“Many forms of government have been tried and will be tried in this world of sin and woe. No one pretends that democracy is perfect or all wise. Indeed, it has been said that democracy is the worst form of government, except for all the others that have been tried from time to time.” – Winston Churchill
Democracy is messy. Someone had to win this election, and in the early hours of Wednesday morning, Donald Trump defied odds and opinion polls to win the race for the White House. The Republican Party furthermore retained control of both the House and the Senate, giving the GOP control of the legislative and executive branches. Once the final votes are counted and the outcome confirmed, the simmering conflict between President-elect Trump and House Speaker Paul Ryan will now take center stage, adding even more uncertainty to an already tumultuous political environment.
Over the days and weeks to come, we will learn more about what a Trump administration will look like, who will staff it and what his priorities will be as he takes office on January 20. That will give us some insight into potential economic or market impacts. Trade issues are particularly important, as tariffs and trade wars would threaten economic activity and raise the risk of a recession.
For now, Trump’s victory introduces an unprecedented element of uncertainty into the economic and financial markets. Dow Jones futures were off as much as 800 points overnight, although those losses have been curtailed in early trading. Asian markets closed at their lows, while European markets have recovered along with U.S. futures. Precious metals are up a few percentage points, whereas the bond market is selling off, a curiously counterintuitive move for a market that typically benefits from a “flight to safety.”
It is tempting to respond to this uncertainty by selling everything and sitting on cash unless and until the political landscape clears up. To yield to that temptation is to simply exchange one risk for another. The fact of the matter is that economic and market cycles are bigger than any one inhabitant of the Oval Office, or any one-party control of Congress. Yes, this outcome raises macro risks. Yes, prices are likely to remain volatile for some time to come. And yes, this is precisely when investment discipline is of most critical importance.
We respond to uncertainty by sticking to our knitting. We invest in companies that have a greater-than-average degree of control over their own destiny through the provision of essential products and services, the maintenance of strong balance sheets, the generation of robust free cash flows, the benefit of loyal customers and the economic engine of high rates of return on reinvested capital. Such companies are not immune to political and economic cycles, but are nonetheless resistant. Acquiring those companies at a discount to intrinsic value introduces an insurance policy in the form of a margin of safety, and that insurance is valuable in volatile markets.
Speaking of volatility, remember that price and value are different things. Price has the great advantage of being transparent, frequent and accessible, but the disadvantage of being volatile. Value, on the other hand, is the opposite. It is not easily accessible, it is not printed in the newspaper every day, and it is not constantly updated. It is, however, durable, and we choose to focus on value. Price is merely the level at which we acquire value.
The parallels to the British vote to exit the European Union are legion. Perhaps the most important parallel is that this election, like Brexit, is a process, not an event. Markets reacted sharply to the Brexit vote, rebounded quickly, but remain sensitive to developments. We expect that financial markets will respond to the U.S. election in a similar fashion.
Political uncertainty will create price volatility throughout global markets. As uncomfortable as that is, disruption reveals opportunities for the disciplined investor. Most of our managers have elevated cash levels in their portfolios – not due to a call on markets, and certainly not due to a call on the outcome of the election, but simply as a reflection of their investment discipline. The option value of that cash is likely to prove appealing in the weeks and months to come. We and our investing partners are prepared to take advantage of that volatility while adhering to an investment discipline focused on preserving and growing our clients’ wealth.
More anon as events unfold.
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