The U.S. stock market rebounded the day after the U.S. presidential election — a quick reversal that erased an overnight 800-point plunge in the Dow futures as investors were initially spooked by a surprise Donald Trump win. “The risk markets hate uncertainty,” said Wharton finance professor Jeremy Siegel. But then investors took the broader perspective that Republicans are vastly more capital friendly than Democrats and changed course. He noted that Wall Street also has learned lessons from Brexit — in which the markets recovered after the initial shock of the vote to exit. It taught investors not to overreact to the surprise election news, he says.
According to Siegel, if the financial markets continue to be calm over the next few weeks, the Fed will likely be on track for a December rate hike. But he saw higher long-term interest rates arriving as Trump talks about big infrastructure spending and tax cuts that could fuel huge deficits. Siegel agreed with some projections that the Dow Jones Industrial Average could hit 25,000 or higher in about five years. His own projection pegs gains at an annual return of 6% to 6.5%, or 5% after inflation. Siegel, and PNC’s chief investment strategist Bill Stone, joined the Knowledge at Wharton show, which airs on the Wharton Business Radio on Sirius XM Channel 111, to discuss the effect of Trump’s election on the markets.
An edited transcript of the conversation follows.
Knowledge at Wharton: The global markets reacted somewhat violently [on election night] with the Dow futures down more than 800 points. The Asian markets were down around 5% to 6%. But that reaction subsided and the markets are higher [the next day]. I will start with your reaction to what happened, professor Siegel.
Jeremy Siegel: When you think about the odds that Trump was going to win, at least in [polling analyst] Nate Silver’s sight, they were actually twice as great as the odds that the [Chicago] Cubs would come back from a 3-to-1 deficit and win the World Series. I told my students that. And when the Cubs did win the World Series, they said, “Dr. Siegel, are you predicting a Trump victory?” I said, “No, no, these things are independent. I just want you to get an idea for what the odds are, when you talk about single events.”
Actually Nate Silver’s FiveThirtyEight website was the most pessimistic of all [the election projection and polling sites]. Many of them had 10-to-1, 15-to-1, 20-to-1 [odds]. He said this could be a black swan type of event, which means something we haven’t seen before, and a fat tail event — as statisticians and economists call it in terms of the fact that there was a lot more uncertainty than in other elections.
Bill Stone: For me, it was interesting because … the market typically sells off for whatever reason in advance of the opposition party, the non-incumbent party, winning the presidency. … The polls had maybe underestimated some of it.
Siegel: We saw the movement. One thing we know about risk markets is that they hate uncertainty. Trump was identified as [bringing] more uncertainty. And therefore the initial gut reaction is exactly what you saw last night when the Dow was down 800 points.
But when you look at it from a broader perspective, the Republicans who swept Congress as well as now the presidency are far more capital friendly than the Democrats by a huge margin. So in many ways people are saying, ‘hey, you know, if we can get beyond the uncertainty, if he can pin down some procedures, if he can appoint some good people, if we can have more confidence there, we have a much better man in the White House than we would with [Democratic presidential candidate] Hillary Clinton.’
Knowledge at Wharton: You mentioned on CNBC, professor, that we could have seen a rather large sell off [the day after the election].
Siegel: Eight hundred points down — and that was actually the limit down. It could have been more. I was thinking it might be [down] 1,000 and then recover later in the day. But I think as things often happen in the market, we got a recovery much earlier.
“The Republicans who swept Congress as well as now the presidency are far more capital friendly than the Democrats by a huge margin.” –Jeremy Siegel
Knowledge at Wharton: What was it that really happened in your mind to flip this in such a quick fashion? With Brexit, you saw losses at the outset, and it took a couple of days, but the markets later turned positive.
Siegel: I think the markets took their hint from Brexit: “I overreacted to Brexit, didn’t I? I’m not going to do the same here.” Markets do that all the time. They look at the most common or likely past event, which was definitely Brexit, and said, ‘What happened there? I was stupid if I sold the FTSE or the Dow or anything in the risk markets then.’ The only thing [that continued down] was the pound sterling. The FTSE started hitting all-time highs, again with the weaker pound. So we get that.
Now the only thing that appears, I’m going to say permanent, in the market, is we’ll definitely have higher long term interest rates. That is, in my opinion, due to the fact that … Trump has talked about huge infrastructure [spending]. He’s talked about huge tax cuts. This means big deficits. I don’t know if we can keep these long rates down. So this is putting some pressure here on the long side. And that has been creeping up.
Knowledge at Wharton: Bill, I wanted to focus on the Fed for a second. A lot of people have talked about whether we’re going to see a December rate increase. And then there has been talk of whether Janet Yellen will continue as the chair of the Fed. Where do you sit on both of those right now?
Stone: [The Fed] would react to instability in the financial markets and say, well, ‘we’ll probably go on hold and not raise rates if financial markets were out of control.’ Since they’ve calmed down all of the sudden, those future expectations have come up. So I think assuming that we do stay relatively calm, I think you can expect that December is also game on.
Siegel: I agree. If the financial markets remain calm over the next five weeks, the odds are definitely still on for a rate hike in December. … We can speculate on who the next Fed chairman might be. Clearly, if Clinton had been elected and Janet Yellen wanted to stay, she would definitely stay.
