After a debate that made it more likely for Donald Trump to beat Democratic incumbent Joe Biden in the November election, more people are interested in a group of stocks that did well after Trump won the election in 2016.
Morgan Stanley equity strategists led by Mike Wilson wrote in a note to clients on Monday that conversations with clients after Thursday’s debate “point to some appetite to rotate to 2016’s largely value/cyclical playbook.” What did clients say? Some people also thought that interest rates were going to go up.
The market’s performance on Friday supported that, according to the strategists. Small-caps, energy, financials, industrials, and materials all did better than the overall market, while the 10-year Treasury yield BX:TMUBMUSD10Y turned higher. The first steps were made because they thought the market would expect fiscal expansion, reflation, and less regulation under a Trump presidency, they said.
One big problem with trying to profit from a strategy that worked in 2016, when small-cap and low-quality cyclicals did well, is that the election result is not yet certain. Wilson and his team say that volatility usually rises in September of election years and stays high through October. It then starts to fall again in November.
It’s important to remember that the economy is more mature now than it was in 2016, when the Conference Board leading economic indicator series didn’t fall for two and a half years. This makes it less likely that something similar will happen again.
Because the market has historically paid more for quality when the cycle is later, they said, “We advise staying up the quality curve and away from small-cap cyclicals, which worked in 2016.” They also said, “The state of the business cycle is more important than the outcome of the presidential election.”
They say to be picky within cycles no matter what the election results are.
People today face more problems with inflation than they did in the past, which is another reason to question whether or not that old playbook is still useful. The strategists said that the U.S. economy was recovering from a manufacturing and commodity recession in 2016. This was helped by the possibility of a pro-cyclical and reflationary policy regime. They also said, “Today, inflation is a notable headwind for consumers as we’ve already talked about, and fiscal sustainability dynamics are top of mind for the bond market.”
Investors should also be aware that “risks are skewed to the downside” for growth if the Republicans win the presidential and congressional elections. This is because of immigration reform and tariffs, which would put pressure on small-caps and lower-quality, cyclical parts of the market. Last but not least, Wilson and his team say investors are still facing events that could take their attention away from the election outcome in the days leading up to it. These include data on jobs or inflation, comments from the Federal Reserve, and earnings season, to name a few.
