This article about investing in the Donald Trump era is by former hedge fund manager turned author Lars Kroijer, an occasional contributor to Monevator. He also wrote Investing Demystified.
New US President Donald Trump is making headlines on an hourly basis. Our social media accounts are going crazy with comments about his presidency being a de facto coup or a one-way route to the apocalypse.
You may well be asking whether you should change your investment strategy as a result?
In short, the answer is perhaps – but probably not how you think.
In previous articles I have outlined how I consider it highly unlikely that the vast majority of investors can beat the markets – whether through active stock selection, market timing, or via picking the one out of ten actively investment funds that may manage to do so over a ten-year period.
I’ve also argued that for your equity exposure you should pick the broadest and cheapest index tracking exposure you can get your hands on, namely a world equity index tracker fund.
‘Just’ because Donald Trump is now President of the United States, that is no less true. You most likely couldn’t beat the markets before 9 November 2016. You still can’t. That hasn’t changed.
But what also hasn’t changed is that you can still expect to make returns of perhaps 4-5% above inflation. This estimate is based on over 200 years of history of equity returns in many states of the world.
However these average long-term expected returns will be volatile over the short-run. You can expect much higher returns some years, and terrible losses in others. And you can reasonably expect to be compensated in higher risk periods with commensurate higher expected returns, though there are no guarantees of this.
Okay, so even if in a Trump world we haven’t found a crystal ball, what can we do?
In my view, there are two main things we should focus on:
1. Evaluate whether the risk of the markets has changed enough that we should re-evaluate the risk levels of our portfolio.
2. Consider if the sudden change in the political landscape has changed our overall economic life enough that our risk profile should change as a result.
For the rest of this article I’ll explain how to do both things.
Market risk under President Donald Trump
You’ll find below a graph of the expected future risk of the US stock market. Without being too technical, it measures the expected standard deviation six months into the future. Since the index value is based on the implied volatility of equity options, it is a market price.
If you think you know the future volatility of the market better than this chart then you can get rich trading it. (Many try!)
Future risk of US equities (click to enlarge)
Source: CBOE.com
There are many issues with this kind of chart, such as that the value itself is very volatile (so the risk changes a lot), the volatility doesn’t capture ‘fat tails’1, and it only looks six months into the future. All that said, it does give a good idea of future expected risk.
Look at the very volatile 2008/09 period circled in red, and compare it to the more recent period, also circled. What this tells us is that as momentous as the election of Trump was politically, in terms of market risk it hardly made a dent.
Because the election of Trump was a genuine surprise – Betfair had the probability of Trump becoming president at about 15% on election day – we can get a good sense of how much things shifted as a direct result of Trump’s election. (If Trump had been expected to win, then the impact of his presidency would already have been built into the market price.)
As things turned out, the equity market risk hardly moved.
Confused? Don’t be.
Just know that the expected risk of the stock market in the future did not change as a result of Trump, and so this factor alone should probably not cause you to change the risk profile of your portfolio.
Your risk with Trump as President
While the market risk has not changed as a result of the election, your personal risk might have. The overall market did not move hugely after the Trump election, but there are clearly some sectors and geographies that could be hugely impacted by his election.
You therefore need to understand how Trump’s election might affect your overall life.
For example, if you work at a Mexican company that exports most its products to the US, then a Hilary Clinton victory would clearly have been better news.
Similarly, imagine a scenario where you work in mid-level management at a BMW factory in the United States. You’re so confident in the company, you’ve previously invested most of your savings in BMW stock, your pension is guaranteed by BMW, and most people in the town you live in are also employed by BMW.
Now imagine Trump goes on one of his 3am Twitter rants:
“BMW are a bunch of foreign losers. Time to kick them out”.
Then imagine some hours later after Trump has slept a bit and had his morning coffee he tweets:
“I meant it. We are shutting them down”.
All hell breaks loose. BMW is down 50% and people start talking about the need to close the US operations. There’s a discussion about the risk of the BMW corporation defaulting on its debts.
Your whole economic life has been turned upside down because of Trump getting out of the wrong side of bed. To say you are overexposed to BMW would be a massive understatement. Your job, pension, savings, and house all correlate to the BMW corporation. You were guilty of putting all your eggs in the BMW basket and are now paying for it.
Very nasty – but less extreme versions of this example are equally worth avoiding.
Is Trump fighting for you or gunning for you?
So how do you know if sectors you are exposed to might be helped or hurt by Trump? Or by Brexit, incidentally, or any other big event?
