This article about investing in the Donald Trump era is by former hedge fund manager turned author Lars Kroijer [1], an occasional contributor [2] to Monevator. He also wrote Investing Demystified [3].
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 [2] 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 [4] 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 [5] 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!)
[6]Future risk of US equities (click to enlarge)
Source: CBOE.com [7]
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 [8], 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.
[9]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 [10]).
Lars Kroijer’s book Investing Demystified [3] 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 [11].
- The fact that unlikely events happen far more than predicted by the normal distribution assumption of the standard deviation. [↩ [16]]