Just prior to the election we postulated that a Trump surprise win would spark a reaction similar to "Brexit" with an immediate selloff when the unexpected happened and the less predictiable candidate won the Presidency. The "Brexit" selloff was short lived and the recovery was in place within a few days. The Trump victory selloff was even shorter lived and the immediate recovery saw new highs in many stocks over the days to come. One commentary we follow wrote the following as a typical response to the Trump victory:
"...SELL EVERYTHING! THE END IS HERE!! SELL!! SELL!! SELL!!
Well...except Biotech because the risk of price controls is over! Sell EVERYTHING but Biotech stocks!! Oh, and Financial stocks! Financial stocks will do very well with less regulation!! Sell everything but Biotechs and Financials! Of course there's Energy and Defense stocks, yeah they will do better with Republicans for sure. OK, we are selling everything EXCEPT Energy, Defense, Financials and Biotechs!! I can't sell [the big Tech companies] though because they will bring all that cash back from overseas now [and maybe invest more of it into their businesses]…Heck, if these stocks go up, it will drag ALL tech stocks higher. Alright, alright, we are gonna buy more Technology today! So here is the plan. Sell everything except Technology, Financials, Energy, Defense and Biotechs! But everything else has to go! Although...with the GOP controlling all three branches, they might actually get some infrastructure spending passed. That could really push Industrials and Basic Materials higher. OK, new plan- We buy Basic Material stocks, Industrials, Technology, Biotech, Financials, Defense and Energy, but nothing else!! Everything else, SELL! But wait, what if they cut corporate taxes like they promised??? That means more cash for share buy-backs, dividends and capital investment. And, if the GOP cuts taxes for individuals, they will have more for Consumer stocks. Well consumers make up 70% of the economy... that will make everything go higher!!!
NEW PLAN!!! BUY EVERYTHING!!!!!...BUY...BUY...BUY!!!!!!!!!!!!!!!!!!"
A great majority failed to vote for any President.
One thing we knew long before Presidential election results were tabulated was that the majority of the American public would be unhappy with the victor. Voter turnout fell to a 20 year low in percentage terms. Many who voted, only cast ballots for local and congressional seats, finding neither candidate worthy of their support. In 14 states more people voted for the Senate races than voted for the Presidency this year. Most people were voting against the candidate they liked least rather than voting for someone they felt they should support, with neither candidate's favorability rating rising close to 50%.
Should we wait for Trump to have an approval rating of over 50% before putting extra cash to work?
To answer this question, we might want to look at the next years returns based upon Presidential approval ratings. In the chart below we find that the absolute worst time to invest is when approval ratings are below 35%. We could assume this is because we are in a severe recession or we have just experienced a major shock to the system. What is more interesting is that the second worst time to invest is when approval ratings are extremely high. We could assume this is because markets could be seen as overvalued in these scenarios. What is most interesting is that as the Presidential approval rating decreases, the next year's historical returns increases as long as we do not head into the severe disapproval territory most commonly associated with a severe recession. What this means is that a little nervousness and concern about the future is good for stock investments. The markets climb a wall of worry especially when approval ratings are below 50%. By looking at this chart, we can see that waiting until people start to feel good about Trump may cause us to miss 5% or more of the market's upward movement, based upon historical averages.
After seeing the markets move so quickly should we take some funds off the table?
To answer this question, we may want to look at the following table which shows the next two months performance of the S&P 500 after Presidential elections for the last 85 years. The average gain over this period from the last 85 years is 1.8% with 12 out of 21 periods giving positive results. If we look at just the month of December, the results are even better. 19 out of 21 periods are positive with no negative Decembers during election years after 1940. Again, the historical results show that it doesn't pay to wait for a selloff or another type of buying opportunity.
What about Trump's Tax Plan?
Like it or hate it, the Republicans kept the House, the Senate and won the White House. This gives us a very high probability of comprehensive tax reform and at the top of the list will be President-elect Trump’s desire to lower the corporate tax rate from 35% to 20%.
Even the most watered down tax reform will have this item at the top of the list – and for the record, I believe the Republicans will pass much more than a basic, watered down tax reform package.
A reduction of taxes will flow right down to the bottom line to profits of all companies probably to the tune of a 20% increase in after-tax profits. Make no mistake about it…that is massive. Dare I say…huge.
With the current forward P/E ratio of the S&P 500 hovering around 16.3 (as of the end of the 3rd quarter) and the 25-year average for that P/E ratio of 15.9, any increase in earnings is going to make that P/E ratio go DOWN, which means stocks will look cheap at their current prices.
This will translate into stocks going up.
I believe that if President-elect Trump’s tax overhaul plan is put into place, we can see the equity markets continue to increase for years. That does not even factor in what will happen if a tax overhaul will include the repatriation of corporate profits currently being held overseas.
That makes now the time for long-term investors to consider investing cash…not raising it. Especially if your lifetime goals and objectives did not change in your sleep.
Remember, over the long-term, the fundamentals have historically dictated the direction of the market…and today, regardless of your emotions surrounding the outcome of the election, the fundamentals are favorable.
When investing, our emotions are our own worst enemy.
The reason the average investor does so poorly in relation to most benchmarks is because they wait too long to get comfortable with a purchasing decision, buying when optimism approaches its peak and selling at the point of maximum pessimism. They throw in the towel on proven strategies just in time to see them work for the next guy. They chase what has done the best recently only to see the investment in question run out of gas. In short, they let emotions get the best of them to their detriment. Those who refrain from investing because they don't like the current administration or want to wait for all the stars to align may find themselves being left behind.
For those who are curious about which investment behaviors are most likely to hold you back and how to recognize them, please refer to Did You Miss the Gorilla. Also feel free to ask for a DVD copy from our Brain Games workshop earlier this year.
"You pay a very high price in the stock market for a cheery consensus" - Warren Buffett
Joe D. Franklin, CFP is Founder and President of Franklin Wealth Management, a registered investment advisory firm in Hixson, Tennessee. A 20+year industry veteran, he contributes guest articles for Money Magazine and authors the Franklin Backstage Pass blog. Joe has also been featured in the Wall Street Journal, Kiplinger's Magazine, USA Today and other publications.
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