Here’s why a repeat of the Trump 2016 stock playbook may not work, Morgan Stanley says
Here’s why a repeat of the Trump 2016 stock playbook may not work, Morgan Stanley says
After a debate that boosted presumptive Republican nominee Donald Trump’s chances of beating Democratic incumbent Joe Biden in the November presidential election, interest has been rising in a group of stocks that benefited after Trump’s election in 2016.
Conversations with clients after Thursday’s debate “point to some appetite to rotate to 2016’s largely value/cyclical playbook,” a team of equity strategists at Morgan Stanley led by Mike Wilson said in a note to clients on Monday. Alongside that was the view from some that interest rates are headed higher.
Market action on Friday backed that up, the strategists noted, with energy, financials, industrials, materials and small-caps all outperforming the broader market, while the 10-year Treasury yield reversed higher. “Market expectations for fiscal expansion, reflation, and less regulation under a Trump presidency drove these initial moves, in our view,” they said.
An overriding issue, however, with trying to cash in on a 2016 playbook, which saw small-cap and lower-quality cyclicals outperform, is that the election outcome is far from certain. Wilson and his team note that volatility, on average, tends to pick up in September of election years and stay elevated through October, only paring back in November.
Another big caveat to hopes for a repeat of what was seen in that election is that the economic cycle is more mature today than in 2016, given that the two-and-a-half year fall in the Conference Board leading economic indicator series wasn’t part of the backdrop in 2016.
“Given [that] a later cycle environment is historically a backdrop where the market pays up for quality, we advise staying up the quality curve and away from small-cap cyclicals, which worked in 2016,” they said, adding that the “state of the business cycle is more important than the presidential election outcome.”
So regardless of the election outcome, stay picky within cyclicals, they say.
Another reason to doubt the relevance of that past playbook is that inflation is a bigger headwind for consumers now than it was then. In 2016, the U.S. economy was rebounding from a manufacturing and commodity recession, which got help from prospects of a pro-cyclical and reflationary policy regime, the strategists noted, adding: “Today, inflation is a notable headwind to consumers as discussed previously and fiscal sustainability dynamics are top of mind for the bond market.”
Investors should also beware that “risks are skewed to the downside” for growth should Republicans sweep the presidential and congressional elections, due to immigration reform and tariffs, which would help weigh on lower-quality, cyclical areas of the market and small-caps. And finally, Wilson and his team say investors are still facing possible events that could steal attention from the outcome of the election in the runup to it — jobs or inflation data, Federal Reserve comments and earnings season to name a few.