The fear of Trump has turned to hope. The Dow rose to a new all-time high overnight as the market digested the results of a Trump presidency. More spending on infrastructure, less regulation and the prospect of lower corporate taxes means ‘buy, buy, buy’!
Let’s have a look at a chart of the Dow. In the blink of an eye, it’s gone from looking vulnerable…to a big decline…to being bullish again.
I showed you the chart below last week. At the time, it had broken support at 18,000 points. The panic and fear over Trump getting elected looked like sending prices decisively below this level.
Then came the Trump reversal. As you can see, the break below support at 18,000 points was a ‘head fake’. It quickly reversed, and now prices have moved strongly out of the consolidation pattern marked on the chart.
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This is bullish. Whatever you think of the market, or Trump, or whatever, you have to respect the market’s verdict. The price action over the past few days suggests the chances of a steep fall in prices are now off the cards.
But let’s keep things in perspective, too. The short-term reaction seems a little overdone. While Trump’s proposed policies will be good for the market, it will take some time to flow through to earnings.
And let’s not forget much of this bullishness revolves around the prospect of a big kick in fiscal spending.
So now that monetary policy has proven ineffectual in promoting growth, all of a sudden everyone expects fiscal policy to do the job?
What makes people think that government-directed spending initiatives will be any better at allocating economic resources than low interest rates were?
Still, as the saying goes, hope springs eternal. The fear of missing out here is palpable. This rally reflects a big shift in positioning, as bearish bets pre-Trump move to the bullish side.
When these shifts occur, it happens very quickly. When the dust settles, I expect some profit-taking and a pullback.
But make no mistake, the outlook is positive, and any correction from here should be bought.
As far as Australia is concerned, the big winners from Trump are resources. The iron ore price has exploded. Whether that’s because of the steel required to build Trump’s insane ‘Great Wall of Mexico’, or something else, I don’t know.
But prices are now around US$74 per tonne. That’s up around 100% from the lows at the start of the year. No wonder Fortescue [ASX:FMG], Rio Tinto [ASX:RIO] BHP Billiton [ASX:BHP] and steel recycler Sims Metal Management [ASX:SGM] have just broken out to multi-year highs.
But there are losers, too. The big rise in bond yields (that started before Trump got in) has an effect on a large part of the Aussie market. I’ve mentioned this before, but ‘yield plays’ like real estate investment trusts and infrastructure stocks aren’t enjoying this market.
Road toll operator Transurban [ASX:TCL] is a good example. Have a look at the chart below. Since peaking in August (at the time of the last interest rate cut), the stock is down nearly 25%.
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You’d think something was wrong with the business, or that economic growth was slowing and taking cars off toll roads.
In fact, it’s simply because investors bought Transurban for the yield. As interest rates and government bond yields declined, it made Transurban’s cash flows more desirable, and investors bid up the prices to get their hands on it.
The rising share price had nothing to do with the performance of the business. It rose purely because bonds yields were falling. (When it comes to bonds, yields and prices move inversely to each other).
This dynamic is creating a bifurcated market in Australia. Even after yesterday’s massive rally in the Aussie market, many real estate trusts and infrastructure stocks fell to new lows.
So keep this in mind when buying stocks for the ‘Trump rally’.
And don’t forget the Federal Reserve is still on track to raise rates in December. If fiscal spending in the US expands as much as people think it will, and moves the current deflationary mindset to an inflationary one, the Fed will continue to raise rates in 2017 and beyond.
That should act as a constraining force on this emerging bullish mentality.
Speaking of US fiscal policy, who knows how the market will react when the spending plans turn into something more concrete?
In the year to 30 September, the US government ran a budget deficit of nearly US$600 billion, or around 3.2% of GDP. Forecasts for 2017 are about the same, but that could jump sharply should Trump’s spending plans become a reality.
Say the budget deficit hits $800 billion in the years ahead. The US would need foreign investors to fund this, given they don’t have the savings at home to plug the gap themselves.
China, a traditional funder of the US government, is currently selling down its treasury holdings to protect its currency from capital outflows. Saudi Arabia, another traditional funder of the US deficit, is reeling from lower oil prices, and is now issuing debt itself.
That leaves Japan. But Trump has said he wants Japan to sort out its own defence spending. This reverses a long-standing post-war deal, whereby the US provides military protection, and Japan uses its savings to fund the US government.
The question of who will fund US government deficits, and at what price, will become increasingly important for the market to work out in the years ahead.
This tells me US government bond yields will continue to rise in order to attract the capital necessary to fund its deficits. By how much is the question.
But one thing seems increasingly certain in the wake of a Trump victory…the longest bond bull market in history looks like it is over.
For Markets and Money