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"The Inflation Inauguration"...
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November 12, 2016
The Inflation Inauguration

We have recently written about the inflation uptick worldwide.  While we view this development positively, higher inflation creates higher interest rates.  Higher interest rates equate to lower prices for interest rate sensitive bonds and stocks.  As you can see in this week’s graphic, a rising inflation/rate environment historically favors small cap value stocks concentrated in more cyclical industries like financials, energy and industrials.  Given our inflation anticipation, we have been rotating our portfolio toward these market regions for months.  We even traded out a defensive global position for an offensive US small cap position on Tuesday in anticipation of a post-election relief rally into year end.  That trade proved prescient as the markets expressed much more than relief post poll closure…will it continue??    

Charting Trump      
Donald Trump’s policy positions instantly translated into rapid repricing’s across global markets.  The same trusted pundits who predicted a Clinton victory also predicted a massive decline in risk assets worldwide should Trump win.  Confoundingly, Trump won and markets have staged their strongest post-election rally evah.  Given that a picture is worth a thousand words, here is a visual rundown of how prices reconciled with policies this week, for better and for worse:

Policy: Grow the US Economy 4%;  Trade: Buy US Stocks

Policy: Reduce Business Taxes; Trade: Buy Small Company Stocks

Policy: Spend $1 Trillion on Infrastructure; Trade: Buy Caterpillar
Policy: Reduce Energy Production Constraints; Trade: Buy Natural Resource Producers

Policy: Reduce Regulatory Burdens;  Trade: Buy Banks

Policy: Reduce Regulatory Burdens; Trade: Buy Biotech Stocks

Policy: Build a Wall; Trade: Sell Mexico

Policy: Repeal Obamacare; Trade: Sell Hospitals

Policy: Rewrite Trade Deals; Trade: Sell Emerging Market Stocks

Policy: Add Fiscal Policy Stimulus to Monetary Policy Stimulus; Trade: Sell Treasuries
Republicans in Residence
As demonstrated, the traders, like the pollsters, entered Election Day completely off sides.  Now that the ballots have been cast and the market’s repriced, what can we expect from the new composition in Washington?  There have been 13 other instances when Republicans controlled the White House, Senate and House of Representatives since 1901.  Over those occurrences, the stock market has risen 77% of the time for an average annual appreciation of 8.03%.  Here is the history courtesy of Bespoke:
Bottom Line: A rapidly shifting political landscape and financial landscape, require repositioning.  For example, I have long postulated that the $200 billion+ Vanguard Total Bond Market Index Funds are the biggest bubble in the financial world.  With loads of interest rate exposure, these retirement plan stalwarts fell 2% on the week, undermining their “risk free” identity.  Fortunately, for our clients, we rotated our portfolios in advance of this week’s move as inflation had already captured our attention.  The Trump victory simply accelerated marketplace inflation recognition, delivering months’ worth of returns within just a few trading days.  We have been awaiting a catalyst to initiate the last quartile rally of this historic bull market, and this may just be it.  Trumps tax and regulatory policies will boost corporate earnings, which bodes well for the markets fundamental performance in 2017.  Unfortunately, his volatile campaign antics do present unique tail risks that must be taken into account, but they are nearly impossible to handicap….like a terrorist event, natural disaster, or a Cubs repeat.  Expect things to calm in the coming week as rapid repricing’s require curing periods.
Have a great weekend!  
David S. Waddell
CEO, Chief Investment Strategist

This communication and its content are for informational and educational purposes only and should not be used as the basis for any investment decision. The information contained herein is based on publicly available sources believed to be reliable but not a representation, expressed or implied, as to its accuracy, completeness or correctness.

Sources include the Bespoke,, Goldman Sachs Global Investment Research, Wall Street Journal, AAII, Morningstar, NASDAQ, S&P 500, US Federal Reserve, Bloomberg
. This information presented is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. No information available through this communication is intended or should be construed as any advice, recommendation or endorsement from us as to any legal, tax, investment or other matters, nor shall be considered a solicitation or offer to buy or sell any security, future, option or other financial instrument or to offer or provide any investment advice or service to any person in any jurisdiction. Nothing contained in this communication constitutes investment advice or offers any opinion with respect to the suitability of any security, and has no regard to the specific investment objectives, financial situation and particular needs of any specific recipient.
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CEO, Chief Investment Strategist
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