of Trumps Fiscal Policies on Stocks, Bonds, Gold and U.S. Dollar
by Victor Sperandeo with the Curmudgeon
Disclaimer: All comments and opinions expressed herein are those of Victor Sperandeo. Curmudgeon Notes have been added for clarity and completeness.
The markets have certainly revalued their view on President elect Donald J. Trump. Theres been a straight up move in equities and the US dollar, coupled with a straight down decline on all debt prices (higher yields). I view those market movements as mostly short covering in equities, asset re-allocation away from debt, and changes in equity sector weightings.
Cyclical stocks were sharply higher in a rarely seen way. US Steel (symbol=X) went from 17.6 to 28.6, while coal stocks, banks, and other such industries are up significantly since election day.
Meanwhile, the high-tech stock favorites were sold. The "FANG" tech darlings had large declines (prices rounded off from high to Fridays close): FB 133 to 117; AMZN 843 to 760; NFLX 127.5 to 115; GOOGL 813 to 760.
The Russell 2000 (^RUT) exploded higher since the Monday before election day. In 11 trading days from November 4th to last Fridays close, ^RUT has risen 13.72% and has been UP EVERY DAY (on a closing basis) - from 1156.08 close on November 3rd to 1,315.64 at Fridays close. As of Friday, November 18, 2016, ^RUT trailing P/E is nil (cant be calculated since cumulative earnings are <=0) vs 145 one year ago. (Source: WSJ)
In other words, cumulative ^RUT earnings have declined over the past year, while the stock price of the index (and IWM ETF) has advanced strongly.
ZeroHedge notes that the Russell 2000 is the most overbought since Jan 2013, while the Financials SPDR (XLF) is most overbought since April 2010 (due to rise in rates expected to benefit spread on bank loans).
In sharp contrast, all categories of international stocks declined sharply (almost a straight DOWN move) since November 9th. That included the EAFE index, emerging market equities, and open end mutual funds like the $16B Artisan International Fund (ARTIX), which the Curmudgeon has owned for two decades. Gold and precious metals stocks and mutual funds also had steep falls in prices.
Effects of Trumps Fiscal Plan:
The detailed aspects of the Trump Fiscal Plan are still very general, but will include large tax cuts and infrastructure plus defense spending. This will cause a huge increase in "Nominal GDP" when and if the new initiatives are passed by Congress. GDP will also increase due to lower regulations on business and a mountain of excess bank reserves which will be available for business and industrial loans.
My "back of the envelope" estimate is a 7.5% nominal and 4.0% real GDP increase one year after the plan goes into effect (see Curmudgeon Note below on timing). That could create a banquet for investors. However, one must ask if the markets are discounting this potential economic (and profit) growth increase way ahead of what seems reasonable?
According to Goldman Sachs, the tax legislation has a good chance of passing in 2017, but it is not expected to reduce revenues by as much as Trump has proposed. That brings us to the practical limitations of Trump's tax reform plan: not everything on Trumps agenda will occur and very little of it will happen quickly. Goldman expects that the major fiscal policy proposals that are being discussed will take the better part of 2017 to enact, and will probably not have significant economic effects until late 2017 or 2018.
Are US stock market participants dreaming of instant gratification? If we assume most of Trump's programs (still very vague) are enacted by Congress in late 2017, it will take at least one year for them to "kick-in" and produce higher corporate earnings. And not all of Trump's fiscal policy initiatives will be passed by Congress.
Also, the funding for new infrastructure spending must be some form of public-private sector partnership; or else the US budget deficit and national debt will balloon to unimaginable levels. The format, methods and procedure of such a partnership is pure speculation now.
We invoke the old clichι: "don't count your chickens before they hatch."
Implications for the Stock Market:
The passing of Trump's fiscal policy later than June 2017 could be a problem for the stock market based on today's richly valued P/Es. The S&P 500 is trading at a 25.1 trailing P/E; the S&P Industrials at 28.9; DJ Utilities at 25.2. [Source: Barrons]
With interest rates continuing to rise, the equity market may not be able to tolerate a delay till next fall for Trumps fiscal plan to be enacted by Congress. It wont kick in and produce substantive results till months or even a year after that. How far out is the market discounting future growth?
Deficits, US Dollar, Gold, and Interest Rates:
Gold is declining due to the US Dollar and interest rates both rising. However, when you have big tax cuts, with huge spending coming from record debt levels, you will get almost as much inflation as you will growth.
After the momentum gets going inflation overtakes growth. The dollar then losses credibility and declines as interest rates continue to rise. Lets look at the 1976-1980 period under President Jimmy Carter for evidence:
The bottom line is that the US dollar can decline in the face of increasing interest rates, when inflation is rising rapidly along with Gold. Alternatively, the dollar and interest rates can rise together, and so can Gold, as it did from December 1972 ($65.20) to December 1976 ($134.75). (Source: Gold Futures CRB 2014 Encyclopedia).
Conclusions and End Quote:
The Fed is now way behind the yield curve and they should raise rates 50bps, not the 25bps which is fully discounted. According to the CME Fed Watch Tool, theres a 95.4% probability of a 25 bps Fed Funds increase at the FOMC December meeting.
The more important news is the Italian Referendum, and the new Austrian Presidential recount vote (the first one was rigged) in the first week of December.
In the November 20th Financial Times (on line subscription required), Wolfgang Mόnchau wrote:
If Matteo Renzi, Italian prime minister, loses his constitutional referendum on December 4, I would expect a sequence of events that would raise questions of Italys participation in the Eurozone . The referendum matters as it could accelerate the path towards euro exit. If Mr. Renzi loses, he has said he would resign, leading to political chaos. Investors might conclude the game is up. On December 5, Europe could wake up to an immediate threat of disintegration.
My view of the markets is the same for now (see recent Curmudgeon blog posts under Current Links of Interest at fiendbear.com). The trends in force should maintain themselves till the end of this month. However, most of the gains are past, for this leg up, and a pause is in the cards.
This new world wide focus on a fiscal strategy was created from the failed Keynesian monetary policies to stimulate borrowing and spending. As Ludwig von Mises put it: "All attempts to coerce the living will of human beings into the service of something they do not want must fail."
So much for Keynesian economics.
Good luck and till next time...
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
Copyright © 2016 by the Curmudgeon and Marc Sexton. All rights reserved.
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