‘There's a certain amount of disorder that has to be
reorganized.’ (William
S. Paley)
Impactful Change
The bull market that was well established in US stocks
accelerated further after a Trump victory. The Trump-rally is mostly driven by optimism
circulating in the business world and anticipation of less regulation and even
possibly lower taxes. Unlike the last few years, the stock market rally was
driven by a coordinated low interest rate environment (i.e QE) that boosted
asset prices while failing to meaningfully stimulate the real economy. Surely,
if the last eight years showcased economic strength (as witnessed in stocks and
real estate) then events like Brexit and Trump victory would have been very unlikely.
It’s quite evident, recently, that “a bullish stock
market does not quite mean a strong real economy” will be the legacy of Obama (and
other European leaders). And the newfound energy of Trump is gearing to revive
the meek economy that’s been wobbling and barely above water. This past year has shown, the centralization
of key decisions, such as interest rates or government policies (at EU, UN and
Central Banks), have driven local Westerners to long for and demand
independence and radical change.
Basically, the unsettled feeling towards the establishment
and status-quo can be reflected in the market dynamics soon enough. Yes – even
if stocks roared with interest rates being low, the middle class felt betrayed
in the US and UK, and even global growth was not as vibrant like in the early
to mid 200o’s. When all is said all and done, Yellen struggled to raise
rates during the last three years because the real economy growth (via wage
growth and inflation) was not quite convincing. It is critical to keep
in mind that inflation expectations are looking upward for now based on
short-term data. However, once the Trump-mania hype settles in and his new
regime takes over the White House and congress, the true test awaits. Markets were
desperate for new catalysts and even more desperate to break out of the
over-reliance on the near-zero interest rate policies.
Shifting Script
The major disconnect between the real economy and financial
markets led by US stocks has been quite alarming for a long while. Certainly,
this misalignment serves as one of many key themes in recent years. The Trump
victory has created the sense that reliance on Fed-driven low interest rates
and big government is going to shift. The Yellen-Trump relationship has been
awaited with great excitement and anxiety since Trump displayed an openly
anti-Federal Reserve ideology. Interestingly, Yellen & Co have postured about
interest rate hikes on many occasions,
only to pull the trigger 12 months after the last rate hike in December 2015.
Thus, higher interest rates and a strong Dollar have been brewing silently,
even before the election. Now, with protectionist policies touted by Trump, the
Dollar looks stronger with domestic companies looking to benefit greatly,
especially in Small Cap companies. At the same time, unease about globalization
hurts some EM currencies, too.
The Trump victory provided a stimulus in the
perception of the real economy. Maybe, this is positioned to replace the ‘stimuli’
from the low interest rate games. However, the Federal Reserve narrative and
credibility benefits from rising inflation expectations as they took a
‘hawkish’ stance, which was illustrated this last week. More interest rate
hikes are expected, albeit a grand promise for now, but that’s nothing new—We
have heard many unfulfilled Fed promises before.
The US 10 year Treasury Yields closed near 2.60%,
sending another wake-up call regarding interest rate trends. The new GOP
congress and Trump are expected to create a business friendly environment.
Thus, justifying a rate hike for Yellen seemed a bit easier than before, and
having interest rates rise enables Trump to ride some ‘hope’ into 2017. For
risk managers, the suspense has heightened. The bull market is aging further by
the day and the narrative is being reorganized. The paradigm is shifting and so
is the risk/reward that many got accustomed to in a very complacent manner. Thus, there is a lot to digest and adjust
ahead, and surprises are plenty for money managers of all kinds.
Search for Bargains
As the surge in US stocks continues, curiosity awaits
about early 2017 market behavior. Are stocks overvalued? Is energy the place to
be given favorable policies? Are interest rates in the US set to rise further?
Is the Fed’s role going to diminish and change dramatically?
First and foremost, a breather seems long awaited in
US markets from stocks to bond sell-offs. Clearly, the strong run has been too
impressive and a correction is long awaited.
