Brexit vs. the Trump election

Trump and Brexit

Right before election day, Donald Trump predicted his victory by saying that it would be just like Brexit, only more so.

That turned out to be correct, in the sense that in both cases the pre-election polls were incorrect and that the result turned on the votes of older, disaffected, less-educated citizens who came out in large numbers in response to a call to roll back the clock to days of former glory.

post-Brexit

The immediate UK stock market response to the Brexit vote was to drop through the floor, with the multinational-laden large-cap FTSE 100 index faring far better than generally domestic-focused small caps.  The FTSE has rallied since, with the index now sitting about 6% higher than its level when the election results were announced.

That does not mean, however, that the Brexit vote turned out to be a plus for UK stock market participants.  By far the largest amount of damage to their wealth was done in the 15% drop vs. the dollar that the UK currency has experienced since June.

post-Election Day

Despite the voting similarity between UK and US, the currency and stock market outcomes have been very different.  In the week+ since the US presidential election,

–the dollar has risen by about 3% against both the euro and the yen since the election result became known

–the S&P 500 is up by a bit less than 2%, with small caps significantly better than that.  Potential beneficiaries of Trump policies–oil and gas, construction, banks, pharma, prisons–have all done much better than that.

Why the difference?

Brexit

Brexit was a simple, binding in-or-out vote on an economic issue (recent legal action seems to show it’s not so clear-cut as that, however).  Leaving, which is the action voters selected, has immediate, easily predictable, severely negative economic consequences.  Hence, the continuing slide in the currency.

Trump

The Trump vote, on the other hand,  was for a charismatic reality show star with unacceptable social views, very limited economic or policy knowledge/interests and a questionable record of business (other than show business) success.   Not good.

The US vote was for a person, however flawed, not necessarily for policies.  In addition, the  legislative logjam in Washington has potentially been broken, since Republicans will control both houses and the Oval Office.

The general economic tone Trump seems to be setting is for fiscal stimulation through tax reform and deficit spending on infrastructure.  Both would relieve the extraordinary burden that has been placed on the Fed (the only adult in the Washington room).  This will likely mean larger, and faster, interest rate hikes.  Hence the rise in the currency.

knock-on effects

Democrats seem to realize the folly of having a cultural program without an economic one; a substantial restructuring of that party may now be under way.  Bipartisan cooperation in Congress seems to once again be in the air, if for no other reason than to act as a check on Mr. Trump’s more economically questionable impulses.   Trump’s “basket of deplorables” social views may make Americans more vividly aware of the issues at stake, and what progress needs to be made   …and serve as a call to arms for activism, as well.

Another thought:  yesterday’s news showed the Trump brand name being removed from several apartment buildings on the West Side of Manhattan.  Based on feedback from tenants, the owner, who licenses the Trump name, concluded that retaining the buildings’ branding would result in lower rents/higher vacancies.  Given that Trump does not intend to have his business interests run by an independent third party while he is in office, the public would seem to me to have an unusually large ability to influence his presidential actions by its attitude toward Trump-branded products.  I’m not sure whether this is good or bad   …but “good” would be my guess.

All in all, the UK seems to be lost in dreams of the days when it ruled the oceans.  The US is less clear.  We may be in the early days of a renaissance.

 

looking at day one of the Trump-era stock market

initial reaction

Very early yesterday morning, S&P 500 index futures had fallen by 5% as the stock market gave its first verdict on the election of Donald Trump as the next president of the US.

That Mr. Trump’s surprise win should be met with initial selling isn’t itself so shocking.  Trump himself had offered a Brexit metaphor to describe his potential victory. (In trading the day after the Brexit results were announced both the British stock market and the pound collapsed.)  And an op-ed in yesterday’s UK Guardian, for example, describes Trump as having ” a folly so bewildering, an incompetence so profound that no insult could plumb its depths” as well as being “the least-qualified candidate of all time.”

