Thursday, November 10, 2016

Sell The Trump Rally?

Sam Ro of Yahoo Finance reports, How Wall Street is trying to make sense of the stunning stock market rally:
Stock prices crashed as it became clear that Donald Trump would be elected the next President of the United States. And then they did a complete reversal to actually rally during the first trading day after the votes were counted.

Just when you thought the stock market was starting to make sense, it goes ahead and does the exact opposite.

The markets were supposed to get crushed

Ahead of Election Day, Wall Street’s stock market experts were in broad agreement that a surprise victory by Republican candidate Donald Trump would be met by a sharp sell-off, ranging somewhere between -3% to -15%. Yahoo Finance reported on this multiple times.

What were behind these bearish calls?

For months, candidate Trump employed a divisive tone as he promised aggressive actions, including renegotiating or withdrawing from NAFTA, tightening the screws on immigration, and pressuring the Federal Reserve and its monetary policy. Most of his promises were considered bearish and recessionary. At the very least, they introduced more uncertainty, which by definition increases the premium investors demand for taking on risk.

On the night of the election, stock prices plummeted as the odds of a Trump win improved. When it became clear that Trump would win, the futures market hit “limit down,” which is just another way of saying that prices would’ve gone lower if the exchanges didn’t step in. S&P 500 futures (ES=F) were down by an eye-popping 5%.

And then the exact opposite happened

As the world awaited the US stock markets to open on Wednesday morning, traders slowly bid prices back up. And in a total shocker, stocks erased all losses and opened in the green.

When it was all said and done, the S&P 500 (^GSPC) closed at 2,163, up 23 points or 1.1% for the day. It would’ve been considered an impressive rally under any circumstance.

(Before we get to the big picture, it’s important to note that there were plenty of losers in the market. IT stocks and utilities tumbled, as financials and health care stocks surged. Our discussion today about the net effects.)

What happened? Were the stock market forecasters dead wrong? Was Donald Trump the better candidate all along?

The most common explanation for the turnaround is tied Trump’s victory speech.

“To all Republicans and Democrats and Independents across this nation, I say it is time for us to come together as one united people,” Trump said in the wee hours of Wednesday morning. “For those who have chosen not to support me in the past, of which there were a few people, I’m reaching out to you for your guidance and your help so we can work together and unify our great country.”

“The President-elect’s more conciliatory tone and pledge to work together with his opponents came as a positive surprise to market participants, many of whom had expected more of the aggressive rhetoric that marked his campaign,” UBS’s Mark Haefele said.

Indeed, while he could’ve taken a victory lap and kicked his opponents while they were down, he didn’t.

“Trump’s gracious acceptance speech has encouraged hopes that he will moderate his more extreme positions when actually in office,” Capital Economics Julian Jessop said. “Indeed, it is fair to ask ‘does Trump mean Trump?'”

This is not to say that Trump won’t eventually push for policies deemed unfriendly to the markets. All these arguments suggest is that Trump is being seen as less bad than previously thought.

Let’s not get too carried away

There are plenty of other theories for the rally, including the suggestion that this is very similar to June’s surprise “Brexit” vote, when the UK unexpectedly voted to leave the European Union. Initially, markets cratered, and then they came back.

But rather than belaboring the rationale for one or two days’ worth of rallies, it’s best to just stop now. Because who knows what the market will do tomorrow or the day after that?

If there’s one lesson to be learned here, it’s that markets are unpredictable and often times they flat out won’t make sense.

As Gluskin Sheff’s David Rosenberg once said: “Nobody ever said it had to make sense.”
There were plenty of stock market strategists and hedge fund gurus warning of Armageddon if Trump was elected. Even Bridgewater, the world's biggest hedge fund, warned of a stock market crash if Trump was elected president.

Well, the political pundits were wrong about Trump and so was the so-called smart money. Last week, when I covered America's Brexit or biotech moment, I stated the following:
I don't know if Trump will etch out a victory on Tuesday but I agree with 'Black Swan' author Nassim Taleb, there is much ado about a Trump presidency:

Taleb said Trump is not as "scary" as people make him out to be.

