November 2016 Newsletter

In this report I discuss politics by way of economic research and tackle some of the asset class implications of a Trump or a Clinton victory. Do you hate me yet?

Let’s begin with the bond market. Risk appears higher for the bond market heading into the post-election period for either candidate’s early administration as higher yields are coming. The Credit Suisse bond team anticipates US yields of 2.14% on the 10 year Treasury by the end of 2017. This is due to:

• the expectation of rising wage growth
• the expectation of higher oil prices
• Chinese PPI inflation turning positive
• policy makers in Japan, Europe and the U.S. moving toward fiscal easing and away from interest rate maneuvers.

According to Credit Suisse Research, a Clinton victory might see some bounce-back in GDP growth given recently postponed capital spending decisions on the part of corporations. A rise in minimum wages and maybe a looser fiscal policy could also help. A Trump victory could imply higher inflation and fiscal reflation.

The sense among analysts at Credit Suisse (CS) is, generally speaking, the stock market has a tendency to overreact to political risk. Tiananmen Square and Brexit illustrate this point. US equities have closely tracked Clinton’s poll rating, but even a Trump victory that includes moderate protectionism may not be that negative for the stock market given potential corporate tax cuts and fiscal reflation policies. Either a Trump or a Clinton victory is likely to raise inflation expectations and macro surprises, with both being positive for equities.

Other factors that are currently supportive of equity markets are:
• the current equity-risk-premium (ERP) is estimated to be 7.4% versus a warranted ERP of 5.4%;
• Corporate earnings revisions are positive for the first time in 5 years. Based upon this information CS puts a target on the S&P 500 of 2,300 by mid-2017.

As a Clinton victory has been tied to valuations in the Pharmaceutical, Biotechnology and Healthcare sectors of the market it’s interesting to note that analysts now believe pharma political risk has largely been priced into the market. As we approach November 8th, election day, we will be watching the Healthcare sectors closely since Pharmaceuticals have outperformed four out of the last six occasions following a presidential election. Using scenario analysis, if one were to assume an 80% chance of Clinton winning the presidency, and a 70% chance of her successfully implementing her policies—resulting in a potential 20% fall in pharma EPS—then pharma stocks should have underperformed by 11% since her ‘price gouging’ comment in September
2015. In fact, they have underperformed the markets by approximately 8 percent.
Meanwhile, some positive fundamentals have been overlooked as innovative drug companies, especially those with new drug discoveries and pricing strategies hold the key for outperformance.

Another sector of note leading into a new Presidential administration is construction. US construction stock valuations are in line with their post-crisis norms and materials are oversold. This has provided attractive opportunities given both candidates’ professed policies for infrastructure spending and the underinvestment in this sector for years. It’s also interesting to note this is a relatively non-disrupted sector.

On the possibility of a Trump victory, the peso looks nearly as cheap as it was in early 1995. This discounting suggests that the market has assigned a 25% chance that an extreme NAFTA scenario may unfold. This may be far too pessimistic. Stronger oil and a rebound in US growth tend to be good for the peso. A Clinton victory would significantly change the landscape on this discounting. A Trump victory could sustain the discount for a time. Thereafter, it’s difficult to build a scenario in which further discounting could occur, especially if oil prices continue to rise.

Under Hillary Clinton, we assume deficit expansion would be far less significant than under Trump; the bipartisan Committee for a Responsible Federal Budget estimates that there would be an increase of $1.65trn in primary expenditure over 10 years, but this would be almost entirely offset by additional revenues, leading to only $200bn of net government borrowing (0.1% of GDP). Nevertheless, although the policy might be fiscally neutral, it would probably boost growth because the multiplier on fiscal expenditure is greater than that on revenues. This would especially be the case if the spending were financed by repatriation of US cash held overseas by corporations.

Clinton’s federal minimum wage proposals are more inflationary than Trump’s. She has expressed support for a $12/hr federal minimum wage (a 66% increase on current levels), or up to $15/hr at the state level. Data from the BLS shows that 3.3% of hourly-paid workers (who represent 1.9% of all workers) earn a wage rate at or below the current federal minimum wage; assuming that, in aggregate, these workers experience a 66% increase in their wage rate, such a federal minimum wage could add at least 130bps to wage growth. For our purposes, the majority of Clinton’s other policy proposals appear to represent a continuation of the status quo and are thus less relevant to this discussion.

Many of Donald Trump’s policies appear to be consistent with inflationary outcomes and
higher bond yields from a number of different angles: First, The Committee for a Responsible Federal Budget estimates that Trump’s policy proposals will lead to net
government borrowing of $5.3trn over the next decade (2.5% of GDP assuming
real growth of 2% per annum). This is even more so if Republicans win the Senate
and thus have control of Congress. Trump has mentioned a commitment to spend
at least double the amount proposed by Clinton on infrastructure (Clinton has
proposed $275bn in direct spending on infrastructure over five years, plus another
$225bn in loans and loan-guarantee programs).

A number of Trump’s trade policies are inflationary. Both raising tariff barriers and removing trade treaties would likely increase import price inflation, and a move toward encouraging reshoring would increase business costs, with firms likely passing these through to consumers.

Trump has suggested he might redeem Treasury bonds below par (The Economist, 6 May) and may attempt to influence the Fed by replacing current Chair Yellen in February 2018, possibly with a more hawkish candidate, as a collection of Trump’s statements on the Fed show. Any move to significantly tighten monetary policy, or indeed a perception that monetary stability is at risk, would likely push rates up. Many of Trump’s policy proposals have centered around greater controls on immigration. A reduction in either legal or illegal immigration would likely lead to an increase in labor costs (foreign-born workers have accounted for 28% of employment growth since 2010), as would any attempt to repatriate some or all of the US’s 11.1m undocumented migrants (6.9% of the labor force) due to an increase in skill shortages. Further, Trump has suggested he supports a $10/hour federal minimum wage, a 38% increase on the current federal minimum. Using the methodology above, this would add at least 70bps to wage growth.

