Welcome!
2017-02-05 10:15:12
Fair Game: The Trump Effect: What’s an Investor to Do?

When Donald J. Trump won the presidential election, investors seemed positively giddy about what he was going to do to improve the nation’s economy. Believing that his promises to reduce corporate taxes and curtail costly regulations would unleash economic growth, investors pushed stock indexes to new heights.

Hope always plays a powerful role in the financial markets — and then reality sets in. So, as President Trump gets down to work, investors are now scratching their heads trying to figure out what his presidency will really mean for their portfolios.

The recent flurry of executive orders from the new president provides a taste of what may lie ahead. This much is clear to many strategists: Mr. Trump’s mercurial tendencies will bring heightened volatility to individual stocks as well as to the securities markets over all. Let’s just say that fastening your seatbelt is probably a smart move.

Because stock and bond markets usually dislike surprises, bombshells coming by way of executive orders are not very likely to be well received. Witness the 1 percent drop in the Dow Jones industrial average and the even larger declines in foreign stock markets immediately after Mr. Trump’s executive order on immigration.

Mr. Trump prides himself on being a disrupter. So investors had better get used to this approach and the volatility it will bring.

Professional traders love volatility, of course, darting in and out of positions to take advantage of precipitous price moves. But buy-and-hold investors often find this action disorienting, and it can chase them out of their holdings at the wrong time. For them, rising volatility is a risk.

By the most popular measure, volatility still remains low. The index that measures the implied volatility in the Standard & Poor’s 500-stock index, known as the Vix, stood at around 12 recently, very near the low for the range during the last year.

But David Kotok, chairman and chief investment officer of Cumberland Advisors in Sarasota, Fla., contends the Vix is the wrong place to look for evidence of rising risks in the markets. “Vix is now ubiquitous, and it has no forecast value,” he said in an interview. “You need to look elsewhere for the measures of volatility that are giving us messages of rising risk.”

Mr. Kotok points to widening spreads between interest rates such as the prevailing London Interbank Offered Rate (or Libor) and the rates on forward loan contracts traded by banks and corporations. These contracts allow institutions to protect against changes in rates or to speculate on such moves.

“Those levels are double and triple where they were a year or two ago,” Mr. Kotok said of forward loan contracts. “If Libor is the same and the interest rate in forward rate agreements is rising, under that construction you are seeing a rising risk premium.”

The stock market rose sharply on Friday, and it does not seem that investors are questioning Mr. Trump’s commitment to growing the nation’s economy. Instead, they may be fearful that his bludgeon-force management style will imperil his goals.

“It feels like what investors had signed up to was fiscal stimulus and downplaying of protectionism, and what we’ve got is a playing up of protectionism,” said Paul Ashworth, chief United States economist at Capital Economics in Toronto. “If that has alienated the Senate in particular, then that could put at risk the chances of getting a timely fiscal stimulus through by the middle of this year.”

What makes this period especially difficult for investors is Mr. Trump’s apparent willingness to make big decisions without weighing the far-reaching and longer-term consequences.

Consider, for example, the perhaps surprising effect that the order banning entry to people from seven countries will have on American colleges and domestic students.

As college costs have rocketed in recent years, foreign students, who typically pay in full for tuition, have become an increasingly significant group on American campuses. The number of international students in the country has grown 70 percent over the past decade — to 5 percent of total enrollment, or more than one million students, said Patricia Healy, a portfolio manager at Cumberland Advisors who specializes in municipal bonds.

International students contribute mightily to the revenues at educational institutions; as such, they help subsidize other students who are unable to cover the cost of college, including those from the United States.

“Many institutions, especially private ones in urban settings and those that are research-oriented, would be significantly affected by a drop-off in international enrollment,” Ms. Healy wrote to clients in a research note. “The ban may not have an immediate effect on the finances of universities, unless there are expenses to aid displaced students; but it will have negative ramifications for these and other institutions in the long run if foreign students reconsider coming to the U.S. for their education.”

According to the Institute of International Education, China and India sent the greatest percentage of students — a combined 47 percent of foreign attendees — to American universities in 2016. Neither of those countries was subject to the immigration order. But Iran was, and it sent 12,269 students, or 1.2 percent of foreign students, to American institutions last year. Those students are now scrambling for alternatives.

Fewer international students enrolling at American universities will mean that fewer domestic students may receive the tuition help they need to pursue their degrees or to conduct research. This is just one of the consequences of restricting the travel of international students.

Given how markets react to the kind of disruption that Mr. Trump revels in, how can investors protect themselves?

Consider reducing risk exposures by retreating to higher-quality instruments. After years of low interest rates, investors have flocked to lower-grade bonds in search of higher yields. Now is the time to rethink that approach, because of the potential for volatility and higher interest rates.

“Higher-quality bonds could be a bit of a buffer if rates go up and news events cause more volatility,” Ms. Healy said in an interview. “These investments have the strength to withstand it.”

Investors should also acknowledge that we are in uncharted territory. “It is remarkable that the markets still see a Trump presidency as positive,” Mr. Ashworth of Capital Economics said. “Political volatility has never been higher, and market volatility has never been lower. It’s an interesting contrast.”