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What Could the New Administration’s Policies Mean for Your Portfolio?

As the President outlines his economic agenda for the coming year and beyond, new opportunities for investors could quickly emerge

FOLLOWING THE NOVEMBER ELECTION of Donald J. Trump as the nation’s 45th President, U.S. equity markets rallied on hopes that his campaign platform of tax reform, fiscal stimulus and regulatory relief would bring about stronger growth and higher asset prices.

In the Q&A below, Christopher M. Hyzy, chief investment officer at Bank of America Global Wealth & Investment Management, shares his thoughts on the prospects for the economy under the new administration and how investors can prepare for the potential opportunities ahead.

After President Donald Trump’s election victory, the U.S. equity markets climbed to record heights. What was behind the “Trump rally?”

CHRIS HYZY: Actually, the table was set for a stock market rally late last summer. At that time, we started to shift from record low — if not negative — interest rates and anemic economic growth to a stronger economy driven by a turn-around in the industrial and manufacturing sectors, rebounding oil prices and strong consumer spending. This set us up for stronger growth — and higher stock prices — in the second half of 2016 and early 2017.

Companies in cyclical sectors like financials, industrials and materials are most likely to benefit from the stronger economy we’re anticipating."— Christopher Hyzy,Chief Investment Officer, Bank of America Global Wealth and Investment Management

Was some of the run up in equity prices the result of optimism around the pro-business, pro-growth agenda President Trump has outlined?

CH: The economic trends were positive before the election, but, no doubt, there is now more confidence in the economy’s prospects — and the markets’— now that it could be easier to pass pro-growth initiatives like tax reform, fiscal stimulus and regulatory relief. So I think we would have seen higher stock prices no matter who won the election, but this administration’s policy proposals were probably fast tracking the market gains we might not have seen until later in 2017 if the election had gone differently. We’re definitely benefiting from animal spirits unleashed by the prospect of a pro-business White House and Congress working together.

If President Trump’s policies trigger stronger economic growth than we’ve seen over the past eight years, what will that mean for the financial markets?

CH: It will accelerate the transition to the new market regime that started to emerge late last summer with the uptick in economic growth and corporate earnings. So instead of an economic environment marked by deflation (or falling prices), low interest rates and sub-trend economic growth, we’re beginning a cycle where we have a reflation of the economy, trend growth of 2.5%, maybe better, and higher interest rates. If they become law, the President’s policies should accelerate and magnify these changes.

So presumably stronger economic growth translates into higher corporate earnings, which allows for asset prices, including equities, to potentially go higher.

CH: Yes, and not just higher asset prices, but an entirely different opportunity set for investors could emerge. Under the old market regime, which reflected secular stagnation and below-trend economic growth, investors flooded into defensive sectors, like consumer staples and utilities. Today, it’s the cyclical sectors — those whose fortunes correspond to the strength of the economic cycle — that are drawing investors’ dollars. So companies in sectors like financials, industrials and materials are most likely to benefit from the stronger economy we’re anticipating.

"Within equities, we like value stocks and U.S. small-cap equities, and we continue to prefer high-quality U.S. large caps that are likely to grow their dividends." — Christopher Hyzy,Chief Investment Officer, Bank of America Global Wealth and Investment Management

How has the prospect of more robust economic growth effected your asset allocation guidance?

CH: We’re overweight equities despite current valuations, which are slightly expensive, but when you factor in potentially stronger economic growth and improved corporate earnings, an overweight to equities makes sense. Within equities, we like value stocks and U.S. small-cap equities, and we continue to prefer high-quality U.S. large caps that are likely to grow their dividends. In international equities, we’re less constructive on the developed economies. But we’re overweight emerging markets because accelerating growth in the U.S. and nascent growth in Europe and Japan could drive up commodity prices, which should benefit this group of countries.

What about fixed income? Does a significant allocation to bonds still make sense when yields are likely to rise quickly?

CH: It does make sense, but with the market environment changing, the role of bonds will change as well. Bonds are shifting from an asset class that for a long time had been a total-return investment, meaning they provided both price appreciation and income. Now that yields are rising — and likely to normalize in the years ahead — bonds should be viewed as a cash-flow producer rather than a total-return asset. They’re also an important portfolio diversifier — and a volatility dampener under unforeseen worst-case scenarios.

Given your outlook for global markets, what advice do you have for investors as they position their portfolios for the new market regime you described?

CH: My most important recommendation is to take portfolio diversification to a new level. We’re in the late stages of our current business cycle, and these late-cycle phases tend to have higher volatility as inflation rises and central banks shift from stoking growth to checking inflation. In this environment, investors need to further diversify their equity and fixed income holdings. They also should consider increasing their allocation to alternative investments, especially hedge funds. Illiquid assets make sense for investors who can tolerate the additional risk. Final point: Investors may need to make tactical, or more short-term, adjustments to their portfolios multiple times because the markets are likely to be very fluid throughout 2017.

3 Questions to Ask Your Advisor

  1. Given all the changes in the markets, how often should I be rebalancing my portfolio?
  2. How can I capture investment opportunities in areas like the cyclical sectors and emerging markets?
  3. Are my equity and fixed income investments diversified enough for today’s market environment?

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Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.

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