Investors reaping early benefits as Trump era dawns in America
One of the remarkable aspects of financial markets these days is how quickly they get used to things.
Terrorist attacks, Brexit, Donald Trump — markets tend to quickly digest the impact of unforeseen events, and then get on with adjusting to the new reality.
In the case of Trump, investors are pretty clearly defining the new reality. The president-elect’s promised policies, especially tax cuts and infrastructure spending, will be inflationary.
It follows that the U.S. Federal Reserve has been put on a clearer path toward rate normalization — something recent remarks from Fed officials seem to confirm. A U.S. rate hike in December now seems a near-certainty.
The response from investors has been dramatic: a huge sell-off in U.S. Treasuries, to the tune of a trillion dollars in the week of the election. Equity markets have been the beneficiaries of the fixed-income rout, and the Trump stock rally pushed all major U.S. indexes — the Dow Jones industrial average, the S&P 500, the Nasdaq and the small-cap Russell 2000 — to record highs in advance of American Thanksgiving.
For Canadian investors, the news has been good, too, with the S&P/TSX composite index hitting a 15-month high this week.
But how long will the good times last?
Well, let’s be clear: the times were not that bad before Trump’s win, nor are they that good yet. The fundamentals of the world’s largest economy haven’t changed — it’s still looking at steady, slow growth for the foreseeable future, and inflation, while picking up, remains well below what the Federal Reserve thinks is acceptable.
Trump isn’t president yet. In the absence of details on his fiscal stimulus plans (and as I’ve said before, his vaunted infrastructure boost might not amount to much), it’s impossible to say for sure that spending-fuelled inflation is a done deal.
The markets are predicting, not responding, and predictions these days oft go awry.
Trump has already proven to be exceptionally unpredictable (he’s already flip-flopped on prosecuting Hillary Clinton, changing libel laws and upping the use of torture), and there may be little reason to expect a steady hand on economic matters, either.
That said, we live in the world we live in, and it doesn’t look like the Trump rally is going to reverse anytime soon.
The CBOE volatility index, a.k.a. the VIX, which indicates the implied volatility of the S&P 500, has fallen since Nov. 8 even as markets have risen — a sign that the bullish mood on Wall Street has a ways to go yet. So, enjoy it while it lasts. If you’re looking for opportunity in all this, note that this rally is different from others in one important respect: the gains are not evenly distributed across sectors and industries.
There are clear winners and some losers in this game, unlike when loose monetary policy lifts all boats (or keeps them from sinking). The question right now is whether there’s still opportunity among the winners.
Let’s look at just two of the benefiting industries, which should do well in a higher-inflation, higher-rate environment.
One of them is the U.S. financial industry, which is expected to benefit from higher interest rates and Trump’s promised deregulation. The S&P 500 Financials sub-index is up 11.5 per cent since Nov. 8, and some U.S. bank stocks may be beginning to look pricey.
JPMorgan Chase, up more than 12.5 per cent since the election, now has a price-to-book of about 1.2 (20 basis points above its fiveyear average); Wells Fargo, up 14.5 per cent, has a P/B of nearly 1.5. By comparison, Bank of America, (up 21 per cent) and Citigroup (up 13.6 per cent) both have P/B’s of 0.8, so they might still have some upside.
Industrials, meanwhile, have done well also, in expectation of higher rates and more infrastructure and defence spending.
The S&P 500 Industrials subindex is up more than six per cent since Nov. 8, with some constituents doing much better; heavy equipment company Caterpillar is up more than 13.5 per cent, for instance, and General Dynamics, an aerospace and defence multinational, is up more than 11 per cent.
Others in this group might provide more upside — for instance, General Electric, which has gained 6.5 per cent since the election but is up only two per cent on the year, and United Parcel Service, up only a little more than three per cent since Election Day.
Another sector to look at is more contrarian: technology. The IT-heavy Nasdaq has gained only 3.7 per cent in the new Trump era, which might seem a bit odd considering that tech stocks typically do well during periods of rising rates. But it’s also a sector where Trump policy uncertainty is really in play, as it could be heavily exposed to his anti-immigration and corporate tax reform ideas. If he doesn’t really follow through on those, there could be upside for investors.
Of course, all of this handicapping could prove itself irrelevant very soon.
Markets digested Trump’s victory and surged forward quickly; they could just as quickly turn tail and run. With an unpredictable neophyte at the helm, weirder things could happen.
But for now, investors look ready to make hay while the Donald shines.