Estimated reading time: 3 minutes, 22 seconds

Trump Victory Highlights Need for Keeping Emotions in Check

Capital markets have reacted dramatically to Donald’s Trump’s presidential election. 

As with most periods of extreme market performance, investors have been trading based on assumptions that Trump’s policies could hurt international markets but also support U.S. economic growth. Yet, a variety of factors point to the need for investors to take a balanced approach to managing assets, in large part because the scope of Trump’s policies can’t yet be fully understood.

At the same time, rather than overreact to expectations over possible Trump policies, investors should focus on market fundamentals and the importance of managing risk by diversifying their portfolios.

In the 10 days following the presidential election, small cap stocks, as measured by the iShares Russell 2000 Index Fund, jumped 10.2%, according to ETFReplay.com. The SPDR S&P 500 ETF, which consists of companies that generate a substantial portion of their revenues overseas, also advanced, but only generated a 2.1% return.

During the same time period, emerging markets were the whipping boy of investors, with the iShares MSCI Emerging Markets ETF declining 7.7%. Other non-U.S. markets, as measured by the -3.2% return of the iShares MSCI ACWI ex U.S. ETF, also declined.

For non-U.S. markets, Trump’s election could be viewed as a perfect storm, at least at first blush. Trump’s proposal for deficit spending as a form of fiscal stimulus, for example, has sent U.S. interest rates upward, which has caused capital outflows from emerging markets. Investors have been attracted to the higher U.S. interest rates while also being concerned that higher financing costs may hurt economic growth and earnings of leveraged companies in emerging markets.

From a broader perspective, Trump has promised to renegotiate global trade deals and has spoken out against free trade, going as far as to say he would even cancel the country’s participation in NAFTA, which is an agreement initiated by Ronald Reagan and finalized under Bill Clinton that eliminates tariffs between Canada, Mexico and the U.S.

He has also argued that China is maintaining an unfair trade advantage by manipulating its currency. Concerns that a trade war could limit our exporting to China, which is a massive market, and to other quickly growing markets, have caused investors to rotate into small company stocks because smaller companies typically have less exposure to foreign markets.

In addition, small companies tend to outperform during periods of economic expansion as they can quickly respond to changes to customers’ needs.

Rather than rushing to embrace small cap stocks and quickly selling off emerging market equities, investors should take a more measured approach to maintaining asset allocations. For example, many of the attractive fundamentals of emerging markets still exist. Emerging markets have been trading with a price-to-earnings discount relative to developed markets of more than 20%, which many investors believe points to the asset class being attractively valued.

Many emerging market countries are also heavily dependent on commodities, so they have been benefiting from increasing crude oil prices and stronger prices for other materials.

Investors should also use caution in trying to forecast the potential outcomes from Trump’s policies. Indeed, many of his policies have been highly fluid as he works building his administration. As an example, he had pledged to totally eliminate Obamacare, but now he is says he will only eliminate certain portions of the legislation.

It’s also likely that U.S. corporations that are heavily dependent of exporting will put substantial pressure on Trump to avoid creating a trade war. Congress may also resist implementing import tariffs with the belief that the economic benefit resulting from domestic company’s not having to compete with foreign manufacturers when selling products in the U.S. may not compensate for a decline in U.S. exports that could result in a trade war.

Either way, investors should continue to maintain prudent asset allocations to manage the risk of their portfolios rather than hastily try to time the markets.

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