Since Donald Trump won the U.S. election on November 8, global financial, telecom and energy stocks have surged higher. But the party may be coming to an end for those sectors – and just starting for others.
Since the election, the U.S. S&P financials index is up 19 percent, the telecom services index is up 14 percent, and the energy index has jumped 10 percent (compared to the 6.5 percent increase in the S&P 500 Index). Investors are anticipating that these industries will benefit from Trump’s policies. (Before the election, we mentioned that financials and the energy sector, specifically natural gas, would do well if Trump won.)
Not surprisingly, these sectors of the MSCI All Countries Index have also outperformed other global sectors, as shown below.
Meanwhile, before the 2016 election – that is, a bit more than the first eleven months of the year – the S&P 500 Index was up 6.6 percent (the MSCI World was up 5.4 percent). The S&P Financials Index had gained 5 percent in the 11 months before the election, and telecom services were up 9 percent over the same period. Energy was having a good year anyway – the U.S. energy sector was up 17 percent before the election.
However, there is an old investment saying: Buy the rumour and sell the fact. As inauguration day (January 20) approaches, it’s time to sell the Trump Rally.
Conversely, sectors that have suffered since Trump’s election are due for a reversal. Bonds, healthcare and alternative energy may soon trade higher, as the Trump Rally bumps up against political reality.
What happens when a rally meets reality
While giddy investors could be right that President Trump’s policies will benefit some industries, there is just one problem: The pro-Trump stocks are already way up, so a lot of these changes are already priced into stocks – and the President-elect hasn’t even taken office yet.
And once he’s inaugurated on January 20, expect real-world Trump policy to begin deviating from investor expectations.
The president-elect’s cabinet has a large number of billionaires and Wall Street veterans who will push pro-business, anti-regulation policy. Oil and gas industry veterans joining the Trump team will want to drill more, while cutting back environmental rules. The theory is that tax cuts, business friendly policies and infrastructure spending will boost industrial companies and U.S. growth.
These policies may be implemented – and may have the anticipated impact. But history and the bureaucratic realities of politics suggest a lot won’t. And even if Trump turns some of his campaign promises into policy – a wall on the Mexican border, a 45 percent tariff on China imports and reversing climate agreements – it will only be after a long fight. The U.S. Congress, angry Democrats, state governments, competing countries and market forces can be expected to throw roadblocks in front of Trump policy. (Of course, other factors – like rising interest rates – will also affect market movements.)
Trump’s victory is affecting Asian markets, too. The MSCI Asia ex Japan Index, which tracks the performance of most major Asian markets except for Japan, has lost 4 percent since the election. China’s Shanghai Composite is flat since the election and Hong Kong’s Hang Seng is down 3 percent.
Trump’s comments on Asia, and China in particular, may be partly responsible for this weakness. (For more details on how Trump’s presidency could affect Asia, download our free report on the subject here.)
It may be time for mean reversion
In the meantime, we think it’s time for mean reversion to come into play during the early days of Trump’s presidency. As we’ve discussed previously, market prices have a strong tendency to reverse extreme price movements and move back to average – also known as mean reversion. After a period of rising prices, securities tend to deliver average or poor returns. Likewise, market prices that decline too far, too fast, tend to rebound.
Humans aren’t naturally good at anticipating mean reversion. When our favourite sports team wins the championship, we tend to believe odds are high it will duplicate the feat next year. Same players, same coach, great team – why wouldn’t they repeat? But back-to-back championships are very rare.
When deciding which stocks to buy, investors tend to focus on recent performance. If a stock’s price has been rising, we tend to believe that means it’s a good investment. Typically it doesn’t work out that way.
In fact, behavioural scientists have a name for our tendency to optimistically buy into markets just before they top and turn down, or panic and sell shares at the bottom. It’s called The Dumb Money Effect. Humans are hardwired to follow the crowd. While that behaviour may have kept cavemen alive in ancient times, it’s bad for modern investors’ portfolio returns.
Rather than jumping on the Trump Rally bandwagon, investors should consider markets and sectors left behind by the Trump Rally.
Sectors to consider
From a mean reversion perspective, several sectors appear especially interesting as we begin 2017:
- Bonds. As we noted earlier, bonds have been killed since the U.S. election. The iShares Barclays 20+ Year Treasury Bond ETF (NYSE; ticker: TLT) is down nearly 8 percent. TheBloomberg Barclays Global Aggregate Total Return Index, which measures the global bond market, has lost 5 percent. In the bond world, those sorts of declines in just two months border on cataclysmic. Since the election, money has moved out of fixed-income and into equities. This “risk-on” behaviour can run for a while. However, as anticipation about pro-business Trump policies wanes, expect a snap-back rally from recently weak global bonds.
- Healthcare stocks. Uncertainty about changes President Trump will make to the U.S. health-care industry has dragged down this sector. Also, health-care stocks are typically seen as defensive, dividend-paying investments. So, they’re not as attractive in a risk-on environment. However, with an aging global population, the long-term trend for health care is up. The iShares Global Healthcare ETF (NYSE; ticker: IXJ) has barely moved since the election.
- Alternative Energy. President-elect Trump has said that “The concept of global warming was created by and for the Chinese in order to make U.S. manufacturing non-competitive.” This doesn’t sound like a president inclined to support green investments. However, alternative energy will grow with or without the Trump administration’s support. China now drives the green investment market – Beijing is spending huge sums on pollution control as it confronts an environmental crisis. That’s not going to change, regardless of Donald Trump.