The bull market is set to turn 9 in 2017. Vanquished by the bull: Eurozone crisis, deflation, China bubbles, taper tantrums, BREXIT, and now Trump. The bullishness of the tape continues to shock, with the Trump rally, after the fact, looking strikingly similar to the BREXIT rally; the market provides every indication that one outcome is good, the other outcome bad, it gets the bad outcome, and not only fails to sell off, but rallies on it! Enough to generate plenty of Aflac goose head shakes. Why did the market change its mind on Trump?
Firstly, a Trump victory was never really “bad” it was just unfathomable, and Trump’s campaign rhetoric was at times, preposterously market unfriendly (forcing production in the US, undoing global trade). Upon further consideration, the market is now ignoring the majority of the rhetoric, while feasting at the prospect of Trump’s business friendly initiatives, which mainly revolve around increased stimulus to the US economy, and lower taxes, in almost all forms, relative to what the country would have faced with Hillary. The largest item, US corporate taxes being cut in half, or even more, down to 15%, is particularly bullish for US small caps (Russell 2000) and led to a revaluation reset of these firms to price in much lower taxes, and higher earnings. Less focused on, but also important drivers of asset markets are the prospects for lower income tax rates, capital gains taxes, dividend taxes, and estate taxes, all relative to where they would be with Hillary. Trump is also much kinder in terms of regulatory stance towards banks, health care, biotech, energy, and utilities. Mentioning “serious” people for the administration, such as Mitt Romney for Secretary of State, also helps set a positive tone for markets over the next four years, and reduces some fear of Trump-gone-wild.
Now the downside to Trump is the attack on globalism, and the gorilla in the room, dramatically higher interest rates. It’s surprising that the market, thus far, is giving the positive forward view the complete benefit of the doubt. Typically an expansionary fiscal policy, and a contractionary monetary policy, is a very bad outcome for markets. The higher interest rates pressure valuations, and lending to businesses gets crowded out. Thus far, with rates initially low, and inflation initially low, room exists to ignore this unpleasant potential. Rates will be back in focus with a second Fed rate hike in December. The market’s valuation is stretched heading into what should be balanced positive/negative new flow and catalysts, so don’t expect a one-way tape to persist without pauses, or even hiccups.
With the VIX crushed back down to 12, CJF continues to focus on letting stock winners run, scooping up out of favor low-valuation names, collecting sound dividends, and protecting against downside with at the money SPY puts.