What’s noteworthy is that, unlike the Brexit case, the selling dried up in short order.

regular trading

During regular trading yesterday, the S&P initially declined by almost a percent …before reversing course and ending the day up by 1%+.  Government bonds declined sharply.  The dollar was basically unchanged.  This happened even though earlier in the week Wall Street rallied on the idea that Hillary would win.

sector breakout

The sector pattern of trading was also revealing:

–the largest gainers, according to Google Finance, were Healthcare (+3.3%), Materials (+2.6%), Financials (+1.6%), Industrials (+1.6%) and Energy (+1.0%)

–relative losers were Utilities (-2.4%) and Staples (-1.0%).  Real estate–part of the Google Finance financials–was down by about 2%

–looking more closely at the Energy sector, big multinational integrateds rose more or less in line with the market, while smaller exploration firms and oilfield services companies (the last being the rocket fuel of the Energy sector) made more substantial upward progress.

economic underpinnings

Led by Wall Street, global markets shifted very quickly away from concern about Trump’s checkered business career and his white supremacist views.  They began instead to explore the implications of the likelihood that legislative gridlock is unlikely to continue in Washington now that one party controls both the Oval Office and both houses of Congress.

On the most general level, this likely means that Washington will approve a large infrastructure spending plan early next year.  This will have two consequences.  It will create demand for labor at a time when the country is already at full employment.  This means that wage growth, which already looks to be expanding at an increasing rate, will continue to accelerate.  At the same time, the presence of fiscal stimulus will remove some of the need for the Fed to keep interest rates at intensive-care lows.  Both aspects imply that short-term interest rates may begin to rise at a more rapid than anticipated clip.

The idea of spending on roads etc. means higher demand for basic materials and for construction machinery.  Rising rates are bad news for government bonds, and for bond-like securities such as REITs.  So, too, is the possibillity that wage-driven inflation may emerge as an issue as soon as 2017.  On the other hand, rising rates tend to be good for large banks, which were among the best performers yesterday.

In addition,

–income tax reform that lowers corporate rates (good for full-tax payers like healthcare companies) seems likely next year.  Republicans seem particularly eager to repeal/replace Obamacare, which would arguably be good for healthcare providers

–the oil and gas industry is one that has been traditionally in the Republican camp.  Trump has promised to stimulate oilfield activity.

 

Let’s see what today brings.

 

 

 

 

 

 

 

 

 

 

 

 

What Janet Yellen did/didn’t say yesterday

Yesterday the Fed announced that its Open Market Committee had decided to postpone, yet again, beginning to raise interest rates from their current intensive-care lows.

In her press conference following the decision, Jane Yellen cited several reasons :  the recent rise in the dollar, a plateauing of consumer spending in the US and worries that the authorities in China might be bungling their way through the necessary change in that economy from export-led growth to one that’s led by domestic demand.  (Ms. Yellen pointed to recent ructions in the Shanghai and Shenzhen stock markets as evidence for the last.  Personally, I don’t think this is correct.  I see those markets’ rise and fall as what almost inevitably happens when a country allows margin borrowing for the first time.)

Whatever the motivations, the fact remains that the Fed sees the current situation in the US as too risky to warrant even a miniscule rise in short-term interest rates.  …and this is despite six years of economic growth and increasing employment since the economy bottomed in 2009.

What isn’t being said here?

Two things, I think:

–after Japan’s financial collapse in 1989-90, that country twice tightened economic policy prematurely–once by raising interest rates, a second by raising taxes.  The result of these miscues was a quarter-century of deflation and economic stagnation.  The Japan example suggests that in a slow growth environment with no inflation the risks of policy tightening are much larger than most people in the US suspect.

–governments have two main tools to influence GDP growth:  monetary (changes in the price or availability of credit) and fiscal policy (changes in spending and/or taxes).  Fiscal acts slowly but lays the general foundation for growth and indicates a broad direction for expansion.  Monetary acts relatively quickly and is most useful for mid-course corrections, slowing or accelerating the pace.  A dysfunctional Washington has meant that, other than the bitterly contested bank bailout plan in 2009, fiscal policy has done virtually nothing useful to stimulate growth over the past half-decade (arguably, it’s a mild deterrent).  Nor is it likely that Congress, now winding up to shut the government down, will change its stripes.  This implies that the Fed has no backstop if it makes a policy mistake.

