The 1980s produced much that is worth remembering and much that is worth forgetting.
The 1983 movie National Lampoon’s Vacation with Chevy Chase is definitely one for the ages. Chevy Chase plays Clark Griswold, a mild-mannered food processing manager in suburban Chicago who plans a dream family road trip with his family to the Walley World theme park in California. The movie begins with poor Clark being conned into buying the Wagon Queen Family Truckster, an old, mechanically failing, gas-guzzling fake-wood-sided station wagon for the cross-country trek. The trip goes downhill from there. Predictably, the anticipation of the Clark family vacation turns out to be far more optimistic and idyllic than the vacation itself.
We took a family trip in January and I have to say that I can sympathize with Clark Griswold. I get a lot of satisfaction around everything that goes into planning an upcoming trip. From deciding upon a place that will be fun for the entire family, researching the various places to stay, the restaurants, the activities, the culture, to the many other considerations unique to a location, I enjoy the process. I even enjoy figuring out travel logistics (believe me, I’m aware I’m in the minority there) – the success metrics for which are of course the fewest number of minutes spent in airports and most seamless transition from arrival to lodging. What can I say – I care about efficiency (that applies to investment portfolios, too).
But the planning and anticipation don’t always play out in reality the way I imagine it. Research studies have shown this to be a common phenomenon. People often feel more satisfaction anticipating an event than in the fulfillment of the event itself. It is this anticipation vs. realization phenomenon that comes to mind when I think about the so-called “Trump Rally” in stock markets that has transpired following the election of Donald Trump as President of the United States.
What do I mean? Stock investors are notorious for trying to trade ahead of new events, meaning, they buy and sell stocks based both on what is currently happening (i.e. good or bad news) as well as what they think is going to happen in the future. In the case of the election and what it meant for future fiscal policy, investors started to buy and sell certain companies they thought could benefit from a Trump administration. This moved markets because many investors had previously priced-in a Clinton victory, which obviously did not happen. So, in the following months, investors had to try to determine what a Trump presidency could mean for stocks. Based on the chart below, investors have generally been very positive on stocks since the election.
U.S. Stock Market Has Risen Significantly Post-Election
N.B. – Market represented by S&P 500 price returns
Sources: Yahoo! Finance, Baker Boyer Bank
Markets offer fairly clear conclusions as to what they think by the way stock prices move. If markets are up, either something good happened or traders believe something good will likely happen. If markets are down, the opposite is true. Given this logic and the fact that economic growth remains steady and measured, the best bet as to why the market is moving so much higher is that people believe something good is likely to happen.
Even though market sentiment may be clear based on the direction markets are moving, why they are moving is often less clear.
We think markets are currently moving higher for two reasons: (1) the promise of tax cuts and deregulation, both of which should make it easier and more profitable for companies to do business, and (2) the prospect of government spending on infrastructure projects like water systems, roads, bridges, rails, etc., which can stimulate additional economic growth. Both of these broad themes are quite exciting, especially if you feel that it has become increasingly difficult to generate profits and operate efficiently in a world of higher regulation and already high corporate tax rates. And all you have to do is drive a few miles in most towns in America to realize our roads and bridges need some investment.
All of this is fine and well, and human emotions can drive markets for better or worse. The anticipation of things is a major emotional pull for human beings. However, optimism alone cannot sustain market movements. Because investors try to trade stocks based on forward-looking assumptions, expectations are embedded in stock prices which must then be met in order to sustain those higher prices. I’m not saying that any particular expectation won’t be met. I’m simply saying that whenever expectations start to affect markets, we want to take a closer look.
Up until now, there has been much discussion around what is expected from the Trump administration. It has been only a few short months, but markets have already priced-in some of the up-side of Trump’s pro-business agenda. This has happened in spite of the fact that there is a difference between campaign promises and actual policy proposals that will survive the Congressional sausage-making machine.
The natural question is what this all means for investment portfolios.
If you’ve read these newsletters in the past, our approach will likely not be surprising. Fundamental to our portfolio construction thought process is a belief in diversification, or owning a variety of different types of companies based in different geographies and balancing stock market risk with the stability that tends to come from bonds. In other words, since we know stocks will swing up and down through time, let’s be ok with that. We manage stock-specific risk by owning a lot of stocks and we manage portfolio risk by adding bonds into the mix. While there is a significant amount of nuance and sophistication that goes into those two actions, at its core, it is quite simple. Put differently, we own a lot of stuff so that any one market change doesn’t negatively impact our clients’ way of life.
For now in U.S. stocks, inspiration seems more important than execution. Eventually, fundamentals win. We will see how much of this market’s inspiration will actually materialize in the form of higher earnings, renewed investment spending by companies, higher consumer sentiment and ultimately a higher quality of American life. Regardless, we believe that a more informed public is better equipped to handle the potential ups and downs in markets. Even though the reality of my vacation wasn’t quite as I’d imagined it, that feeling didn’t bother me as much because I was prepared for it. In the end, that feeling was a moment in time, but I was soon back focused on my real goal, which was to have a wonderful vacation making memories with my family. Markets have rewarded long-term investors through many sets of expectations – some met and some missed. If the promises made by this administration do not come true, it can help to know how markets react to expectations so that you can maintain a healthy perspective.
Chief Investment Officer