Donald Trump and the Stock Market

Article by Theo Vermaelen, Professor of Finance, INSEAD / Program Advisor, Amsterdam Institute of Finance
Portfolio Manager, PV buyback USA

Predicting the stock market consequences of a political event is difficult, as was demonstrated recently. Many so called experts predicted disaster if Trump got elected. The Financial Times and Citigroup predicted a 5 % stock market decline as well as a collapse of the dollar. Bridgewater, the largest hedge fund in the world even predicted a 10.4 % decline and a 4.9 % surge in the Euro.  All of them predicted an increase in volatility because of the unpredictability of Donald Trump.

While initially, on election night, stock index futures seemed to confirm these fears, on November 9 markets turned positive and started a stock market and dollar rally, especially in small stocks represented in the Russell 2000.  Small firms are mainly domestic firms that are expected to benefit from Donald Trump's plans to cut corporate taxes to 15 % and reduce regulations, without being negatively affected by the strength of the dollar and the fear of a trade war. Some large firms such as Apple with a lot of overseas cash may benefit from lower taxes if they decide to repatriate and spend it in the U.S., provided of course that these firms have profitable investment opportunities in the U.S.

Losers included gun manufacturers as their customers no longer had to speed up their purchases out of fear of Clinton's gun control laws. Indeed, companies like Smith and Wesson that flourished tremendously during the Obama administration took a big hit on November 9. Technology firms initially did not react enthusiastically as many of them are global firms concerned about Trump's trade war threats. As most of their cash inflows only are expected to be realized in the distant future, they are expected to be more negatively impacted by the rise in long-term interest rates. The biggest losers appeared to be the green energy equipment manufacturers that fell on average by 10 %.  The prospect of a president who believes global warming is a hoax is not really encouraging for the industry.

On the other hand, clear beneficiaries included defense stocks, as well as non-renewable energy, including the few remaining listed, non-bankrupt coal companies.  Pharmaceuticals were relieved because Clinton had planned to put caps on drug prices. However, the biggest winners turned out to be the financial sector that looked forward to deregulation and higher long term interest rates. Trump has promised to get rid of Dodd-Frank and the Consumer Protection act. This will provide more freedom for banks to take more risk and increase growth. The fact that financial stocks represent 27 % of the Russell 2000 explains why this index beat the S&P 500 significantly. Among the individual winners, the biggest winner on November 9 was Corrections corporation of America, a company that manages prisons. and rose almost 50%.  As Trump is expected to crack down on crime these firms are expected to benefit from the resulting demand for private company prison management.

Note that these are initial price reactions, based on what Mr. Trump is expected to do. Whether he will stick to these promises remains to be seen. The market seems to have little concern, based on the fact that the VIX volatility index has returned to its one-year low.  The large elephant in the room remains the level of his stated hostility towards foreign trade. Investors who are concerned about this risk should stick to smaller U.S. firms as they are mostly domestic firms and less exposed to foreign exchange risk.  These firms will also benefit more from the measures that Trump clearly wants and is able to pursue: cut corporate taxes as well as red tape.