Last Tuesday evening, while dining with family and business associates, I had one eye on the elections and the other on the Dow Jones Futures Index, a proxy for the Dow Jones Industrials (DJIA) in the non-trading hours. At one point, the futures were down 900 points, and I was drooling over the prospect of one of those quite rare buying opportunities produced by extreme market fear, irrationality and emotional distress.
Last June, during Brexit, we had a couple of big down days before the market returned to some form of rationality. But, by 3 a.m. EST (midnight on the West Coast) when Trump claimed victory and Hillary conceded, the futures had come back to being down only 300 points. Just before the market opened, the futures were almost even, and by day’s end, the DJIA was up 256 points and added 271 on Thursday.
Extreme market volatility
The market moved more than 1,420 points between election night despair and the close of business on Thursday. That has to be among the biggest moves in recent market history. After the initial bout of fear and uncertainty had passed, the market next moved to irrationally reward market sectors it perceived would benefit from a Trump presidency and pummeled sectors it perceived would suffer from one — all based on what seems to me to be extremely unlikely assumptions. Just look at the difference through Thursday in the index movements. The NASDAQ, weighted toward technology (a sector Trump targeted in his campaign) was up 0.3 percent from Tuesday’s close, while the S&P (up 1.3 percent) and the DJIA (up 2.6 percent), more heavily weighted toward sectors Trump’s policies would favor (Financials and Pharma), fared better. So, let’s look at the policy issues, especially those likely to garner his party’s (well, sort of) congressional support and view market reactions in light of such:
- Taxes: The U.S. corporate tax rate (35 percent) is among the highest in the developed world. The policy to tax, at that 35 percent rate, repatriated foreign earnings on which taxes have already been paid to the country in which those were earned has kept corporate funds offshore and is likely a large factor in the lack of U.S. corporate investment at home. In addition, that same tax policy promotes the corporate desire to move headquarters offshore to lower taxing countries (called corporate inversions). If Trump gets a reduced tax rate plan through Congress, which is highly likely, the top rate would fall significantly (Trump advocates 15 percent), and that is a real positive for corporate America and the equity market. So, some market run-up makes sense.
- Energy Independence: Trump wants to reverse the tide of regulations from the Obama EPA on the oil and gas industry. That would allow for more drilling and exploration and is a large positive for the oil, gas and traditional energy industries, including coal. No wonder Pennsylvania and much of the rust belt turned red this election.
- Banking: Trump has promised to get rid of much of the Dodd-Frank regulatory environment, which has restricted big bank activity and choked profits — so bank stocks have risen since election night.
- Health Care: Trump has promised to repeal and replace Obamacare. Pharma and most areas of health care are enjoying higher equity prices, but the one area that has been pummeled is the hospital sector. That is because the market has made the assumption, absent Obamacare, uninsured hospital patients will increase and reduce hospital profitability — this appears to be an extreme assumption — but it is how markets operate in the absence of more certainty.
Overreaction in Bondland
The bond market, too, has repositioned itself using extremely unlikely assumptions. The 10-year yield closed on Thursday, Nov. 10 near 2.14 percent, up from under 1.80 percent at the end of October. The backup in yields is due to the view Trump’s fiscal spending (including the tax cuts) will lead to significantly larger fiscal deficits, and, with a tighter labor market, a resurgence of inflation. This doesn’t appear to me to be realistic. Normally, a Republican Congress wants to lower deficits (not raise them) unless there is a recession or some other crisis. The U-6 rate of unemployment (includes discouraged workers) is 9.5 percent, not an indicator of labor tightness; and, capacity utilization, at 75 percent (recessionary levels) does not imply a hot economy. In addition, the CPI would be flat to negative if rents were removed. While the Congress may give Trump some initial deficit spending, it appears unrealistic to me to assume significantly higher deficits than they gave Obama.
As I have written previously, long-term interest rates only rise permanently when the economy is growing. Even if Trump is successful in all of his endeavors, significant economic changes won’t occur in his first 100, or maybe not even in his first 1,000 days. The assumption, that we are going to immediately get large fiscal deficits and inflation, appears unrealistic. Thus, the rapid rise in long-term rates looks to be temporary — perhaps, at some point, a buying opportunity.
It appears today’s markets have adjusted to extreme views of the policies of the upcoming Trump administration. As a result, there will continue to be significant sector price movements as actual policies become known and the market readjusts to them. For those savvy enough to figure out what those policies actually will be, market opportunities could be abundant.
Robert Barone, Ph.D. is a Georgetown-educated economist and a financial adviser at Fieldstone Financial (www.FieldstoneFinancial.com).
He is nationally known for his writings, and Robert’s storied career includes his having served as a professor of finance, a community bank CEO and a director and chairman of the Federal Home Loan Bank of San Francisco. Robert is currently a director of CSAA Insurance Company (an AAA company) where he chairs the Finance and Investment Committee. Robert leads the investment governance program at Fieldstone Financial and is the head of Fieldstone Research (www.FieldstoneResearch.com).
Statistics and other information have been compiled from various sources. The facts and information are believed to be accurate and credible, but there is no guarantee as to the complete accuracy of this information.