These past 8 years, returns have enjoyed both cheap starting levels and a large rate of change. The new administration may have neither. What does that mean for investors?
As we approach the inauguration of Donald Trump as U.S. president, expect wall-to-wall discussions of what his policies will mean for markets and the legacy of his predecessor, Barack Obama. Rather than add to that chatter, I’d like to discuss what unites both themes, principally, that returns will likely do worse under the new administration than the old, and where we might look for exceptions.
Eight years ago, stocks were in freefall, credit markets were frozen and a highly leveraged U.S. banking system was struggling to avoid collapse.
That statement may seem deeply unfair to an administration that hasn’t had a chance to make policy—and incongruous with the sharp rise in investor and business confidence in recent surveys. But it’s linked to a simple idea: Good market environments often involve a shift from economic despair to optimism, and a shift in psychology from “fear” to “greed.”
Both occurred over the past eight years, producing returns well above the long-run average. In other words, whoever won the White House would have a tough act to follow.
And what an act it was. Eight years ago, stocks were in freefall, credit markets were frozen and a highly leveraged U.S. banking system was struggling to avoid collapse. Car sales had fallen 50%, consumer confidence was at all-time lows, and the housing market—the single biggest store of wealth in the United States—was witnessing foreclosure rates not seen since the Great Depression. Two foreign wars and falling tax revenues were pushing the budget deficit toward historical highs.
It was a troubling time. Market pricing, unsurprisingly, reflected that despair. The last time the market cared this much about what a new U.S. president would do, the S&P 500 was at 805, high-yield bonds yielded 18.1% and the VIX Index (the so-called fear index of market volatility) stood at 56%. Those same numbers today? The S&P stands at 2267 (as of the close of market, Jan 17, 2017), high-yield bond rates are at 5.8%, and the VIX hovers around 12%.
Those levels reflect a remarkably changed backdrop. Today, U.S. car sales and consumer confidence are historically high. Residential and commercial real-estate prices are above prior cycle peaks. U.S. banks are now trying to return capital, not raise it; and US credit markets saw their highest level of bond issuance ($1.3 trillion) ever in 2016. U.S. jobless claims have hit a 40-year low; and the budget deficit is back to the average since 1980. The S&P 500 equity risk premium was 5.8% in 2009, and now it stands at 1.4%.
Returns under the outgoing administration, in short, enjoyed both cheap starting levels and a large rate of change. The incoming one may have neither. Things, of course, could get better. We certainly hope that strong returns continue.
What’s the key take away for investors who want to keep the good times rolling from this look-back at the past eight years? Starting points matter. Which makes it logical (if not always intuitive) to start with those who either weren’t invited to the party or didn’t particularly enjoy a good time.
One key candidate: The European Value sector has underperformed for 10 years, and has only just started to bounce. Our European equity strategists believe it will be in the unusual position of combining low valuations with strong earnings growth in 2017, while remaining under-owned.
More broadly, non-U.S. equities have underperformed the S&P 500 by 90% over the past eight years. In dollars, they underperformed by 108%. Again, a better starting point, and a preference for Japan and European equities in 2017 remains a core view.