 30 years.

Here, at Jim Hannley LLC we were busy during this upset examining our client accounts to determine which, if any of our allocations needed to be rebalanced. (For more detailed information about rebalancing; especially how tactical and strategic rebalancing differ, please find that elsewhere on our site.) Not surprisingly, due to the sharp sell off of equities last Friday and Monday, we found that our allocations to our large cap funds, our international funds, our emerging markets funds (both equities and fixed income) and our core bond funds had moved away from their target allocations. In response, we placed many orders to buy or sell these funds to restore their model allocations.

This is strategic rebalancing because we are not increasing or decreasing our allocations away from our models (sometimes referred to underweighting or overweighting an asset class) by speculating that one asset class or another will be a winner or a loser. However, this does not mean that strategic rebalancing cannot result in a short term gain. For instance, if we find that the AJAX large cap fund is down 2% and, as a result, our 20% allocation to AJAX as our Large Cap vehicle is now 19.6%; we will buy more AJAX to restore it to 20%. This means that in a $100,000 portfolio AJAX, for example, prior to the event was selling at $10/unit and it is now selling at $9.80 we might need to buy $400 of AJAX to bring the AJAX allocation of $20,000 from $19,600 back to $20,000. We now own 40.8 more units of AJAX than we did before the event. If the price of AJAX cycles back up to $10.10/unit we find that we now hold 2040.8 units with a value of $20,612. If we rebalance once again, we will sell 60.6 units for $612 and realize a short term gain of $212 ($612-$400).

Conversely, because our international, domestic and emerging markets equities are collectively down 4% in the portfolio, our fixed income allocation has grown from 30% to 31.25% (up 4%) in our depressed portfolio now valued at $96,000. The fixed income fund has not increased its share price, but its proportional amount to the entire $96,000 portfolio has increased. We are going to have to sell $1,250 of our bond fund to bring the bond fund from $30,000 to $28,800 ($28,800/$96,000 = 30%). We now have another $1,200 in cash with which to buy more equities while their share prices are (temporarily) depressed.

This exercise will, hopefully demonstrate that roiled markets bring investment opportunities to investors who know how to strategically rebalance their portfolios to take advantage of price changes in their funds.

Strategic changes to my model portfolios

I have been for some time considering changes to my model portfolios. This has been precipitated by questions I have about traditional models that I was exposed to while I held my book of business at Genworth Financial Wealth Management and, prior to that as a financial planner in the capacity of Investment Advisor Representative at AXA Advisors.

Elsewhere here, I describe my practice philosophy as adhering to principles of Modern Portfolio Theory. MPT places great emphasis on asset allocation. Model portfolios are guides to investing client funds by diversifying their investments in mutual funds that hold various distinct classes of assets. Also elsewhere here I  list those I use. The models reflect a range of investment objectives and risk tolerance from “Capital Preservation” to “Aggressive”. The exact models I use are proprietary so I don’t display them to the public.

While my book of business resided at Genworth Financial Wealth Management I employed various institutional wealth managers to compose model portfolios for my clients. I assessed their risk tolerance and investment objectives and based upon these I would advise them to use a model portfolio of one of the wealth managers. Because these wealth managers held different views, they composed different models. Some were “strategic” some were “tactical”. The tactical portfolios could change their asset allocations for asset classes with some limitations. For example, they could have a target of 20% for Domestic Large Cap Growth but they could “overweight” or “underweight” that 20% in a range from, say 10% to 30%. They would adjust the allocation based upon their best guesses for near term Market moves. I don’t tactically adjust my portfolios.

Recently I attended a workshop organized by the Tucson Chapter of the Society for Chartered Financial Analysts and the Financial Planners Assn. Tucson Chapter. The presenters were from Oppenheimer Funds. Brian Levitt, economist and head of capital markets research for Oppenheimer Funds spoke extensively about the outlook for financial markets globally. The upshot of the presentation is that it is time for investment advisors to examine their views on allocating stocks and bonds in light of the increasing market capitalization of non-US companies. He stated that at this time US based companies own just 43%  of the share value of all the corporations publicly offered in the world. It is for this reason I am increasing the proportion of foreign stocks in bonds in my portfolios.