"In the end, Trump is a real estate salesman," Taleb said. "When you elect real estate salespeople to the presidency, they're going to try deliver something."

Because of that, Trump probably won't do anything apocalyptic, Taleb said.

The author further said he is against the two-party system and is voting for neither Trump nor Hillary Clinton. He said, however, that whoever wins won't make nearly as much of a difference as people think.
I tend to agree with Taleb on this, a vote for Hillary Clinton will essentially be a vote for the status quo and a vote for Donald Trump sounds a lot scarier than it actually will be (President Trump will be very different from candidate Trump but his ego stays so if he manages to pull off a victory, he definitely doesn't want to be remembered as the worst president to ever hold office).
Trump pulled off a victory and the knee-jerk reaction was stock market futures crashed (limit down) and everyone started panicking for no real reason.

And I don't think it was Trump's conciliatory victory speech that calmed market jitters. Instead, I think logic prevailed and people who actually stepped back to THINK made a killing buying futures when they were limit down, just like I made a nice trading profit on my biotech call which I was going to stick through regardless of who won the election.

What is the logic that I am talking about? Trump is for cutting taxes and getting rid of regulations. Tax cuts benefit mostly the ultra wealthy. Who invests in the stock market? Mostly very rich people, that's who, so it was a no-brainer to buy any dip in stocks on a Trump victory.

And while I touted biotech (IBB and equally weighted XBI) and healthcare (XLV) shares last week, before the election, the day after rally was broad and you saw financials (XLF) and metal & mining shares (XME) rally sharply.

Why financials? The number one reason financials rallied is that a Trump victory spells the end of Dodd-Frank regulations which effectively means big banks will get back to taking big risks on their books. We can argue whether this is a good thing for society but there's no arguing it's great for big banks which have been drowning in regulations ever since Obama got into office.

What else helped financials rally? Long duration bonds (EDV) got whacked hard as market participants assimilated how Trump was going to pay for his trillion dollar infrastructure spending program. The thinking is the Treasury department will need to emit more 30-year bonds, which is why the yields on those bonds backed up the most on record Wednesday following Trump's victory (click on image):


So, not only do banks and insurance companies benefit from less regulation going forward under a Trump administration, they also benefit from higher interest rates and a steeper yield curve -- and remember, for banks which borrow on the short end and lend out on the long end, a steeper yield curve bolsters their net interest margins. No wonder Goldman Sachs (GS) and other big banks are rallying hard (click on image):


Conversely, utilities (XLU), REITs (IYR) and other interest sensitive sectors are getting whacked hard as the market prices in rising rates.

Which other sectors are selling off after Trump's victory? Emerging markets (EEM) and Chinese shares (FXI) for the obvious reason that Trump has threatened to rewrite trade deals and put pressure on China for "manipulating its currency."

Gold miners (GDX) are also getting killed as investors realize the world isn't coming to an end, much to the chagrin of Zero Hedge's "buy bullets and gold' short-selling traders.

The big question now is how long will the "Trump rally" last and more importantly, what does a Trump victory mean for my earlier warning that global deflation risks are not fading?

Here, I remind myself about what Keynes said about when the facts change, but the problem is the facts aren't changing fast enough and there is a real danger that global deflationary headwinds pick up under a Trump administration.

Francois Trahan and Stephen Gregory of Cornerstone Macro put out a comment yesterday trying to look past the election where they stated:

If there is one thing that 2016 has taught us it is to not rule out the unlikely scenario. Indeed, the events surrounding the Brexit vote and now Donald Trump winning the U.S. presidency were unexpected to happen, at least according to the polls and their proponents. So what does all of this mean for the stock market anyway? It's hard to know exactly what powers congress will convey on the new President but the biggest potential problem as we see things has to do with trade.

At this time, there is already a dynamic for an economic slowdown in place, one that the new president will inherit. Money supply has slowed across the developed world and rates have backed up. All of which will eventually add to a weaker U.S. economy. The real troubles with this story lie overseas where a number of countries have come to rely on the U.S. for trade. If the new President holds true on his promise to tear up trade agreements, then the outlook just got a lot more complicated. Our call for a bear market in 2017 was never about potential U.S. election results. Rather, it is about the consequences that tighter policy will bring to an already fragile world economy. As always, we shall see.
Francois and Michael Kantrowicz of Cornerstone Macro also cited ten reasons why markets are about to get a lot harder going forward before th election regardless of who wins:
  1. Growth Is Likely To Slow ... From Already Low Levels
  2. The Risks Of Zero Growth Are Higher Today Than In The Past
  3. The U.S. Consumer No Longer The Buffer Of U.S. Slowdowns
  4. The World Is Battling Lingering Structural Problems
  5. A U.S. Slowdown Has Implications For The World's Weakest Links
  6. The Excesses Of China’s Investment Bubble Have Yet To Unwind
  7. Demographic Trends In Japan ... An Insurmountable Problem?
  8. Central Banks Have Reached The Limits Of Monetary Policy
  9. Slower Growth Is The Enemy Of Portfolio Managers
  10. P/Es Are Hypersensitive To The Economy At This Time
I firmly believe the risks of global deflation are not fading, and if there is a severe disruption to global trade under Trump's watch, this will only intensify global deflationary headwinds.

Another factor adding to my worries? The US dollar index (DXY) which has been rising since August when I correctly told you to ignore Morgan Stanley's warning that the greenback was set to tumble (umm, NO, it was set to rally, click on image):


Now, we can argue whether the US dollar index can continue climbing higher from these levels as it tests a key resistance but if it does break above this resistance, a rising dollar will lower import prices and import deflation to America (and wreak more deflationary havoc on China which sort of pegs the yuan to the US dollar and a basket of other currencies).

[Note: A rising US dollar might also put off the much anticipated December rate hike from the Fed, especially after October's Fed game changer (Yellen doesn't care, she knows Trump will fire her).]

All this to say, President Trump is going to inherit a slowing US economy and a global deflationary mess, and if his administration isn't careful, it will turn a bad situation into a deflationary disaster.

As far as the Trump rally, I would sell it and book my profits here (click on image):


Don't get caught up in all the soundbites, THINK long and hard about global deflation and whether Trump's policies will add fuel to the fire or not.

I like his plan on spending a trillion dollars on domestic infrastructure and think his administration should court US and global pensions to offset the cost of such an ambitious program, but his trade policies worry me as less global trade will only stoke global deflationary headwinds.

As I end this comment, stocks are rolling over, oil and gold are down, the USD is gaining on the euro and yen, and the yield on the 10-year Treasury note stands at 2.08% (click on image):


If I were a large asset allocator, I would be jumping on bonds (TLT) after the latest backup in yields and taking profits on stocks. Don't kid yourselves, Trump isn't going to burst "the bond bubble" and if he isn't careful, his economic policies might cement global deflation for a very long time.

I don't get paid enough for sharing all these market and pension insights with you but that's alright, my aim is to educate as many people as I can and hopefully make you think carefully about the long-term picture and what really matters.

Again, retail and institutional investors can support my work by subscribing or donating to this blog under my picture on the top right-hand side (make sure you are viewing web version on your cell phone). I thank all the individuals who support my efforts and value my insights.

Below, Stanley Druckenmiller, the founder and former chairman of Duquesne Capital, discusses how wealth inequality and monetary policy helped Donald Trump win the White House. Druckenmiller also discusses his large bet on economic growth following the presidential election.

Given my continued worries on global deflation, I disagree with Druckenmiller and think he should book his short bonds/ long stocks profits as soon as possible and wait until we get more clarity on US and global growth.

Another person I disagree with is Alan Greenspan who appeared on CNBC earlier today saying he'd love to see Dodd-Frank disappear and warned of 'stagflation' and entitlement spending running amok.

Someone should explain to Greenspan that cutting entitlements is deflationary and only exacerbates rising inequality which is in itself deflationary because it negatively impacts aggregate demand.

Druckenmiller understands how unconventional monetary policy exacerbated rising inequality but it shocks me how smart people don't understand how bad fiscal policy can also fuel rising inequality. 



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