We believe markets will remain volatile as investors around the world absorb the unexpected American election results over the coming weeks and months. During periods of uncertainty and change, it is particularly important to remain disciplined -- for BBH, that means staying committed to our long-term, bottom-up focused investment philosophy. We are not shifting our strategies or our valuation approach as a result of the election. One of the key objectives we have across all of our strategies is to provide strong downside protection during periods of market weakness. Downside volatility also often presents opportunities for us to identify positions that meet our strict investment criteria and trade at attractive valuations. Similarly, with an eye toward capital preservation, we are willing to sell into strength when markets are buoyant.
In the coming months, we will see how policy proposals from the Trump campaign platform are translated into tangible plans, and, until that time, we expect continued volatility and uncertainty. The GOP’s1 control of the White House and both chambers of Congress provides Mr. Trump with a mandate to advance conservative priorities on tax rates, fiscal policy, global trade and social programs among other policy dimensions. In the balance of the year, we will also be alert to the possibility of changes to Federal Reserve interest rate policies.
U.S. equity markets tempered the losses that occurred in overnight trading with the S&P 5002 and Dow Jones Industrial Average3 (DJIA) finishing positive for the day. In the weeks leading up to the election, our Core Select team considered the implications of a Trump presidency and how it might affect our fundamental views regarding the operating environment for the businesses in our portfolio and other areas in which we could potentially invest. Trump’s administration will likely push for a re-examination of the Affordable Care Act (ACA), if not a full repeal of the 2010 law. Generally speaking, if the ACA and its multitude of provisions is modified or repealed, many healthcare companies will likely benefit as the push to payor consolidation eases. Similarly, an easier stance on drug price regulation would widely benefit the pharmaceuticals industry. However, such changes are still very speculative at this stage, and the future landscape is difficult to envision. While we expect that volatility will likely continue, we remain confident in our healthcare holdings and believe that they should perform well regardless of the political shifts in healthcare legislation in the U.S.
The future of a Trump presidency has a less clear impact on the financial sector. President Trump may embrace policy actions that result in lower regulatory pressures on the banks, but volatility in the markets due to his election may stall interest rate normalization, which would prolong the challenges faced by traditional banks. Our positions in the banking sector are anchored in our fundamental assessments of capital soundness, deposit stability, asset quality, and long-term earnings power of the institutions. We will carefully monitor regulatory and legislative developments that impact the sector and look for opportunities to prudently deploy capital into well positioned banks, insurers, and other financial service providers at attractive prices.
Fixed Income Strategies
Intermediate to long bond yields have increased over 20 basis points4 (bps) (0.2%), and the benchmark 10-year Treasury is trading well over 2%. With Republican control of both chambers of Congress and the White House, a large infrastructure program is a likely policy goal for the Trump administration. Funding will likely be through increased US borrowing, which we expect would pressure yields higher. In addition, if fiscal policy is stimulative under Trump, the Federal Reserve Board of Governors may feel less pressure to be accommodative, resulting in more rapid rate normalization. Finally, protectionist trade measures may decrease foreign willingness and ability to buy Treasuries. There isn't a lot of value in long Treasuries, although there is a bit more today than yesterday.
Prices for credit instruments are firming across the board, with a few exceptions in the managed healthcare/hospital sectors. It is possible that Trump policies will affect the repatriation of cash balances abroad and even the deductibility of interest expense. This won't happen immediately, if at all, but it would tend to dampen corporate credit supply in the future. Deregulation in banking, via Dodd-Frank repeal, and energy, via a new free-market EPA5 head, are also likely. We already maintain a fairly opportunistic stance in the credit markets and are positioned in only stronger players in the financial, utility, and healthcare sectors. The uncertainty of the coming months should provide some interesting new value opportunities.
Treasury inflation protected securities (TIPS) significantly outperformed nominal bonds today, suggesting that the market views a Trump presidency as inflationary in the long run. Even in this changing market climate, our investment process remains centered on our fundamental bottom-up valuation work. Our approach benefits from the opportunity that market volatility presents and our strategy remains the same.
In addition to the aforementioned pressures, another tenet of the Trump campaign platform was a significant decrease in tax rates which would add additional headwinds to the municipal market. Should this come to fruition, the tax advantage of municipal bonds would decline and the market would likely weaken. Through our disciplined value-based approach, we are actively seeking opportunities in the municipal markets for strong credits offered at attractive yields. In the coming months, we will look to see specific policy proposals that will give us greater transparency into the changing municipal landscape.
In the weeks and months ahead as the Trump administration commences and Congressional math continues to favor conservatives, we expect to see a translation of campaign promises into tangible policy. At that point, we will have greater insight into the long-term impact of policy changes and political leadership on our investment decisions. We remain committed to our practice of avoiding macro and political predictions, instead focusing on the underlying fundamentals and long-term attractiveness of the positions we own. It is here that we feel we can provide lasting value to our clients.
This publication is provided by Brown Brothers Harriman & Co. and its subsidiaries ("BBH") to recipients, who are classified as Professional Clients or Eligible Counterparties if in the European Economic Area ("EEA"), solely for informational purposes. This does not constitute legal, tax or investment advice and is not intended as an offer to sell or a solicitation to buy securities or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code or for promotion, marketing or recommendation to third parties. This information has been obtained from sources believed to be reliable that are available upon request. This material does not comprise an offer of services. Any opinions expressed are subject to change without notice. Unauthorized use or distribution without the prior written permission of BBH is prohibited. This publication is approved for distribution in member states of the EEA by Brown Brothers Harriman Investor Services Limited, authorized and regulated by the Financial Conduct Authority (FCA). BBH is a service mark of Brown Brothers Harriman & Co., registered in the United States and other countries. © Brown Brothers Harriman & Co. 2016. All rights reserved. 11/09/2016.
1 Republican Party, commonly referred to as the GOP (abbreviation for Grand Old Party), is one of the two major contemporary political parties in the United States, the other being its historic rival, the Democratic Party.
2 S&P 500 is an unmanaged, market capitalization weighted index of 500 stocks providing a broad indicator of stock price movements. The index is not available for direct investment.
3 Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq.
4 Basis Points: A unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.
5 The United States Environmental Protection Agency (EPA) is an agency of the Federal government of the United States which was created for the purpose of protecting human health and the environment by writing and enforcing regulations based on laws passed by Congress.