Ghosts of Christmas past

On the

AContrary re the ghosts of Christmas past about to pay investors a visit?

Equity markets have been full of optimism, even exuberance, this December, with many stocks setting new 52-week highs and several indexes at all-time highs.

That is eerily similar to what played out in the world’s largest equity market last year, when the S&P 500 rebounded from late summer lows ahead of an expected 25-basis-point December rate hike by the U.S. Federal Reserve.

In 2015, the S&P 500 jumped nearly 13 per cent from its August lows through to its early December highs, while the U.S. Dollar Index (DXY) rallied nearly six per cent over the same period.

This trade appears to be happening once again with the S&P 500 and U.S. Dollar Index having gained nearly eight per cent and over nine per cent from their June lows, respectively.

One difference has been the bond market, which didn’t correct last December but did move higher throughout 2016, as pundits dropped their aggressive expectations for further Fed rate hikes.

However, this changed following Donald Trump’s election win as the rate-hike trade came back on, sending bonds crashing back down to beginning-of-the-year levels.

You now have a situation where the U.S. bond, equity and foreign exchange markets are all pricing in the expectation of up to four rate hikes in the coming year.

We certainly hope it doesn’t play out like it did at the beginning of 2016, when the markets clearly were not ready for higher rates. Following last December’s rate hike, the S&P 500 and U.S. Dollar Index fell nearly 13 per cent and 4.5 per cent per cent from their December highs to their respective February lows.

We think the real test this time around will be whether the global economy can handle not only higher interest rates and a higher U.S. dollar, but also president-elect Donald Trump’s protectionist policies.

In our opinion, it is still way too early to say whether Trump’s election win is reason enough to justify higher rates and a higher dollar, though if the recent selloff in bond markets is any indication there is potential trouble ahead.

In the meantime, European investors have learned from the reaction to the Brexit vote that these events don’t really matter in the near term, so it isn’t a surprise they ignored the recent referendum results in Italy.

Thanks to OPEC, oil and oil stocks now appear to have a floor in place and there is finally upward momentum in a sector that has been beaten up pretty badly since correcting in mid-2014.

Interestingly, stock investors are more optimistic than oil investors factoring in a higher oil price in valuations. Such a divergence isn’t uncommon when other sectors are trading at 52-week highs, leaving money managers buying once underweight energy stocks in order to play catch-up to their benchmarks before year-end.

Finally, you have investors piling into U.S. stocks as evidenced by recent funds-flow data. According to EPFR Global and as cited in the Financial Times, investors have plowed over US$35 billion into U.S. stock funds following Trump’s win.

Investors are clearly buying into the Trumpflation trade with strong economic growth expected from his upcoming fiscal plans. In particular, Steven Mnuchin, Trump’s Treasury pick, believes that sustained U.S. growth rates of three per cent to four per cent can be achieved — a huge jump from the current two-percent pace.

From a market perspective, David Rosenberg says U.S. stocks are now more expensive than at the 2007 peak and are pricing in a whopping 30-per-cent earnings growth rate next year, which statistically is a onein-twenty event.

Only time will tell if those materialize.