Again, because Trump’s victory was a surprise we can see the market impact right after the election. If Trump’s hypothetical BMW Twitter rant had taken place before the election then you would expect BMW stock to be down a lot right after the election. That’s how you know.
It was not a surprise to see the Mexican Peso decline after Trump’s surprise win.
My advice? Sniff around. Understand your economic exposure and see how those sectors fared in the market’s mind after the election. Then look at how much Trump’s various statements and Tweets impact on how these things move.
Maybe it’s time for a change
If your investment portfolio consists of a world equity tracker combined with super low-risk government bonds, you will have broadly diversified away a lot of the sector and company-specific Trump risk.
But as illustrated by the BMW employee example we just saw, your individual non-portfolio exposures may still lead you to change the risk you feel you can afford to take in your investment portfolio.
For example, you may previously have felt quite relaxed about stock market risk, and employed a fairly bullish 75%/25% split between equities and bonds.
But after assessing your Trump-adjusted risk, you may feel a 50%/50% risk is appropriate.
This would not be because the markets have gone down in value, or up in terms of risk. Rather it would be because the sectors or geographies you are otherwise exposed to has changed your overall risk profile under Trump.
Has the appropriate risk level of your portfolio changed? (Click to enlarge)
Deciding how a Trump presidency might impact your overall economic life is far from a science. We don’t really know and can’t expect to be precise about it.
But you shouldn’t ignore the issue. The Trump presidency has the potential to be very consequential on your economic life.
There will be other shocks in the future, too. If you’re uncertain as to how much risk you should be taking in your portfolio, perhaps consider using a financial advisor to help you think through your exposures.
When hiring someone, make sure you don’t start paying them to actively outperform the market. Just as you probably can’t do that for yourself, they are likewise extremely unlikely to be able to outperform.
But they should be able to help you understand your overall economic life, how your risk profile may have changed – or even how you can protect yourself from being the mid-level BMW manager in the example above.
President Trump and you
I know it may feel odd that something can dominate the news like the Trump presidency and yet we are still not able to justify having a different perspective to that of the overall market.
However do think about how Trump might impact your job, sector, house, pension, insurance policies, and other things that contribute to your overall economic welfare – and then perhaps re-consider the risk of your portfolio as a result.
Below you’ll find a video that recaps the things I’ve discussed in this article. (You will find some other investing videos on my YouTube channel).
Lars Kroijer’s book Investing Demystified is available from Amazon. He is donating all his profits from his book to medical research. He also wrote Confessions of a Hedge Fund Manager.
- The fact that unlikely events happen far more than predicted by the normal distribution assumption of the standard deviation. [↩]
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Wise article from the European Bogle! I’m looking forward to the next new book from Lars.
Is that chart telling me that this index that predicts US equity volatility 6 months into the future through some derivation of option prices predicted the financial collapse of 2008?
I really enjoy this blog -very relevant articles and comments.
Having come through 2008 Donald Trump doesn’t come close as a Black Swan Event to me.
The Markets seem to agree.
What I never read /hear about is why SNP,Brexit and Trump have occurred-presumably very important to know in order to work out our forward investing plans.
Perhaps we are all still working through the 5 stages of grief?
I would love to hear from other Investors why they think the”political tectonic plates” are shifting purely to have some sort of handle on our investment decisions going forward.
French and Dutch elections to come soon
Uncontrolled immigration and a feeling of lack of representation is the best I have come up with so far.
Any other ideas?
xxd09
@Malcolm — Those are interesting questions, but I don’t think we want to go into all the political weeds in these comments here please. Let’s stick to investing specifics for this post.
I’ve read vast quantities of theories about why Brexit/Trump occurred, that discussion is definitely happening. I’ve also explored it and there’s loads of different sociological and political views on the reader comments in my various Brexit articles. See: http://monevator.com/tag/brexit/
Thanks!
For me this is a very flawed and one-sided view.
Firstly, Trump targeting single names won’t effect the wider market material. He would have to take entire sectors down with his tweets to have a significant impact for investors. Obviously that’s in the realms of possibility but much less likely.
Secondly, It assumes that government bonds are a low risk asset. Trump has the potential to borrow huge amounts (with congress approval) and escalate the US national debt. Now obviously the US don’t need to default as they can print dollars – but that is a hugely inflationary shock (and defaulting by another means) which means your government bonds could have a very significantly negative real return. Meanwhile companies typically have some form of pricing power and an ability to grow revenues with inflation.
