“Interest rates have been at stupid levels, they’ve been held down…they’re like beach balls under water.” – Stan Druckenmiller
Since the election last Tuesday night market participants and media outlets have been scrambling to understand and explain what a Trump presidency might mean for financial markets. Global asset prices had all but priced in a Clinton victory, and the chaos that ensued in overseas and futures markets as Trump’s victory took shape throughout the evening reflected a sense of confusion over how to interpret the results. At one point Dow futures were off by nearly 1,000 points, gold and bonds were through the roof and the Dollar was falling against most major developed currencies. By Wednesday morning, however, the chaos had subsided, and by the end of the day the knee jerk reactions had completely reversed themselves with stocks ending solidly in the black and bonds getting hammered.
It has been interesting to watch market action over the last week as the reality of a Trump presidency and Republican congress has begun to manifest itself in a changing of the guard within financial markets. Despite relatively benign headline index level data, there has been tremendous amounts of divergence within certain pockets of the market. The difference, for instance, between the top performing industry (regional banks) and the worst performing industry (gold miners) was over 30% last week!
While there is clearly a lot that has yet to come into focus, a handful of assumptions about Trump’s impact have emerged as the clear consensus for the time being. At its core, Trump’s platform is perceived to generally be pro-business in that it is biased towards less regulation and favorable tax reform, to include a potential tax holiday on foreign profit repatriation (see our post Is Repatriation A Patriotic Duty? for a discussion on this nuanced topic). Trump’s desire to aggressively invest in the country’s infrastructure is also perceived to be accretive to economic growth and likely to stoke inflation. On the flip side, his vocal opposition to trade deals such as NAFTA and the pending TPP, as well as his generally unpredictable style and temperament, are creating a cloud of uncertainty over the future geopolitical and trade dynamics in store for our country.
Of all the market movements over the past week, the one that has most caught our eye has been the sharp spike in long-term bond yields. As described in the opening quote, yields have shot upwards like a beach ball released from below the water’s surface.
This trend has been driven primarily by the expectation that heavy fiscal stimulus into infrastructure improvements would finally be the tipping point for the type of inflationary growth the Fed has been trying to stimulate for years now. If aggressive deficit spending does end up materializing in the coming years, it will almost certainly drive nominal GDP growth higher by a percentage point or two. Commenting on this possibility, Jeffrey Gundlach said, “If nominal GDP pushes toward 4%, 5%, or even 6%, there is no way you are going to get bond yields to stay below 2%.”If he’s right, it could be a while before we see a 1-handle on the 10-year yield again.
So what has this meant for other corners of the capital markets? Bond yields have risen across the globe, but have been especially pronounced here in the US. This has led to a strengthening US Dollar, especially against emerging market currencies in countries that would be disadvantaged if current or future trade deals are threatened. A steepening yield curve, along with the possibility of a repeal of Dodd-Frank regulation, has also provided a renewed tailwind for shares in national and regional bank stocks while US industrials and materials are catching a bid on the prospects of a major infrastructure spend. The laggards in this “Trump rally” have been international developed and emerging market stocks and bonds, partly due to the currency impact of a strengthening Dollar and partly due to uncertainty around Trump’s foreign policy positioning. Hospital stocks have also gotten creamed, down over 10% since the election, on the expectation that the Affordable Care Act could be in real danger of being repealed (reduced insurance coverage would negatively impact revenue projections for hospital operators).
As far as our positioning goes, our bond market allocations held up very well amidst the pop in yields we saw over the past week, and our general philosophy of being spread across numerous different asset classes allowed us to weather the volatility with a good amount of confidence. Coincidentally we are seeing MarketVANE STOCKS already begin to rotate us into alignment with the Trump-driven trends described above, while in HARD ASSETS we are going back into cash after another head fake buy signal in oil. Regardless of your political views, it’s important to put aside emotion and remain flexible in your thinking as it pertains to financial moves in this environment. While we’re watching things unfold with a great amount of interest, we remain committed to our disciplined process and believe that over time it will add more value than trading purely on gut conviction or political bias.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
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