 

Nothing about either is particularly new news.  But the Fed decision calls attention the major structural difficulties the US economy faces.  This is not a recipe for having stocks go up.

economic/stock market cycle: 4 years or 8?

phone call from sunny CA

My younger son called the other day to talk about the stock market.  He reminded me that I had often spoken as he was growing up about the four-year stock market cycle seen in the US.  It’s sometimes called the presidential election cycle, from the belief that the sitting president injects PEDs into the economy in the fourth year of his term to aid his reelection bid.  It’s also called the inventory cycle.

the traditional four-year market cycle

The idea behind this is that in the post-WW II US the typical period of business cycle expansion, during which government policy is to stimulate growth, has lasted about 2 1/2 years.  As we reach full employment and upward wage pressure commences, the policy stance reverses.  Interest rates rise; the economy slows–and sometimes contracts.  This latter period lasts around 1 1/2 years.

The stock market exhibits the same behavior–2 1/2 years of up followed by 1 1/2 years of down–but leads the economy by about six months.

a rule of thumb

The four-year cyclical pattern generates a practical rule for investors:

–when the stock market has been rising for two years, start thinking about becoming more defensive, and

–when the market has been falling for a year, think about becoming more aggressive.

the eight-year cycle

The point of my son’s phone call is that this traditional pattern can’t be found in charts of market action for almost two decades.  It has been replaced instead by an eight year cycle–5 1/2 years of up, followed by 2 1/2 years of down.  More importantly, two months ago, we entered the fifth year of rising market.

His conclusion from looking at the charts:  early in 2014 the S&P will hit the skids.

 

This is a very interesting thought, even if it turns out not to be correct.  It makes you stop looking the leaves on individual trees and start to think about the shape of the forest as a whole.

differences?

Is the stock market situation today substantially different from the tail end of the internet bubble of 1999, or of the emergence of the mortgage fiasco/financial crisis of 2008?  If so, what are those differences?   …can we conclude that today’s story will end up any better than those two did?

I think there are key differences.

More about this on Monday.

 

 

the four-year “Presidential election” cycle in the US

As a stock market rookie in the late 1970s, I started to absorb what was hen conventional wisdom.  Looking over charts of the movements of the S&P 500 over prior decades, investors had reached the conclusion that the US stock market traced out an irregular four-year pattern.  For roughly 2 1/2 years, stocks generally went up; for the following 1 1/2 or so, the went down.

There was some macroeconomic sense behind this movement.  The mandate of the central bank, the Fed, has been, and continues to be, to maintain maximum sustainable, non-inflationary growth in the domestic economy.  If the economy started to grow too fast–meaning wage inflation was starting to occur–the Fed would raise short-term interest rates to cool the economy down.  In those pre- supply chain software days, the policy change might take six months to have any noticeable effect on corporate or consumer activity.  The economy might take another year or so to slow to the point that Fed felt justified in lowering rates to keep the economy from deteriorating further.

Wall Street linked this economic rhythm with a political one–the desire of the incumbent president to create favorable economic conditions during election year–so that either he could be reelected to a second term, or at least his party’s candidate would have a tactical electoral advantage.  How would the president do so?  He would pressure the Fed to take an inappropriately stimulative stance about a year before the election so that the domestic economy would be powering along just as voters would be going to the polls.  After the election, the inappropriate stimulus was to be removed through contractionary action by the Fed.

Stock market lore revealed that every modern president did this, with the sole exception of Gerald Ford, who paid a penalty for his economic honesty by not being elected.  …which, pundits argued, made every subsequent president that much more eager to try monetary policy manipulation.

Quaint, to our 21st century eyes, but true.

Nevertheless, that’s the genesis of the idea that the first year of the new presidential term is a testing one for stocks and bonds.  Interest rates are presumed to be rising as cleanup from the late-term party of the previous election cycle begins.

Even though we’re in a globalized world today, where the US is not the only industrialized power and where economic developments in Asia, Europe or Latin American can have important consequences for the domestic economy, many Wall Streeters haven’t advanced much beyond the clichés of over a half-century ago.

The present situation in the US differs markedly from the Presidential cycle in two main respects:

–the Fed has publicly announced that it won’t be changing its current ultra-stimulative stance for at least the next 2 1/2  years

–the major impediment to growth is fiscal, the inability of Washington to reach a compromise on how to begin to pay back the large amount of debt the federal government took on during the Great Recession.

If press accounts are to be believed, a large part of the Washington gridlock comes from President Obama’s unwillingness to enter into pragmatic and meaningful discussions with Republican legislators.  He’s promised to change his ways if reelected.   Let’s hope he carries through.