2016 Q4 Legacy Group Commentary

President Donald Trump

Does that look right to you yet?  The day after the election I sent a good friend of mine a message….”President Elect Donald J. Trump.  There.  Just had to give it a go and see if it feels more real.”  It didn’t really help.  Whichever side of the election you were on I think everyone can agree the concept of “President Trump” seems strange.  Yet on Friday, January 20th, 2017 Donald J. Trump was sworn in as the 45th president of the United States of America.  

In the weeks leading up to the election the news media was overwhelmingly predicting a Hilary Clinton victory.  Simultaneously, the financial news media was reporting that a Hillary Clinton election would be viewed positively by the financial markets whereas a Donald Trump election was sure to cause market chaos.  The actual results of the election and the subsequent reaction of the stock market were a reminder of how poorly the prognosticators prognosticate. As election night unfolded and the possibility of a Trump election became greater the futures market on the Dow and the S&P sank lower and lower.  But by the end of election week the Dow had posted its best week since 2011.  

By their fruits you will know them

It seems that a good portion of the news these days is spent on what “will” happen instead of what has happened.  Nowhere is this truer than in the financial media.  This time of year is full of forecasts: where the market will be at the end of the year; what direction interest rates will go; what sectors will out-perform, under-perform, etc.  After being an observer of these forecasts for more than a decade I can tell you the vast majority of them turn out wrong.  My favorite from last year: Bloomberg interviewed 65 analysts asking where interest rates would be at the end of 2016.  Every one of them said the yield on the 10 year treasury would be below 2%.  It closed the year out at 2.45%.  65 experts…all wrong.   

Every year I see similar forecasts from the experts and every year they fall short of being right.  When it comes to accurately forecasting the future the experts do not have a good track record.  But don’t just take my word for it…. Philip Tetlock is a professor who authored the book, Superforecasting: The Art and Science of Prediction.  He spent over 20 years interviewing 284 experts while tracking the accuracy of their forecasts along the way.  After compiling 20 years of data, here’s what he found in his own words: “the average expert was roughly as accurate as a dart-throwing chimpanzee.”

To be fair, Dr. Tetlock’s discovery does not disqualify all expert forecasting, as he makes clear in his book. What it does illustrate is the rarity of good forecasters.  Arriving at a correct understanding of current events is hard enough.  Then to take that and extrapolate what will happen next is extremely difficult.  There are always unknowns and there is always a human element, which is impossibly hard to predict – just ask the Baseball Prospectus guys.  Every year they run a simulation based on player and team statistics to predict each major league baseball team’s record.   In 2015, a team the system said would lose 90 games won the World Series (I’m not still bitter about that prediction…really, I’m not).  

In 2016 there was no shortage of incorrect forecasting.  The Presidential election, the Brexit Vote results and the subsequent market reaction from each of those events were all forecasted incorrectly by the vast majority of pundits on TV and the experts in the fields.  This brings us to a stark reality: most of the pundits on TV and the experts do not have a clue what is going to happen whether it regards the economy, politics or financial markets.  At the end of the day, all their running commentary is just a lot of noise.  

As investors, it is important to recognize the limitations on our ability to foresee future events.   We can’t predict with any accuracy where the market will be in six months or how we will get there.  Nor can we predict how one event – like the election – will impact the markets.  Pretending we can will result in making imprudent short-sighted investment decisions.   

However, that does not leave us blind and without a road map.  There are things we can know or have varying degrees of conviction through which we can make good decisions.  We can gather a lot of current factual information: economic growth rates, demographic trends, and government and private sector debt levels just to name a few.   We can have a general sense of where we are.  Economies and financial markets tend to move in cycles.  Economies move from contraction to expansion and vice-versa.  Markets move from euphoria to fear and back again. We cannot identify when a cycle will change but we can have a general idea of where we are. We can identify and evaluate various risks: geopolitical risk, economic risk, market risk, valuation risk, interest rate risk, and many other forms of risk.  

What this information will not do is tell us exactly what will happen over the next few months.  We cannot accurately forecast from this info where the S&P will be at the end of the year or what the yield on the 10 year treasury will be 6 months from now or how First Solar will perform over the next 3 months.  What we can do is use this information to make decisions regarding long term economic trends, current valuation levels, long term growth trends, short-term mispricing opportunities, conviction levels, allocation percentages, hedging needs and many other factors that go into building a diversified investment portfolio.  

Trumps Impact on Investing

As we look ahead to a Donald Trump Presidency the most important question we ask ourselves is not what impact President Trump will have on the stock market.  We don’t know how his presidency will ultimately impact the market and anyone who says they do is not being honest with you or themselves.  The real question to ask is what changes now that Donald Trump is President?  We would argue that the facts largely remain the same: the developed world is mired in too much debt; despite accommodating monetary policy of central banks (low interest rates and Quantitative Easing) economic growth is slow; productivity growth is stalled; the best long term growth opportunities still appear to be overseas; domestic assets – stocks and bonds – are at historically high valuations; and people will continue to eat food, drink water and use oil.  

What we will likely see from President Trump are policies that will have definite short term impacts.  For example, the tax policy proposed by the incoming administration will likely have a short-term benefit to corporations by lifting their profitability.  In addition, the administration is planning on infrastructure spending, which could have a positive impact on the general economy.   His foreign policy looks to be very different from past presidents which will adjust geopolitical risk.  His strong language against current trade policy and, more specifically, China will certainly have impacts on foreign markets.  But will any of these things substantially move the needle on the big picture items I stated above?  Probably not.  In our view, the Trump presidency does not completely change the landscape of investing.  It just shifts the shrubs around a little bit.  

The presidential administration may be changing but our focus on the long term remains the same.  The domestic portion of our portfolios will be conservatively allocated to value oriented portfolio managers or in sectors where we believe long term trends will prove out over short term volatility.  We will allocate positions to geographic areas where we believe there is good relative value, stronger growth potential and less debt.  Portfolios will have low exposure to interest rate risk.  Our focus on having non-correlating assets will also remain the same.  And we will continue to invest in areas where we see value and the greatest potential for long-term growth. 

Blake

Past performance is not a guarantee of future earnings.  Asset allocation does not assure a profit or protect against loss in a declining market.  Blake A. Stanley, CFP® is an Investment Advisor Representative of Legacy Advisory Group, LLC a Registered Investment Advisory Firm.

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