Revisionism Arrives: Goldman Says Trump's Victory Will Have Little Impact On The Market

As we stated first thing this morning, far from widespread predictions and expectations of a stock market apocalypse, what a Trump victory really means is strength for both the economy, and the stock market. This can be observed in the market open moments ago which has sent both the Dow Jones and the S&P furiously into the green after being limit down as recently as a few hours ago.

And now that the time for revisionist history has arrived, and strategists no longer have to serve a political agenda and scare investors and traders into voting with their wallets, the research reports calling for precisely the outcome that we expected are coming in fast and furious, starting with none other than Goldman, whose chief strategist David Kostin issued a note overnight in which he says that "the equity market response to the election result will be limited" and adds that "our year-end 2016 price target for the S&P 500 remains 2100, roughly 2% below the current level of 2140."

For those who care, his full note is below.

US equity implications of a Trump Presidency

Donald J. Trump will take the oath of office to become the 45th President of the United States on Friday, January 20, 2017. With more than 145 million votes cast, the popular vote looks to be around 48%-47% with Trump defeating opponent Hillary Clinton in the more important electoral college. Counting has not yet been completed but Trump has at least 289 electoral votes, more than the 270 minimum necessary to win the presidency. Mike Pence, the current Governor of Indiana, is the Vice President-elect.

Polls, political prognosticators, and investors all underestimated the magnitude of dissatisfaction of the US electorate. Watching the election returns, we were reminded of the quote attributed to the American writer Mark Twain (Samuel Clemens): "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so." Market participants were nearly unanimous in the view that Hillary Clinton would win the general election convincingly. Indeed, on Monday, the day before the election, S&P 500 rallied by more than 2% as forecasters raised the likelihood of a Clinton victory. Prediction markets actually assigned a 90% probability that Clinton would win the Presidency as late as 7:00 pm on election night. However, when it became evident that Trump would win, US equity futures fell by 5% in overnight trading before partially reversing the sell-off to close down 2% from the previous day's close.

In another surprise, Republicans retained control of both the Senate and House of Representatives. Two races are still undecided, but the Republican majority in the Senate will remain, although it will be slightly narrower than before the election. As widely expected, Republican control of the House of Representatives will continue, albeit with a slightly reduced majority compared with a 30 seat margin prior to the election.

Single-party control of the White House and both Houses of Congress has positives and negatives from a portfolio manager perspective. Following several years of gridlock inside the Beltway, the potential now exists for a number of legislative initiatives to be passed. Examples would include fiscal stimulus/infrastructure spending, corporate tax reform, reducing regulation, and addressing rising health care costs. However, the prospect of new legislation also raises uncertainty about policy specifics and may prompt corporations to delay action until details are finalized.

We expect the equity market response to the election result will be limited. The US economy has been expanding for seven years and continues to grow at a subdued pace. Goldman Sachs Economics forecasts 2017 real GDP growth will average 2%. Inflation has been slowly climbing towards the Fed's 2% target. Investors anticipate the FOMC will hike interest rates next month. The ten-year US Treasury yield now equals 1.93%.

Market: Our year-end 2016 price target for the S&P 500 remains 2100, roughly 2% below the current level of 2140. Stocks trade at a high valuation on most metrics including relative to history, relative to interest rates, and relative to inflation. Further P/E multiple expansion is therefore unlikely, in our view. The forward P/E multiple for the S&P 500 has increased by 70% during the past five years (10x to 17x). The only expansion cycles greater than the current experience occurred in the mid-1980s (1984-87, ending with the Black Monday collapse) and during the Tech Bubble of the late 1990s. We expect the US stock market will climb slowly during the next few years in line with earnings growth, ending 2017 at 2200 and 2018 at 2300 (see Exhibit 1).

Exhibit 1: Our S&P 500 operating EPS forecasts and index targets, 1996-2018E
as of November 8, 2016

Sectors: Cyclicals should continue to outperform Defensives. However, most of the return is behind us following the sharp rally since mid-year (Cyclicals +8% vs. Defensives -5%) that narrowed a three point P/E multiple discount of Cyclicals to less than one point today. Cyclicals now trade slightly above the long-term relative valuation vs. Defensives (see Exhibits 2-4). The Financial sector trades at a discount relative to the market and shares would benefit from a rising interest rate environment and reduced regulatory oversight.

Exhibit 2: Cyclicals have outpaced Defensives so far in 2H 2016
as of November 7, 2016

Exhibit 3: Relative forward P/E of Cyclicals vs. Defensives
as of November 7, 2016

 
Exhibit 4: Performance and fundamentals of our sector baskets
as of November 7, 2016

 

Themes: Bifurcated performance should continue: (1) Between stocks with high domestic and international revenues; (2) between stocks with the highest amount of earnings permanently re-invested overseas and the rest of the market; and (3) within Health Care.

1. Trade will certainly be a major area of focus for the new Trump Administration. Stocks with high US sales exposure have outperformed firms with high foreign sales since 2010 as the trade-weighted US Dollar (TWD) strengthened. However, the opposite has occurred this year as stocks with high US sales (GSTHAINT) rose by 2% compared with a 13% rally for firms with high foreign sales (GSTHINTL). An interest rate hike in December should strengthen the USD and benefit firms with high US revenues. Domestic-facing stocks have faster expected sales and earnings growth but trade at a nearly two point P/E multiple valuation discount relative to stocks with high international sales. The median stock in our high US sales basket generates 100% of its revenues domestically while our non-US basket generates 70% of its sales abroad (see Exhibit 5).

Exhibit 5: Performance of our US sales vs. International sales baskets
as of November 7, 2016

2. Infrastructure spending is likely to be a key policy initiative of President-elect Trump. One source of funding for fiscal spending will likely be corporate tax reform on previously untaxed foreign profits. Trump has discussed the idea of a one-time tax of 10% on previously untaxed foreign profits. S&P 500 stocks with the highest earnings invested overseas (GSTHSEAS) should benefit from an earnings repatriation holiday. Stocks in our High Overseas Earnings basket hold $1.7 trillion of permanently reinvested foreign earnings, equal to 70% of the $2.4 trillion held by all S&P 500 firms. Information Technology and Health Care account for nearly half of the 50 constituents in the basket. The basket has returned 9% YTD vs. 6% for the S&P 500 (see Tax reform: Show me the money…held overseas, October 13, 2016). The valuation of the equal-weighted basket is currently in line with the S&P 500 (see Exhibit 6).

Exhibit 6: High Overseas Earnings vs. S&P 500
as of November 7, 2016

3. Pharmaceuticals and Biotechnology will lag while Health Care equipment and Services will outperform. New regulations targeting drug pricing and the cost of the Affordable Care Act (ACA) legislation (a/k/a "Obamacare") will pressure revenues of Pharmaceutical and Biotech firms while increased utilization will continue to benefit Medical Equipment and Services companies. Health Care Equipment & Services is one of the few slices of the US market that has demonstrated a statistically significant relationship with changes in presidential election odds (see What to Expect When You’re Electing, Sep. 11, 2016). The long Health Care Equipment & Services vs. short Pharmaceuticals and Biotech pair trade returned 300 bp in the last month as Democrat odds rose (see Exhibits 7-8).

Exhibit 7: Healthcare stock performance has reflected prediction market election odds
as of November 7, 2016

Exhibit 8: Relative performance and valuation of health care industry groups
as of November 7, 2016