What Trump Effect?

August 2017

Market overreaction reverses

  • Market overreaction reverses
  • Updating economic and market outlook
  • The cost of holding cash

September’s arrival focuses financial markets’ attention on approaching year-end performance and the 2018 investment outlook. Markets are still adjusting almost one year after the surprising 2016 presidential election. As reflected by the past several weeks’ performance of domestic stock indices, the robust equity “Trump rally” has decelerated into a “Trump stall.” In comparison, bond markets have tracked a more quiescent course this year following their decisive post-election sell-off. Interest rates are currently near their lowest levels of the year.

The municipal bond market has recouped the post-election 5.19% price decline from late 2016. The 2017 rebound is characteristic of prior municipal bond price recoveries that followed significant market declines. The Bloomberg Barclays Municipal Bond Index has climbed 5.20% through August, putting the municipal market back on its pre-election course.

S&P Municipal Bond Index Performance
Periods of Significant Municipal Market Negative Performance, December 2007 - August 2017
chart 1
Source: Bloomberg and SMC

Investor sentiment was particularly dour late last year. SMC FIM’s December 2016 Commentary, “2017 Outlook: Opportunity Amidst the Volatility,” highlighted potential risks as well as our contention that investors were overreacting: “With a new U.S. administration taking office, 2017 looks to be a year of many unknowns and the investment horizon more unpredictable. For anxious financial markets, the developing ‘Trump Revolution’ raises numerous questions that will not be answered quickly: tax restructuring, infrastructure spending, regulatory reform (Obamacare), pension liabilities, and new municipal debt issuance are considerations. Agenda advancement should be slower than many are now anticipating, and outcomes possibly not determined for a long time. The knee-jerk bond market reaction to the election outcome is overdone in our view. As 2017 unfolds, financial markets should return to a more balanced position.”

SMC FIM’s refrain (“Stay the Course - Again” in 2017) has proven to be the best course to follow this year. Our 2016 year-end note recommended that, besides staying the course, investors should take advantage of post-election offerings of sharply discounted tax-exempt bonds. We cited six reasons last December supporting our forecast for 2017.

"Stay the Course - Again" in 2017
Reason Expected Outcome
1 Trump agenda will face some challenges Financial markets will recover from overreaction
2 Federal Reserve interest rate hikes will be limited Predicted four rate hikes forecast will not occur
3 Bond market technicals will be supportive Falling new debt issuance; large cash reinvestment
4 Late 2016 municipal market sell-off = opportunity Market will rebound as it has done in the past
5 Sub-par global economic growth U.S. GDP less than 3%; less in Europe and Japan; China slows
6 Strong U.S. dollar (USD) Bad for U.S. exporters; good for U.S. Treasury bonds

Heading into the 2017 home-stretch, of the six reasons given to stay the course, only the last one (Strong U.S. dollar) has failed to materialize this year. Furthermore, the impact of Hurricane Harvey will negatively impact U.S. economic performance over the next few months.

The federal government’s borrowing capacity is now bumping up against another debt ceiling. Failure by Congress to act and raise the ceiling could severely impact the U.S. economy since the government’s bills will not be paid and its borrowing capacity halted. Given these additional uncertainties and the likely political fallout, the Fed should be reluctant to risk further exasperating matters by raising short-term interest rates again before year-end.

These reasons argue for staying invested, and the third reason (Bond market technicals will be supportive) presents the most compelling case. SMC FIM is concerned that the municipal market supply/demand imbalance could intensify, further lifting prices. Foregone tax-free income and possible price appreciation might be considerable. We do not foresee any significant impediments to market performance. Therefore, sidelined cash should be redeployed into the municipal market.

Disclosures

The information provided in this commentary is not intended to be a complete summary of all available data. Certain information contained herein has been obtained from published sources and/or prepared by sources outside SMC Fixed Income Management ("SMC FIM"), a division of Spring Mountain Capital, LP, and certain information contained herein may not be updated through the date hereof. While such sources are believed to be reliable, no representations are made as to the accuracy or completeness thereof by SMC FIM or any of its affiliates, directors, officers, employees, partners, members or shareholders, and none of the former assumes any responsibility for the accuracy or completeness of such information. Nothing contained herein shall be relied upon as a promise or representation as to past or future performance.

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