Four Tips for Making Your New Year Happy

Question: What should I be paying attention to in the coming year?

Answer: Besides interest rates, inflation and corporate earnings, prudent investors should watch what policy shifts the Trump Administration and the Republican-controlled Congress actually pursue on matters such as deregulation, tariffs and fiscal stimulus.

• Deregulation: The new administration has plans to reduce regulations in key sectors such as finance, energy and technology. While deregulation itself might create some modest efficiencies, when combined with lower expected interest rates, the moves could foster optimism in the business community. Optimism, in turn, drives investment. Greater optimism might sound like fluffy reasoning at first, but the U.S. economy thrives on risk-taking, and optimism drives the willingness to take risks and fuels a free-market economy. Additionally, deregulation in banking and energy could lower the cost of investment, increase output and help reduce inflation, which might prompt the Federal Reserve to lower rates faster.
• Tariffs: While deregulation might stimulate growth without inflation, or even push it down, tariffs work in the opposite direction. Increased tariffs proposed by President-elect Donald Trump could drive up costs for businesses and consumers, pushing the nation’s inflation rate higher.
• Fiscal stimulus: The new administration’s plans for high deficit spending could spur economic growth in the short term. However, it’s also a significant driver of inflation. If inflation resurges, the Federal Reserve might need to halt or even reverse interest rate cuts, potentially dampening the optimism that underpins economic growth.

It’s too soon to tell how all this will play out: Political promises and statements are not policies, and it’s the details of what gets enacted that will determine whether these policies encourage or discourage risk-taking or create inflation and trade problems. The good news? We don’t need a perfect environment for markets to perform well; moderate optimism can be enough.

So, what should I do with my portfolio?

Investors should protect their nest eggs against new government policies that become detrimental, while still allowing for upside if the increased-optimism scenario plays out. 

Consider these four tips: 

1. Taking profits in large-cap stocks: Large caps, especially the growth stocks, currently have high valuations, which in addition to their multi-national footprint, make them highly susceptible to trade disruptions and interest rate hikes.
2. Increasing allocations to small- and mid-cap value companies: These stocks often have more reasonable valuations and less international exposure, making them more resilient to protectionist trade policies and upward interest rate shocks.
3. Remembering cash and bonds: With rates in the mid-4% range, bonds represent a reasonable return for the “safe” portion of your portfolio. Having some cash on hand can also provide flexibility in uncertain times.
4. Exploring private-equity opportunities: When traditional capital gets spooked by uncertainty, opportunities for private investments can arise and even thrive.