Secondly, a follow-through is needed for the stronger Dollar, higher
yields and higher stock that’s been witnessed after the US election. Finally,
new trends are inevitably set to develop from energy to financial services,
especially in areas that have underperformed in recent years. That will offer
great upside benefits, but with policy changes playing out in Europe and
Trump-GOP dynamics being a wildcard, there are a lot of unknowns.
Amazingly, the Nasdaq index is up over 300% since
March 2009 lows as tech related areas have shown notable strength since the
2008 crisis. Meanwhile looking ahead,
bargains maybe found in Energy, Emerging Markets and US-based sectors. The market has been rewarding shares broadly,
but soon winners and losers will be clearly defined. Thus, the
short-term suspense can create longer-term opportunities. Perhaps, the focused
investor with high conviction may find fruitful returns even if the suspense
expands.
Article Quotes:
“Like all bonds world-wide, Chinese bonds are under
pressure from the U.S. Federal Reserve’s plans for faster interest-rate
increases than some expected. China may guide its own rates higher to prevent the
Chinese currency from weakening faster against the dollar, a scenario that
would further squeeze Chinese borrowers in need of cheap finance. China’s total
debt surged to around $27 trillion this year, or 260% of gross domestic
product, compared with 154% in 2008 at the start of a stimulus program to
offset the financial crisis. It is continuing to grow at more than twice the
pace of the economy…. The clearest sign that many Chinese are worried is the amount of
money flowing out of China despite strict measures to stop it. China’s
foreign reserves have dropped by 21% to $3.05 trillion in the past two years. But
since much of the financial system is lightly regulated, the true amount of
leverage in the system is unknown. Market experts say asset managers
routinely use bonds as collateral to buy more bonds, repeating the process many
times over.” (Wall
Street Journal, December 18, 2016)
“There is a fairly broad but cautious agreement that
QE has stimulated demand. The causality is hard to prove, but since the launch
of QE growth has picked up in both of its main aspects: investment and
consumption. Studies document the positive impact on asset prices and a
reduction in long term borrowing costs. The bigger question is when we should
begin to exit the programme. Some argue that the time is now. For example,
the German Council of Economic Advisors agree that QE has managed to stimulate
demand, but feel that the ‘exceptionally loose monetary policy by the European
Central Bank is no longer appropriate.’ Another
line of complaint against QE is that it squeezes the profitability of banks.
This is a valid concern, because weak profitability encourages banks to tighten
the supply of credit to the real economy. Improving access to credit was the
very purpose of the ECB’s QE programme, so it would be counterproductive to
carry on if the programme is hurting bank profits.” (Bruegel, December 8, 2016)
Key Levels: (Prices as of Close: November 25, 2016)
S&P 500 Index [2,258.07] – Over a
9% rally since November 4th lows of (2,083.79). The common theme of all-time highs continues.
Crude (Spot) [$51.90] – Facing resistance at $52; however, the uptrend
remains intact. The last several months have displayed stabilization around
$45-50. Even before the OPEC deal, Crude rallied from $26 to $50; something to
keep in mind given several narratives.
Gold [$1,173.50] – Steady decline since July 8th peak.
It appears that Gold is even more inversely correlated to the Dollar strength.
Even a recent commodity rally has not awoken Gold prices for revival.
DXY – US Dollar Index [102.95] – Explosive
forth quarter. Further strength in the Dollar showcases a continuation of the
uptrend established in 2014. Relative to other currencies and Gold, the Dollar
remains appealing.
US 10 Year Treasury Yields [2.59%] – A rate hike combined with
increasing inflation expectations has continued the yield rise. A remarkable
turnaround since July 6, 2016 lows of 1.31%.
Dear Readers:
The positions and strategies discussed on MarketTakers
are offered for entertainment purposes only, and they are in no way intended to
serve as personal investing advice. Readers should not make any investment
decisions without first conducting their own, thorough due diligence. Readers
should assume that the editor holds a position in any securities discussed,
recommended or panned. While the information provided is obtained from sources
believed to be reliable, its accuracy or completeness cannot be guaranteed, nor
can this publication be, in any Publish Post, considered liable for the future
investment performance of any securities or strategies discussed.
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