Election Recap: ‘Trumponomics’ 2.0 is Here

SUMMARY

• We expect higher growth and somewhat higher inflation during Trump’s 2nd term.
• We believe a ‘value’ rotation is the likely outcome.
• We are positioning our portfolios accordingly.

With a nation bracing itself for a drawn-out, contested battle decided by the thinnest of margins, the election itself seemed like it was over in the blink of an eye. Americans awoke on November 6th to find former (and future) President Donald Trump reelected in a landslide, with Republicans also winning back the Senate by a considerable margin. While the fate of the House of Representatives still hangs in the balance, this powerful GOP performance brings into clear view the ‘Red Wave’ scenario we first dimensioned out back in July. While we believe in Profits Over Politics the idea that US Economic Exceptionalism under either party, and that earnings and interest rates are more powerful stock market drivers than politics — a sweep scenario opens the door to policy with ramifications to both earnings and rates. As we’ve discussed before, Trump’s platform of deregulation, lower taxes, and tariffs is likely to result in stronger US corporate earnings, inflation between 2% to 4%, higher interest rates, and a strong US dollar. It is also likely to extend the long-term relative strength trend for US assets versus international ones, in our view. We think this is a recipe for continued gains in US stocks, but it comes with some risks, as we highlight in our scenario analysis below.

At Riverfront, we often perform scenario analysis, in which we define three to four potential outcomes for the economy and markets. This analysis includes what we’ll be monitoring to determine which outcome is more likely at any given time, and the potential ramifications of each. From there, we update our likelihood of each scenario as the market moves and new economic data is available. Currently, we view the four scenarios in Table 1 below as the potential outcomes.

Given our view that President Trump’s policies, especially if Republicans win control of Congress, will stimulate growth with moderated but elevated inflation, we see the bottom right ‘reflation’ scenario as the likely result, though there is a risk that uncontained inflation would cause ‘Stagflation.’

A ‘value’ rotation, when value-oriented stocks take market leadership, is something we have discussed in previous Weekly Views, but is worth revisiting given our expectations for Trump’s second term. If Trump’s economic policy drives strong growth with only moderate inflation, we would be squarely in our ‘Reflation’ scenario. This scenario provides a very strong economic backdrop for value stocks. Specifically, we believe the strong growth would drive revenues for these companies, while moderated inflation would allow the Fed to ease rates unlocking the balance sheets of these value companies.

However, there is a key caveat to this value rotation. When we have previously discussed a value rotation, we have included International Equities as potential winners. While we believe the above environment would stimulate US value (both large- and small-cap), headwinds created by Trump’s foreign policy could exclude international from a potential rotation. If the Trump administration successfully enacts tariffs on imports into the US, international companies could experience reduced or even negative earnings growth, in our view.

On the other side of the coin, if the combination of tax cuts and tariffs creates runaway inflation that outpaces growth, we would find our ‘Stagflation’ scenario. As a refresher from our previous discussion ‘Stagflation,’ stagflation is the combination of economic STAGnation and inFLATION. While historically rare, this combination of economic forces places the Federal Reserve in a no-win situation. They must either pursue a restrictive policy of fighting inflation by stifling growth, or enact an expansionary policy of stimulating growth, while allowing inflation to continue. Learning from the lessons of the 1970s and early 80s when the Fed initially let inflation get out of control, we believe an independent Fed will chose to focus on inflation at the expense of growth.

The market ramifications of this scenario are widespread and negative. Both bonds and stocks would struggle, creating a perfect storm for balanced investors to deal with. With traditional protective assets failing to provide diversification, investors would need to seek alternatives such as commodities and treasury inflation protected securities (TIPS). From an international standpoint, it is difficult to see this being contained to the US, especially given the widespread nature of the tariffs. However, a weakening dollar could provide some benefit to US investors investing in international markets, in our view.

Based on last week’s market movement, investors seem to believe that reflation and a strong dollar are the probable outcomes; US equities rallied, with small cap leading the way, followed by more cyclical sectors such as financials and industrials. International markets saw negative dollar-denominated returns due to concerns about tariffs and weak currencies. The good news is the portfolios are adequately positioned for this scenario. Our balanced portfolios are overweight US equities and underweight international equities and fixed income relative to our global benchmarks. Additionally, our long horizon portfolios hold positions in US small-cap equities, which align with the higher risk profile. In our shorter horizon portfolios, the bar for investing in small- and mid-cap companies is higher due to their greater volatility and higher risk, hence those portfolios have focused on cyclical sectors, like energy, financials, and industrials. If these trends continue, we could move more of our international equities to the US, with a focus on value, cyclicality, and small-cap.

For a stagflation scenario, as we mentioned above, portfolio action becomes less clear. To help insulate the portfolio, we could reduce our equity weightings, moving to cash, TIPS, and/or commodities. However, this scenario seems more of a future concern than an immediate one. This is where our risk management discipline comes in. We will continue to monitor macroeconomic data, company earnings and market technical to attempt to identify cracks forming and adjust the portfolios accordingly; adhering to our mantra of Process over Prediction.

For more news, information, and analysis, visit the ETF Strategist Channel.

Risk Discussion: All investments in securities, including the strategies discussed above, include a risk of loss of principal (invested amount) and any profits that have not been realized. Markets fluctuate substantially over time, and have experienced increased volatility in recent years due to global and domestic economic events. Performance of any investment is not guaranteed. In a rising interest rate environment, the value of fixed-income securities generally declines. Diversification does not guarantee a profit or protect against a loss. Investments in international and emerging markets securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. Please see the end of this publication for more disclosures.