The intriguing post-election rally

on Wednesday, 28 December 2016. Posted in Editorials, Opinions

By John R. Coble, Coble Wealth Management

Wall Street likes certainty. When startling financial, political, or societal events occur, volatility usually follows, and the major indices may fall. In late October, the Dow Jones Industrial Average went on a multi-day losing streak as Donald Trump caught up to Hillary Clinton in the polls tracking the presidential race.

Wall Street had been anticipating a Clinton victory; suddenly, that looked less certain. The Dow gradually sank below 18,000. When Trump won, however, the Dow did not drop further. It rallied for seven days and notched four record closes. What sparked the Dow’s rally?

One, a new presumption of massive federal spending on infrastructure and defense. In August, Trump pledged he would “at least double” Clinton’s proposed federal stimulus if elected, which would mean committing more than $500 billion to repair the nation’s highways, bridges, and ports. He has also talked of greater military spending.

Many, if not all, of the 30 companies making up the Dow could play significant roles in such efforts. Two, a Trump presidency is perceived as pro-business, with the potential for decreased regulation, renegotiated trade agreements, and tax cuts.

The small caps also soared after Trump’s win. The Russell 2000 advanced 9% during November 9-17, leading some investors to wonder what the small caps had in common with the record-setting blue chips. The quick answer is that these small-cap firms have greater exposure to the U.S. economy than they do to foreign economies.

Bulls believe that these firms will be particularly well positioned if infrastructure spending increases. Why did the S&P 500 & Nasdaq Composite lag the Dow and the Russell? The S&P rose 1.8% from November 9-17. This returned the index to the level at which it had been for most of the third quarter.

A closer look at the S&P’s recent performance reveals a striking gap between its industry groups. Its financial sector climbed 10% in the eight days after Trump’s victory, aided by hopes for friendlier bank regulation in the new administration. By November 15, its YTD performance was 17% better than that of the S&P’s worst-performing sector, utilities.

This degree of difference had not been seen in the index since 2009. Basically, a major rotation happened, taking invested assets out of certain sectors and into other sectors presumed to benefit from the policies of a Trump presidency.

Hearing about the Dow’s surge, some investors assumed their portfolios would see large, abrupt gains – but in any sector rotation, money flows away from some industry groups toward others. In the three days after Trump’s victory, the Dow had gained 2.81%; the S&P, 1.16%; and the Nasdaq, 0.84%.

While the Dow is only comprised of 30 companies, the S&P and the Nasdaq are much broader benchmarks, exponentially larger in their scope. Both the Nasdaq and the S&P contain many tech companies – and, broadly speaking, Silicon Valley was not high on Trump.

Investors scratching their heads at recent portfolio performance would also do well to remember that large caps are just one of six asset classes. The gains for U.S. equities stood out globally after the election; there were losses in emerging and developed markets abroad, and losses in the debt markets.

As assets in many portfolios are allocated across various asset classes to try and manage risk, this helps to explain why many retail investors saw only small gains or no gains at all immediately after November 8. They were not invested merely in the member firms of the Dow Jones Industrial Average.

Will this rally continue? It’s difficult to say. As you know, history provides information of the past, and no assurance of future returns. While it’s possible that the new administration’s policies will bear out this goodwill, it’s also possible, after the administration convenes, that there is a new perspective. Time will tell.