There were two big surprises this week for investors: one was of course an election outcome few predicted, and the other was the market's reaction to it. We are not surprised that stocks recovered; but rather how swiftly. Not even the market's surprisingly fast recovery from the unexpected Brexit "leave" vote in the U.K. back in June of 2016 prepared us for this. After Dow futures were down over 800 points after the result became clear late on election night, the blue chips reversed course the next day (November 9) to end more than 250 points higher, before adding another 218 points on Thursday and 40 points on Friday. The Dow was down all five days the prior week before rising each day last week; a wild ride to say the least.

By week's end, the S&P 500 had produced a five-day gain of 3.8%, the best week for the index since October 2014. The 5.4% and 10.2% gains for the blue chip Dow Industrials and small cap Russell 2000, respectively, were the best since December of 2011.

We believe several factors are behind the rebound:

The strength in the broad stock market indexes this week was notable, but the dispersion in the sectors also stood out. Sectors and industries expected to benefit from President-elect Trump, such as healthcare, financials, and infrastructure, all soared, while those that may be hurt by Trump's policies sold off, including emerging markets and interest rate sensitive sectors such as utilities.

Here are our updated views on some of these areas following the election:

2. Energy. Trump is likely to be positive for fossil fuels. He has promised less regulation on drilling, along with expansion of drilling areas. Should oil and natural gas prices hold up, some pipelines may get built that would not have under Hillary Clinton's leadership. Refiners may see easing ethanol requirements, and the segment of the industrials sector that services the energy sector may also benefit. The risk is that increased production sends oil prices down and hampers sector performance, although master limited partnerships may be less sensitive to that risk than the oil and gas producers.

3. Financials. The election outcome has put upward pressure on interest rates and steepened the yield curve (difference between short and long-term interest rates), which is good for bank profitability [Figure 2]. The Trump administration has stated its desire to roll back financial regulations, including the Dodd-Frank financial reforms created to reduce risk in the financial system following the financial crisis. Implementation of the Department of Labor's fiduciary standard for retirement investment accounts, slated for April of 2017, could now be delayed, which could benefit the asset managers and mutual fund and annuity distributors. Finally, de-regulation and infrastructure spending could lead to increased bank lending. 

4. Healthcare. Trump has stated his desire to repeal and replace the Affordable Care Act (ACA), which would negatively impact segments of healthcare that rely most heavily on those insured under the ACA. However, lowering drug prices through regulatory actions is unlikely to be a priority for President Trump, as it would have been under Clinton's leadership. As a result, we expect a Trump Administration to be friendly to pharmaceuticals and biotech stocks.

5. Industrials. Trump has put infrastructure spending at the top of his agenda, throwing out numbers of as much as $1 trillion in additional spending. Within industrials, construction and engineering firms are poised to benefit (as will related materials companies). Industrials are also poised to benefit from increased defense spending, another emphasis of the Trump campaign. On top of that, some of the big global industrial companies have a lot of cash trapped overseas that could come back should tax reform include repatriation of overseas cash, as we expect. In addition, less energy regulation may support the segment of industrials tied to oil and gas infrastructure. Finally, we expect improved global growth from the increased spending to support the sector in the coming year.

The risk to these areas is again restrictive U.S. trade policy, should Trump follow through on his campaign threats to slap tariffs on Chinese and Mexican imports. The industrials and materials sectors are among the most globally focused. The potential for U.S. steelmakers to gain market share against overseas competitors is a potential offset to this risk.

6. Small caps. Policies aimed at bringing manufacturing jobs back to the U.S., a key campaign goal for Mr. Trump, are positive for small cap stocks. More bank lending is also positive because small companies are generally more dependent on bank credit. Technical analysis suggests small caps have the potential for a relative performance run given they broke above a downward sloping trend line [Figure 4].

Conversely, favoring large caps over small is the likelihood of tax repatriation, which benefits larger companies with the most cash parked overseas. Valuations for small caps relative to large are rich, in our view. And although we do not expect a recession as early as 2017, the latter stage of the business cycle tends to be friendlier to larger caps. Bottom line, although small caps may experience a short-term run of outperformance on the election results, the strength may not be sustained beyond the near term.

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.

Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.

The fast price swings in commodities and currencies will result in significant volatility in an investor's holdings.

Small cap stocks may be subject to a higher degree of risk than more established companies' securities. The illiquidity of the small cap market may adversely affect the value of these investments.

All investing involves risk including loss of principal.

INDEX DESCRIPTIONS

The Standard & Poor's 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Dow Jones Industrial Average Index is comprised of U.S.-listed stocks of companies that produce other (non-transportation and non-utility) goods and services. The Dow Jones industrial averages are maintained by editors of The Wall Street Journal. While the stock selection process is somewhat subjective, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors, and accurately represents the market sectors covered by the average. The Dow Jones averages are unique in that they are price weighted; therefore, their component weightings are affected only by changes in the stocks' prices.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index. 

• The degree to which the election results impact volatility will depend a great deal on which policies are actually enacted as a result of the changes in Washington.
• Corporate tax reform, including repatriation that allows companies to bring overseas cash back to the U.S. at a discounted tax rate, stands a very good chance of being passed following the Republican sweep.
• We do not believe the election results have changed the Fed's outlook. 

The results of the November 8, 2016 U.S. presidential election have not changed our long-term outlook for the U.S. economy. Elections do not in and of themselves change economic trajectories, policies do. We need to wait to see which policies Trump moves forward with and the details of those policies. Our Recession Watch Dashboard continues to point to an overall low risk of recession within the next year.

President-elect Donald Trump, whether you support him or not, won't get everything he campaigned over because the process of lawmaking is a compromise, even within one's own party. All presidents - even those like Trump who sweep into office while holding both houses of Congress - will have to compromise. Why?

Checks and balances are an important part of our political system. Although Trump is not a traditional politician, he will likely share the experience of leaving a fair amount of his campaign agenda undone. Checks and balances help to eliminate the extremes that may be making investors nervous. Further, newly elected presidents tend not to have as much political capital as they think they do, which is one of the reasons they are typically unable to get all of their top priorities accomplished. Trump has a narrow Senate majority, won a closely contested election, and the Republican Party (not to mention the Democratic Party) is fragmented, making the policy path more difficult. Still, he is likely to make a difference in several key areas impacting the economy:

In addition, his election may have an impact on the decisions of the Federal Reserve (Fed) this year and over the next several years. We'll address the tax and infrastructure proposals, as well as the Fed, in this commentary, and plan to discuss the impact of President-elect Trump's other economic related proposals at a later date.

TAXES AND INFRASTRUCTURE SPENDING CHANGES ARE LIKELY UNDER PRESIDENT TRUMP

Looking ahead, President-elect Trump has said conflicting things about Janet Yellen in recent months, so it's unclear today whether or not he would reappoint her as chair when her term is up in 15 months. Trump will also be able to immediately nominate candidates to fill at least two vacancies on the Fed's 7-member Board of Governors, and since the members of the Board are appointed to 14-year terms and are also voting members on the Fed's policy-making arm, the Federal Open Market Committee (FOMC), those candidates may impact monetary policy for years to come.

This research material has been prepared by LPL Financial LLC. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity. Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

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