by Brooke Thackray, AlphaMountain Investments
Its an upside down world!
President-Elect Trump was supposed to bring weakness to the stock market. Very few called for a strong rally the day after the election. My own prognostications called for initial weakness and then stronger markets as investors figured out that his policies would bring stimulus to the economy and stock market. I hardly expected the whole cycle take place in less than a day.
Even with a Republican sweep, the strength of the rally has surprised many, including me. There are so many uncertainties about the future: which policies will be implemented and which ones will be watered down. Although tax cuts and deregulation can be implemented with short-term influence, infrastructure will more than likely take a while to go from planning, vetting to shovels in the ground.
Despite the strength of the rally, there is probably more to go. The S&P 500 has broken above 2200 and has strong momentum... it can keep going. In a momentum market, it usually takes a catalyst for it to change direction. Right now it is Trump promises that are driving the stock market. His promises cannot be “reality fact checked” at least until he is inaugurated on January 20th. Generally, U.S. Presidents are given a 100 day honeymoon period before they are strongly judged. Trump will probably have policies lined up to be enacted fairly fast, which should afford him the honeymoon grace period. Investors are piling into the stock market to try and take advantage of this period. The hot sectors of the stock market have been the cyclicals, and sectors of the market that benefit from lower corporate tax rates. The major losing sectors of the stock market have been the bond proxies– the sectors of the stock market that attract investors because of their high yields or dividends, such as consumer staples, REITs and utilities. As the Trump policies have forced up the yields on government bonds, both bonds and bond proxies have been hit hard.
The bad news for bonds and bond proxies are that from a seasonal basis, they do not perform well from January into April. Sure, bond proxies will probably perform well intermittently, nevertheless, it is still expected that they will underperform over the next few months. If it really is the “end of the bond bull,” bonds and bond proxies could suffer for an extended period of time. Over the last few years, investors piled into these “safe” sectors as they lived on the premise that “there is no alternative” (TINA). Investors did not necessarily want to be in the stock market and they did not want to be in ultra low paying bonds either so they compromised, buying stocks with a high dividends or payouts. Given how much money went into the “TINA” stocks, it is going to take a while for it to come out. If bonds and bond proxies keep falling in value investors are not going to start piling into bonds, at least not initially.
Low interest rates are low interest rates! The average investor does not see much of a difference between 0% and 1%. Both numbers are close to zero or zero. Investors will probably not rush back into bonds until they feel that bond prices have stabilized. Currently, the medium-term expectation is for bond yields to rise and subsequently for bonds to fall in price. The world of falling bond and stock prices has not existed for a long, long time. Bond yields are still low compared to historical standards and investors probably still have time to enjoy the favorable conditions for equity markets.
Enjoy the rally while it lasts.
Short-term market risk:
The stock market has already baked (priced) in a 25 bps rate rise by the U.S. Federal Reserve on Wednesday December 14th with an expected probability of 95% (http://www.cmegroup.com/trading/interest-rates/ countdown-to-fomc.html). What is important is the Federal Reserve’s speech afterwards. The Federal Reserve has to be concerned about the rising value of the USD and the recent spike in bond yields. At this point, a dovish statement is probably in order, decreasing the expectations of future rate increases. If this happens, then the result is a possible reverse fl ow on a temporary basis from the cyclicals back into the defensive sectors of the market. This would have the effect of taking the air out of some of the sectors of the stock market that have outperformed recently, such as the financial sector.
Read/Download the complete 11 page update below:
Thackray Newsletter 2016 12 December by dpbasic on Scribd
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