“Faith is a continuation of reason.’ (William Adams 1564-1620)
Vibrant Action
The last few weeks have set-off all types of reactions: Surging bond yields, skyrocketing Crude prices, further optimism in US stocks, weaker Gold prices, rapid migration to Small Cap stocks, sharp rises in bank stock shares, and even more hope of better business environments. There is a lot to digest, globally. Yet, some trends were already in place, notably the strong stock market and strengthening dollar. Even yields were moderately bottoming since the summer months, during a period when Trump was the underdog. Now, the Federal Reserve may feel compelled to raise rates as the mentality has shifted focus towards more real economy optimism rather than the failures of QE to stimulate in a meaningful manner. It’s amazing what attitude can do, but this market perception is still fragile enough to stir more suspense.
Re-affirmations
The familiar status-quo since 2008 has been lower rate policies, higher asset prices (stocks and real estate), limited stock market volatility, more regulation and an aourdous environment for small businesses. Yet, the post Trump victory era further accelerated the stock’s bullish run, reaffirmed strength in dollar and reawakening further inflation expectations. Of course, this is a knee-jerk reaction over a very limited period – but the buzz is on and the thought of shake-up adds on to the narrative. Simply, there is a theme that suggests infrastructure spending will lead to jobs, and many are quick to buy into it. This is reflected in inflation expectations rising, which suggests that financial markets are optimistic about Trump’s pending policies.
Similarly, domestic companies expected to benefit from protectionist policies surely alerted a manic buying in smaller cap companies. However, it is way too pre-mature to make government policy calls, even if markets are celebrating a new business friendly regime. Even market calls seem susceptible to even more volatility than witnessed during the last 8 years. The recent euphoric purchasing seems like panicked buying by confused investors, indicating potential disappointments ahead. For now, one can reiterate the same thing we knew in the summer and spring: The well-established bullish run in stocks is intact. Hence, the S&P 500 index is currently up 10% for 2016, which is rather impressive considering all the worries of Brexit, Trump and the indigestible instability in both developed and developing countries.
Pending Shifts
In a paradoxical way, the post-Trump victory rally is not the origination of much talked about recent themes but rather it’s the acceleration of some existing market trends. The Dollar has been strong for few years following the collapse of EM and commodities. Stocks have been up for several years. Even weakness in Tech names such as Apple, Google, and Netflix started in October, ahead of the elections. Thus, investors should ask: Which existing theme is going to get derailed?
Naturally, the low-rate environment is the topic of high priority. Was it due for a shake-up after QE failed to stimulate the economy? Yes – regardless of Trump— the skeptics of Central Banks were groaning and those groans were getting louder this year, globally. Was the bond market due to see a sell-off? Sure, the Great Rotation, a slogan for the shift away from bonds into stocks, has been talked about without much to show. Now, incredibly, the US bond market dramatic sell-off is re-triggering the panic out of fixed income, leading to further buying in stocks and running to other alternative/non-traditional areas. Importantly, since bottoming at 1.31%, yields have been rising in the US 10 Year Treasury since July. Now, if Crude prices rise and inflation picks up then there is a case for a robust economy. But more substance is needed than just near-term perception.
Before being swept away in the Trump-mania, a deep breather for all is a reminder that not many things dramatically change over-night. In other words, foundations and sentiment were building way before the highly anticipated election. Amazingly, Yellen might be thrilled that Trump has redefined the current script, which should help the Federal Reserve justify a pending hike. The market paradigm is eager to shift, bringing thrilling suspense back to markets again.
Article Quotes:
OPEC’s decision:
“While there remains uncertainty, it is increasingly evident U.S. shale can rebound sharply when prices recover. Just how quickly it returns and how quickly global demand grows will determine whether OPEC’s decision to cut output maximizes its revenue through higher prices or just losing market share to U.S. suppliers. Both the magnitude and shorter time cycles of U.S. shale oil are now acting as significant new constraints on OPEC’s ability control oil prices and the producer group may not have the power long feared following the Arab Oil Embargo of 1973 to manipulate oil prices. Saudi Arabia holds little spare oil production capacity to tap when oil prices spike. It has made clear that it has no interest in being the swing supplier to prop up low prices resulting from structural market forces. But the agreement in Vienna is a reminder that OPEC collective action is still possible when producers see opportunities and favorable circumstances to boost revenue. In addition, looking beyond 2020, significant new OPEC supplies will yet be needed to meet higher demand.” (Reuters, December 2, 2016)
As US looks to trim stimulus, European Central Bank set to extend stimulus efforts:
“The ECB will keep the pace of purchases -- currently scheduled to run until at least March -- unchanged “at least initially’ and “might communicate that they retain the freedom to adjust this if conditions change,’ said Claus Vistesen, chief euro-area economist at Pantheon Macroeconomics Ltd. in Newcastle, England. ‘This will be a difficult balancing act, and markets won’t like that.’ Draghi might tread carefully after last year’s December policy announcement fell short of investor expectations and markets sold off. While their calls for government support have grown louder, officials have committed to keep their stimulus in place until the recovery is self-sustained and inflation on an upward trend. An extension of QE will require the ECB to tweak some of the parameters that regulate the program, according to 88 percent of respondents, even if an increase in bond yields has alleviated concerns that the central bank will face a scarcity of debt to buy” (Bloomberg December 5, 2016)
Key Levels: (Prices as of Close: November 25, 2016)
S&P 500 Index [2,191.95] – Hovering around all-time highs. The intra-day highs were set on November 30 at 2, 214.10.
Crude (Spot) [$51.68] – Despite the dramatic rise post the OPEC supply cut announcement, and it is important to remember, Crude has been trading between 44-50 since May. The peak of $51.67 on June 9, 2016 remains the next critical point. At $44 buyers seem eager, at $50 the buyers’ moment has faded.
Gold [$1,173.50] – Steady decline since the July 8th peak. Expectations growing for a rally here, as the commodity is trading below the 50 and 200 day averages. Reactions at or near $1,200 will remain critical.
DXY – US Dollar Index [100.77] – Further strength confirmed. The last two times the DXY index peaked around 100 was in March 2015 and December 2015. It is unclear if this breakout will last, but several forces favor a stronger dollar.
US 10 Year Treasury Yields [2.38%] – Closely approaching June 2015 highs of 2.49%. Inflation expectations are rising, economic growth perception is rising as well, with pending rate hikes all contributing to higher yields. So far a very explosive run since July 6 lows of 1.31%.
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