I think she has another year [from next] January to go. … What is interesting is that Trump was among the original Republican candidates [who] was actually more supportive of Janet Yellen than any of the others. He actually said, you know, [he favored] low interest rates. Of course, he was in real estate, so he must love low interest rates.
“If the financial markets remain calm over the next five weeks, the odds are definitely still on for a rate hike in December.” –Jeremy Siegel
Then he got the Republican religion, “Oh, come on. Don’t. The Fed is artificially keeping them too low.” So he kind of jumped on that bandwagon. But I don’t know where his heart is here. … Among the Republicans who were out with daggers for Yellen and the Fed, he was actually much more Fed friendly. However, he has said that if he were appointed, he would seriously consider replacing Yellen as chair.
Knowledge at Wharton: If you look at how this election has played out, obviously the Democrats were not going to be supporting him. And obviously there was a good segment of the Republicans that were not supporting him. So realistically Donald Trump goes into this not beholden to anybody.
Siegel: That also means he has to have support [from] legislators. … In contrast to the parliamentary European model, … you don’t get to be president or prime minister unless your party takes a majority of the seats. Now I know the Republicans have [done that], but most of them have disowned most of his policies. So he needs to convince Republicans and he needs to convince enough Democrats. He’s not beholden to anyone, but he also can do very little without actually gathering a consensus.
We talk about presidential orders, and people say how much damage could he do just on his own by issuing orders on immigration, orders on trade.
Knowledge at Wharton: The Supreme Court too.
Siegel: The Supreme Court appointment, this is a whole different area. Obviously, now with the Republicans holding the Senate, definitely the Republicans have the upper hand on picking the next Supreme Court [justice]. Now the filibuster rule of 60 is still in effect. And what was so interesting is that I and a number of colleagues were talking before the election that if Hillary gets in how will she get her Supreme Court? If the Dems take the Senate, they’ll abolish the 60 filibuster rule to get a majority like they did for the appeals courts. Now the question is, will the Republicans who were always against that say to themselves, ‘if we abolish the 60 rule we’ll automatically get all our choices?’
Knowledge at Wharton: One of Trump’s economic advisors, Peter Navarro, was on CNBC … and he brought up the idea that the Trump presidency can, through various economic means, lead to Dow 25,000.
Siegel: He did. I was there. But I thought he said after five years. And someone pointed out … that’s not that great a return.
Certainly, that is a number that’s realistic because it doesn’t mean huge returns. I’m predicting about 5% after inflation returns, which is about 6% to 6.5% a year. So I’m in that ballpark.
What is unrealistic is this idea that you could, by cutting taxes by X trillion, get 5.5% GDP growth. That’s one reason why mainstream economists basically stayed away.
“It’s hard not to see that health care was a huge winner.” –Bill Stone
Stone: Dr. Siegel is right on. Mid-single digit returns are, I think, a reasonable thing to think about. … So in terms of the target they threw out there, I think it’s certainly within reach assuming we continue to grow at a decent clip.
Knowledge at Wharton: So then what are the realistic numbers on GDP growth going forward?
Siegel: That’s been the most disappointing thing in this recovery. We’ve had the worst GDP growth of any recovery in U.S. history in the post-World War II period. And we don’t completely know why. Productivity has collapsed. … I think there are too many regulations — I do like that part of the Trump thing. It’s going to be very interesting because I think Obamacare was going to explode on its own next year, even with Hillary [in power].
If we make business a little more regulation friendly and a little less restrictive, maybe we could squeeze an extra 0.5%, 0.75%.
Stone: I agree. It’s exciting to see the opportunity around deregulation, corporate tax reform. Those kinds of things are something that could, like he said, add something. … But, you know, it’s not going to catapult you to 5%.
Probably a fair point of what people do worry about in terms of his plan is that the fear of maybe too much protectionism, too much meddling in trade. We’ll have to see how that plays out. I’m hopeful on that.
Knowledge at Wharton: It becomes very important to see how and what happens with NAFTA. And obviously [the Trans-Pacific Partnership trade deal] I think is pretty much off the books at this point.
Siegel: It’s off the books. [And,] how do we repeal NAFTA? Now, I don’t know how much he can do by presidential order, in terms of changing one thing or another; we’re going to have to wait and see. And then he can always be challenged. I mean, there are entrenched interests.
He wrote the book, The Art of the Deal. Now let’s see what kind of deals he can make in Congress. That’s really, I think, the bottom line there.
Knowledge at Wharton: Bill, what sectors are you focused on moving forward? Especially in the first six months to a year of the Trump presidency?
Stone: It’s hard not to see that health care was a huge winner. And I say that because it’s much bigger than expected. Because even if you thought it was an upset, and Trump was going to win, you wouldn’t have necessarily assumed that Congress would remain Republican.
So the interesting part is, Trump was kind of out there. He had talked about maybe thinking about drug price negotiations with a Republican House in particular.
On top of that, the interesting thing is Proposition 61 in California [– banning the state from buying any prescription drug at a price over the lowest paid by the U.S. Veterans Affairs Department –] failing by a large margin. So you really saw the sector that could be much further in the doghouse all of a sudden get some political life again.
Knowledge at Wharton: Jeremy, what are you focused on?
Siegel: I agree. The health care sector had done well today because interest rates are rising. In the long run, we see pressure on telecom, on real estate because what’s going to happen with interest rates is certainly very, very important.
