The election of Trump was a huge surprise to the markets, and has created enormous uncertainty as well as significant potential. Most importantly, IF his new administration can accomplish two primary catalysts, then the upside potential for the markets is quite significant. These two important catalysts are:
- Tax reform - In essence the goal here is to lower corporate and individual tax rates. The U.S. has the highest corporate tax rate in the developed world. Lowering corporate taxes could facilitate repatriation of cash held overseas by U.S. multinationals. This could provide a huge catalyst for the markets as this cash amount is approximately $2.4 trillion.
- A roll-back of burdensome regulation and government over-reach - This would lower the cost of doing business across corporate America, allowing resources to be redeployed in more productive areas. Moreover, this would free up the entrepreneurial spirit within the private sector, a positive for growth as well as job creation.
The result of these two fiscal policy changes may very well result in faster economic growth in the U.S. After 8 years of sub-par growth, there is tremendous pent up demand and if the economy starts growing 3-4% per year, there would likely be a surge in corporate profits and stock prices.
Developments over the next several months will not be linear. What we mean is that some of what the new administration does will have positive effects. Conversely, some of their decisions will not work out well. In addition, many of the reforms they will attempt to make will take years before we fully understand their impact. Health care reform is certainly one of these very complicated issues that may take years to resolve.
In the meantime, while all these changes are being debated, proposed, and implemented, the market will tend to over discount successes and it may over react when the administration stumbles. We expect this emotionally-charged environment to make the market even more volatile. Our plan, which we have already implemented, is to use this heightened volatility to our advantage as we look for opportunities to sell over-valued stocks and to buy under-valued stocks. Doing this well will require discipline, but our team has been through volatile times before, and we are confident we can navigate these turbulent waters safely.
We have outlined below the election's impact thus far on specific Willingdon portfolio strategies:
Interest rates have risen sharply following the election. We have maintained relatively short to intermediate duration in our bond portfolios so we have weathered the rate increase relatively well. Beyond that, we own individual bonds, not bond funds. Individual bonds may fluctuate but return to par value at maturity, thereby affording protection against a rising rate environment. Bond funds, have no maturity date, and hence do not offer the same protection when interest rates rise. In essence, higher interest rates provide more income over time.
Interest-sensitive securities have corrected in response to the increase in interest rates since the election. We have maintained the overall yield on this portfolio of approximately 5.6%. As long as the goal of owning this portfolio remains generating a steady dividend of around 5.0-5.5%, we do not recommend making any asset allocation changes away from this portfolio despite the recent drop in the prices of the securities held in this portfolio. If interest rates continue to move higher, more toward a normalized level, we would gradually and opportunistically increase our exposure to bonds within this portfolio. If this transition does happen, we are confident that we can maintain the same approximate level of current income while reducing the overall risk level of the portfolio.
This hybrid portfolio has held up particularly well after the election. While the interest-sensitive names have corrected, the growth-oriented names have rallied. We will continue to focus on adding names to this portfolio that have demonstrated a strong track record of paying above average dividends and also increasing those dividends consistently over time.
The impact of the election may have been most profound on this portfolio, which has rallied sharply. As we stated above, should the administration be successful driving the two catalysts then we anticipate the growth sector of the market should benefit.
We are always available to discuss any questions or concerns you may have related to asset allocation or changing market conditions. Please do not hesitate to contact us if there is anything we can do.
One final note, we will hold our next monthly conference call, to discuss current issues, on Tuesday, January 3rd at 12:00 noon. We look forward to sharing more of our thoughts with you during that call.