Contrary to many market “experts’” prior expectations, equity markets have rallied sharply since the surprising election of Donald Trump on November 8th as the next President of the United States. Through the close yesterday, the S&P 500 Index had gained over 6% since Election Day, while the Russell 2000 Small Cap Index had vaulted more than 15%.

Investors have poured into U.S. equities in the last five weeks, believing that a Trump Administration will be unabashedly positive for the U.S. economy and U.S. companies. Several reasons supporting this belief are frequently cited

  • Trump is likely to support increased government spending programs (such as an infrastructure program) in an effort to jumpstart economic growth.
  • U.S. tax policies are likely to be modified. Frequently cited changes include reductions in both individual and corporate tax rates, amnesty for multinational companies allowing repatriation of billions of dollars of foreign profits, and allowing more generous tax deductibility of capital investments.
  • Deregulation, especially in areas such as environmental law, energy production and banking and finance could also be a factor.

The rapid response by investors to these possibilities has been somewhat remarkable. We are mildly concerned that several potential negative factors have been largely ignored. First, increased government spending in tandem with lower tax rates is likely to result in upward pressure on materials and wages, and hence inflation. This additional spending is also likely to require an increase in government borrowing, potentially at a higher rate of interest. Indeed, the ten-year Treasury yield has increased by 65 basis points since Election Day, and now stands at about 2.50%.

Second, President-Elect Trump has been quite vocal about U.S. trade policy and how disadvantageous it is to U.S. workers and consumers. Many multinational companies could suffer to the extent that trade agreements are renegotiated or tariffs on imports are introduced. We estimate that the constituents of the S&P 500 derive about one-half of their revenue outside the U.S., which could be at some risk if trade barriers grow. Indeed, one reason smaller company stocks may be outperforming is that they derive a much larger percentage of their revenue--perhaps as much as 80%--from within the U.S.

As we mentioned in our Election Day note, we are avoiding “short-termism” and instead will evaluate the longer-term impact of these and other potential changes on financial markets. Our investment approach is decidedly “bottom-up”, focusing on each potential investment’s fundamental condition. However, we have made one tangible change to our forecasting methodology that is worth highlighting.

As you know, we build our own Fundamental Equity models to forecast earnings and free cash flow generation for many potential investments, including all companies included in our small cap and large cap value portfolios. We now believe it is more likely than not that a new Trump Administration will succeed in reducing the U.S. corporate tax rate, currently set at 35%. There are several competing proposals being discussed, ranging from a reduction to 15% (Trump campaign) to the low 20’s (supposedly “revenue neutral”) or perhaps 25%. After careful consideration and much discussion among the Fundamental Equity team, we are now assuming in our “high-end” forecast, to which we typically assign a 20% probability of occurrence, that the corporate tax rate will be reduced to 20%. In our “base case” forecast, typically assigned a 40% probability, our tax rate assumption is now 25%. We have not made any change to the tax assumption in our “low-end” cases, which typically also carry a 40% probability of occurrence.

The impact of this change varies across our holdings as a variety of other factors affect a company’s “effective” tax rate. The impact has been to increase the value of the stocks we own by as much as 10% in some cases, and 6-8% on average. Of course, we may simply be playing “catch-up” as markets have already moved by this much and more.

We continue to evaluate these and other policy changes that may affect the value of U.S. equities and the companies in which we invest. It stands to reason that we may experience periods of above-average short term volatility as the new Administration’s plans unfold. In any event, 2017 promises to be another exciting year for equity investors around the globe.



Manager commentary provided by Great Lakes Advisors, a Wintrust Wealth Management Company. Market commentary represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice.