Trumponomics: Why the current rally may not last!

November 27, 2016

 

Stocks have rallied since the U.S. election and surprised even the most steadfast of bulls. The S&P Bank index has posted an unprecedented +20.4% gain since President elect Trump gave his victory speech. The Russell 2000 posted a gain of +16% in two weeks. Such a rally is absolutely unheard of (at least in the recent past). The question here is – will this rally last? Or is the market sentiment too bullish? As the markets enter the final phase of the year, uncertainty remains high and no one seems to know how the near term will play out. So what does one expect in the weeks to come?

Let’s assess the S&P 500 for a moment (SPX currently: 2,213.35 (+0.39%), Nov 25th). Market pundits are already warning that the period of panic buying is set to end. Indeed, the market does seem overbought, however, it might be prudent to observe and allow the movement to continue over the next couple of weeks. The markets expect SPX to top off at 2,260 over the next week or two as chart levels suggest that an emotional market will continue to speculate on possible, but very uncertain, future economic developments. A wise investor, should, at this moment, not put any new money into the market. Short term active traders and other speculators might be able to take advantage by selling into strength and unwinding their longs closer to 2,200 mark, but should be aware that movement past the 2,260 mark might not be sustainable. Here’s why:

Pricing in a Trump victory is indeed mystifying. Last week’s story highlighted some of the reasons why the markets have rallied since the victory, however, consider the following scenario playing out. There are key policies being discussed:

  • Increase in infrastructure spending – promotes growth
  • Stricter trade policies – subdues growth
  • Lower individual and corporate taxes – promotes growth
  • Raising interest rates – subdues growth

These are quite major policy considerations and any one of them could have an enormous impact on the economy both in the U.S. and worldwide. However, the President elect is opting to make all four changes together! Recall that, almost 50% of revenue of the S&P 500 companies come from abroad. Given the recent, rally in the dollar, consolidated earnings from overseas sales will take an enormous hit. American exports will become noncompetitive as goods become more expensive. This will undoubtedly weigh in on the S&P 500 company earnings.  Furthermore, the U.S. 10 year treasury yield has risen by ~2.5%. This suggests that we can expect a marginal increase in the cost of debt as well as the relative attractiveness of bond investments relative to equities.

Just a few months ago, any off the cuff talks of an interest rate hike was grounds for a selloff in the stock market. Now, the futures market indicates that a rate hike is almost inevitable and despite this the market has continued to surge! It is astonishing to witness how the market has suddenly decided that a bad idea is now a fantastic prospect. The only explanation now is that the market has already priced in the potential benefits of the upcoming Trump presidency, but underinvested managers and players continue to panic buy. What’s left to assess is how many of the promises made will be kept. One potential path for our scenario may be as follows:

  • An accommodating fiscal policy, will quite possibly be offset by a tightening of the monetary policy – resulting in little to no benefit in the long run.
  • President elect Trump’s most recent declaration to withdraw from the Trans-pacific partnership (TPP) will most likely drive up U.S. prices even further.
  • Wages will increase providing a short lived satisfaction as the impact of inflation and the rising interest rates kick in.
  • As the markets enter a long cycle of rising interest rates, interest sensitive assets such as REIT’s, MLP’s, utilities, and other yield based instruments will suffer.

In the short run, we might expect flat to rising equity levels due to the current “euphoria” in the market, but in the long turn and especially after about six months to a year of the Trump presidency, the markets will experience a significant downturn and quite possibly a mid-range recession as the effects of “Trumponomics” make the presence felt .

 

Sandeep Suresh

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