In terms of pure scenario analysis, the most clearly positive outcome for bonds would be if the more extreme protectionist elements of Trump’s policies were enacted and resulted in an all-out trade war and subsequent recession. However, as above, this is an unlikely scenario, given that the world is so interconnected via global supply chains and ownership. The average global applied tariff rate has fallen to 3% from above 20% in the 1930s. If very large tariff barriers were eventually applied and large multinational corporations had to reshore their income, it’s doubtful US consumers would welcome the consequent price increases.

In general, equity markets overreact when pricing political risk. To take two very different examples, the Hang Seng fell 22% in a single day following the Tiananmen Square protests of 1989, losing 37% from its peak, before steadily recovering back to its previous peak over the following year. In the case of the Brexit vote, the FTSE 100 fell by 5.5% in the two days following the referendum outcome, before rallying 19% (albeit against the backdrop of a sharp decline in the pound). This suggests that markets initially overreact to political shocks.

The volatility of the first month after an election can sometimes be extreme, 70% of the last ten one month post-election periods have experienced a gain or loss of greater than 2%. The average return during these periods, -0.67%, was greatly influenced by the Global Financial Crisis where the one month post-election return was -12.89%. However, half of the time the market has gone up the month after the election. The top performing 12 month post-election period returned 32.01% in the post-recession mid-90s when the tech run was gaining strength, the bottom returned -22.07%, with an end period shortly after September 11, 2001. Only two of these periods had a negative return of more than 10%. The range of these outcomes is very dramatic, however, 70% of the time US Equities were higher one year later, with an average return of 7.63%.
Figure 25: US equities have tended to decline in the immediate aftermath of elections, before going on to make gains

Source: Thomson Reuters Datastream, Credit Suisse research

We know the historical results and the current forward expectations regarding a victory by each candidate. A week from now we will know the results of the election. Soon, the realities of the results of this election cycle will begin to become clear. Enjoy this historical election for all of its conflict and uncertainty. In the end, we’re all in this together.

Credit Suisse, Global Equity Strategy, October 19, 2016. Research Analysts: for Equity Research Investment Strategy: A. Garthwaite, M. Pronina, R. Grffiths, N. Wylenzek, A. Hymers, M. Yuan and A. Evans.
Securities offered through Bolton Global Capital, Inc. (“the Firm”), 579 Main St., Bolton, MA. Member FINRA, SIPC 978-779-5361. Advisory services offered through Bolton Global Asset Management, a SEC registered investment advisor.
This report is being generated as a courtesy and is for informational purposes only and is not intended, in any manner, as an official account statement from any custodian or product sponsor. This report is not to be used as an official books and records statement of the Firm. Please contact the relevant custodian or product sponsor if you have any questions about the statements.
Data illustrated on this document may be provided by third parties. The Firm is not responsible for errors, misstatements, or variances in what is reported herein and what is reported on official account statements from custodians or product sponsors. Some assets and values contained herein that are provided by third parties are unverified. The Firm is under no obligation to verify the existence or value of any assets held at third parties.
Values are as of the date(s) indicated herein. If no date is indicated, then it is as of the date reported by the custodian or product sponsor. Please consult the official account statements of the custodian or product sponsor for actual values as of any given date. We believe the sources to be reliable, however, the accuracy and completeness of the information is not guaranteed. In the event of discrepancy, the sponsor’s valuation shall prevail.
Data contained within this report may reflect data held at various custodians and may not be covered under SIPC. The Firm’s SIPC coverage only applies to certain assets held through the Firm. In addition, certain other reported entities may be SIPC members that provide coverage for assets held there. You should contact your financial representative, or the other entity, or refer to the other entity’s statement, regarding SIPC coverage. Assets reflected on this report that are not held at the Firm on your behalf are not part of the Firm’s books and records.
Performance data quoted represents past performance and does not guarantee future results. The investment return and principal of an investment will fluctuate so that an investor’s shares when redeemed may be worth more or less than original cost. The values represented in this report may not reflect the true original cost of your initial investment.
Cost basis information may be incomplete or may not accurately reflect the methodology used by a particular client. Clients should consult with their tax advisor.
This document may be delivered to an address other than the address of record. If this is the case, it is done at the client’s request. Source documents, the name and contact information for custodians and product sponsors of the assets included herein, and account numbers are available upon request. Please contact the Firm or your financial representative for this information.
For non-traded real estate investment trust asses and direct participation program assets only: non-traded real estate investment trust and direct participation program investments are generally illiquid. The value displayed herein may differ from the initial investment price. Due to the nature of these investments, accurate valuation may not be available.
For fee-based accounts only: The data may or may not reflect the deduction of investment advisory fees. If the investment is being managed through a fee-based account or agreement, the returns may be reduced by those applicable advisory fees. The information contained in these reports is collected from sources believed to be reliable. However, you should always rely on the official statements received directly from the custodians. If you have any questions regarding this report, please call your representative.
The time-weighted rate of return eliminates the effect of cash flows. In the case of the daily time- weighted rate of return, the portfolio will be revalued whenever a cash flow takes place therefore completely reducing its impact on the return. Returns are measured from day-to-day or cash flow to cash flow. These returns are then compounded or geometrically linked resulting in the time- weighted rate of return.
Performance returns for time periods longer than 365 days have been annualized.
Any benchmark return calculations included on this report were performed using a cash flow adjusted calculation.