In summary: Given Trump is very pro-business in general, a bit of volatility on individual companies like BMW are a drop in the ocean compared to slashing corporation tax for ALL US companies.
Don’t forget, there is also a third thing to focus on:
https://github.com/maxbbraun/trump2cash
Um, the article specifically says the election of Trump isn’t expected to have much of an impact on the market. You seem to be in agreement?
What it is arguing is that general economic risk may have increased for some people — or at least the perception of risk — so that might be a reason to adjust portfolio allocations.
To quote:
I agree with you that if he doesn’t go off the deep end with his other views and activities, his administration is likely to be pro-business, and possibly pro-markets. (Some downsides here may come later — e.g. a too thorough rollback of financial regulation could create the conditions for a new financial crisis, etc).
Very good article , thanks. For what it’s worth (zilch), the dollar may be the tail to wag the dog and if you are trying to beat the market you just need to get this right. Good luck!
Another interesting Monevator article – it’s become one of my favourite resources for trying to plan my investing future.
Speaking of which, i’m in the final stages of transferring out of my DB pension scheme and i’m torn between letting my IFA invest (1.65%pa) or going the diy route using iweb as a flat-fee SIPP platform.
I’ve tried to educate myself and have a (basic) laymans understanding of the impact of asset allocation, fee impacts, sequencing risks, volatility drag, swr’s etc etc.
I’m 44 with 10 years to go to retirement but plan to use both mine and spouses ISA allocations between now and then so I estimate 15 years before I need to start drawing down the pension fund.
I’ve looked at the VLS versus the Retirement Date funds with the former (VLS60) looking a little more suitable as I don’t necessarily need to be moving in to bonds too early.
I discussed this plan on mse on one of the ifa’s on there was of the mind using VLS60 was a far from perfect solution but didn’t/wouldn’t expand. I don’t want to just dismiss his/her comments as “an ifa would say that” as Vanguard must be a threat to their livelihoods.
So my question I guess is this:
Does VLS60 meet the needs for:
1. Someone who will need to start drawing their pension in around 15 years
2. Looking for around 1-2%pa above inflation over that period
3. With the minimum of volatility/risk to achieve that
Thanks!
Mick – VLS60 may be an answer is what I would think the IFA was referring to. Other options could also be the answer.
The VLS range don’t cover all asset classes, property for example is missing as are Small Cap equities.
The VLS60 fund holds 40% in Bonds it near cash notes so not sure it meets the “don’t need to move into bonds too early” idea.
If it is the IFA I think it is on MSE then they have said in the part they use VLS for clients it is suitable for as opposed to it threatening their livelihood. Like any other fund it can be purchased via the diy route and the advised route.
@mick – maybe link to the MSE thread in question?
Hi Mick
As I was gaining confidence in managing my own SIPP and ISA,s -I occasionally ran my Portfolio past an IFA till I gained enough self belief in my investing abilities.
Usually you get one free overview as they think that you will have buisness for them
Remember to ask for the Costs as well over the Investment period-if you are 44 then ask for a 50 year projection-the figure might surprise you!
The IFA is by law duty bound to tell you that your Portfolio is OK -if it is!
If he finds big holes in your arrangements then you go back to the drawing board
Took me 2 or 3 IFA overviews to have enough self confidence
I appeared to be on the right lines from the word go -as you seem to be
Remember you never stop learning -you have to maintain a continual interest in your investments
Keep reading Monevator!
xxd09
Alan – Perhaps i’ve been a little harsh on the IFA, it just seems that he has a negative view of diy and passive investing without really expanding on where it is deficient (in as much as he reasonably could).
As far as the bond element goes my thinking was that the Global Bond Fund (19%) covered a wide spread so i’m definitely open to some guidance on alternative options for portfolio structuring. When I looked at the historical returns it seemed that 60/40 gave a reasonable draw down v gains but I do understand we are in unusual times with yields.
Malcolm – I chatted to the IFA about passive options and to be fair he didn’t push the active route and did say his company used trackers etc. He’s going to produce a couple of suggested example active portfolios for me to look at before I make a decision.
I agree about the potential costs being steep when you consider that average life expectancy means I could (touch wood) have 40 years of management at 1.65%pa – that’s a huge amount. That said, i’m not shut off to the idea of paying for management as long as it proves to be cost effective in returns over the long term.
