November 9, 2016

Outlook Post 2016 Presidential Election

The Trump victory keeps us in the bizarro world that I described in the July Quarterly Client Letter. Expect the unexpected is the lesson for 2016. Who would have thought that the UK would vote in favor of leaving the European Union in June? Who would have thought that many developed countries would have negative interest rates? Who would have predicted 12- or 6-months ago that the US would be saying President Trump in 2017?

Greater Conviction for a Lower Expected Returns

The election results gives me greater conviction in my investment outlook. I expect more days of large market gains and declines. Expected returns over the next 10 years will be lower than historical averages. I expect average annuals gains for US stocks to be between 4% and 7% over the next 10 years. The historical average since 1926 around 10%.  Returns for US bonds should be be between 1% and 3% versus 6.2% over the last 20 years.

Time to Review Outlook for Investment Goals

Investors should revisit the outlook for their investment goals using more conservative return expectations. Many retirement or financial planning calculators use as expectations the optimistic historical averages. If returns are lower than their historical norm, many people may be in for an unpleasant surprise. Their investment portfolio may not be able to support their retirement plans or run out of money.

2 Reasons for Lower Expected Returns: Greater Uncertainty & High Valuations

Two reasons for lower expected returns are greater market uncertainty and high valuations. A vote for Trump was a vote for change for many voters. With change comes uncertainty. Will President-elect Trump will with Congress? How will he change healthcare, trade or tax policies? Until they have more clarity, I look for investors and companies to be more conservative with their investments. This implies less risk taking and less willingness to pay up for their investments.

Greater investor uncertainty adds to larger market swings. US stock futures tumbled 5% overnight as a Trump victory seemed more likely. Stocks then opened the next day on a down note only to rebound and be up over 1% for much of the morning after election.  Large market swings will be more common until uncertainty subsides. Uncertainty also makes it more difficult for stock valuations to increase beyond current levels. At 25x, the price-to-earnings of the S&P 500 is above its historical norm of 16x but below periods such as 1999 when it was over 30x.

Position for the Long-Run

Predicting daily moves in the market with any consistency is a near impossible task. My years conducting investment research taught me that it is better to focus on the long-term. Your portfolio should reflect your financial goals, the priority of those goals, your risk tolerance and time horizon.  The approach that I think is most applicable in the current environment is to cast wide net. Holding an appropriate amount of broad assets will increase the chances of capturing market gains. It will also reduce risk through diversification.  It is also important to emphasize lower cost investments. Lower costs will help maximize your returns in an otherwise low return environment.


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