@mick You are right 40 years of management at 1.65% is huge. If you assume fund charges at 0.35% approx + 1.65% management charge, that makes 2% approx. 2% charges over 50 years would mean that you are effectively giving two thirds of your money away according to Jack Boogle. Over 40 years it would be less but not a lot less it might be a good lesson for you to work out how much. Source http://wallstreetonparade.com/2013/04/pbs-drops-another-bombshell-wall-street-is-gobbling-up-two-thirds-of-your-401k/
Hi Mick
Jed is right
Get the actual IFA costs figure in cash.
A Portfolio will be doing well to make 4-5% going forward and you are going to give half of this away!
I remember the IFA doing my costs at age 50 and it came to £175000 over a similar timescale as yours
It was a powerful incentive to manage my own money.
If you leave all to someone else there is effectively 2 people living off your hard earned cash!
I do not grudge the IFA his fees BUT surely it would be worthwhile with the large/huge sums involved that you keep as much of you hard earned cash for yourself as possible!
PS Jed means Jack Bogle-his books are easy and worth reading re Index investing
I would take your time -a year?-and do some reading/learning
xxd09
@malcolm I think you’re right about taking more time to fully understand how to construct a balanced portfolio. I’ll give the ifa a year with it while I get my head around how a global small cap/ REIT / emerging market etc can fit in to the picture.
It’s just a bit more complicated than a ‘fire and forget’ VLS60!
Hi,
I am looking to invest my this year’s ISA allowance (£15240) in a passive fund, lump sum via iWeb. This is my first ISA, was thinking of putting it all in FTSE global all cap Acc fund. Its would be for 25+ years (I am 33). Do you guys think its a good idea? Any suggestions? Alternatives?
Thanks
Hi mick
VLS 60 is a good investment and would do the job for most people
Re a Investing-Fire and forget is good and cheap!
Complicated is bad and expensive
Lars Kroiger book-“Investing Demystified ” is a good read
xxd09
The election I’m worried about is the one in France. Given the unpredictability of elections of late one can’t assume Le Penn won’t win. If she does then I see serious trouble ahead, her election manifesto is essentially illegal under EU rules. Which will lead to one of three things happening.
1) She back peddles (she doesn’t look like a back peddler to me, I give this a low probability)
2) The EU alters/bends it’s rules, they didn’t for us but they are much chastened and France is more important, in a win this is the road I think will be most likely.
3) She pulls France out the Euro and EU – That is the scenario I fear most, British exit was a storm in a teacup, French exit is a don your hard hat event.
Currently I’m betting she won’t win and if she does the EU will compromise and allow her to implement her agenda, but my political predictions have been woeful, I didn’t see a BrExit win (despite hoping for one) and I really didn’t see a Trump win.
From my point of view the key thing to remember is we have Trump in power for a maximum of 8 years. Over an investing time scale of 30-50 years this isn’t a huge time. At least 6 months of this time towards the end of his “reign” he will have a lot less power A la Obama who it seemed was just pottering around for a while!
@FrugalFox — I look at that too, but we shouldn’t take our democratic reshuffles for granted. From Nobel prize winner Paul Krugman:
https://www.nytimes.com/2016/12/19/opinion/how-republics-end.html?_r=0
I read Lars’ article with interest and tried to work out what he was saying to me as an investor who tries to be as passive as possible.
I can’t beat the market except by accident, so my diversified global portfolio of index funds is as good as it was before Trump or Brexit. It might gain or lose, but I cannot have a better mix except by accident if I buy into the basic passive model.
What I am being asked to look at is my non-portfolio risk, whether that is changing and whether I should do anything about it. There are two components to that; the facts and the emotion.
The facts relate to things like my job; for example could the actions of others mean I could lose my job, not get a promotion I had been confident about, or not get a bonus I had been (at least subconciously) counting on. Or maybe interest rates suddenly spike, affecting my ability to pay my mortgage or whatever.
The emotional side is how we would react to that turbulence and should we adjust portfolio balance to reflect the change in our risk appetite in response to perceived changes in our circumstances.
This makes sense. I draw a company pension. My confidence in its stability allows me to be more agressive in my stocks/bonds allocation. If I thought there was a real risk of the scheme closing I would have a different allocation in my portfolio.
So we should be monitoring all our assumptions about income, wealth and expenditure. We all have a tendency to assume many parts of our life will glide on essentially unchanged whilst focusing attention on one or two elements where we feel we need to take action. The take home for me from Lars’ article is we need to regularly look at all our assumptions about lifestyle, wealth, health etc. Trump and Brexit are simply very visible examples. Other changes in underlying assumptions can sneak up on us with as much or greater impact.