What's Next

November 10, 2016

We have now had a day to digest the "shocking" result of the election. Essentially every model deployed by Wall Street was wrong on the outcome of the election. Worse, their predicted reaction by the market should Donald Trump win was also completely wrong. I do not know if it was scare mongering by an industry that was afraid of a "non-traditional" president or genuine concern, but when the dust settled stock market participants showed enthusiasm for the Trump Presidency.  Bond market participants showed much greater concern.  So what's going on here?

 

I spent a large portion of yesterday on conference calls, reading research reports, and studying each of our trading systems. Here are my notes:

 

-In theory this should not be a shock. The final polls were within the margin of error for a Trump win. Nearly every state came down to a  60/40 probability or less that Clinton would win yet everyone seemed to assign a 100% probability.

 

-The contentiousness of the campaign along with the likelihood that Mrs. Clinton will win the popular vote will only serve to create social unrest and raise potential problems down the road. We already saw some protests turn violent last night.

 

-Campaign "promises" are easy. Enacting those promises is much more difficult. The Republicans retained control of Congress, but the election was not a clear "mandate" as they lost seats in both the House & Senate. Mid-term elections in 2 years could already be a factor as President Trump attempts to act on his promises.

 

-There is a growing camp that believes Candidate Trump was simply an act and a President Trump will be much more level-headed. His victory speech early Tuesday morning was refreshing to investors. In addition, for the first time in a long time, the President is not an "ideologue", meaning he is not married to the strict party platform. As a businessman he understands the value in finding a compromise and we may see him work more with the other party than past Presidents have.

 

-As far as potential changes the Republicans pushed for throughout the campaign, the tax cuts are likely to be smaller than promised (but there still will be significant tax cuts), the changes to the Affordable Care Act could be smaller and delayed (they need to find a replacement to get anything through Congress), and the moves on trade are likely to be slow and cautious.

 

-The economic impact of the likely changes are most likely the reason for the big moves in the stock and bond markets:

  • Taxes being lowered & Infrastructure spending picking-up should lead to economic growth

  • Immigration crackdown may lead to more jobs

  • Repatriation of cash held overseas should also lead to increased US investment & growth

  • Moves to change trade agreements should lead to a weaker dollar, which is good for growth in multi-national firms.

-While those things are all great for the stock market (in theory--the devil is in the details), ALL are INFLATIONARY. Inflation erodes the value of bonds & makes it likely the Fed will be forced to raise rates. The yield on 10-year Treasuries jumped from a low of 1.72% Tuesday evening to 2.07% by the close on Wednesday.

 

-Much was made about Candidate Trump's criticism of the Fed and their policies, but President Trump's economic plans will require a DOVISH & cautious Federal Reserve, so he may be inclined to want to keep Janet Yellen when her term expires in 2018.

 

-Regulation is likely to be significantly reduce, but the pace will be slower due to the legislative process. Congress may especially be slow on financial regulation reform given the populist outrage at Wall Street.

 

-The biggest & quickest change may be the reversal of executive orders enacted by President Obama. Some changes may create uncertainty & cause rifts with certain segments of Congress.

 

-In general, the consensus seems to be to expect more volatility & potentially large moves to the downside as the risk of "policy shock" are high.  Patience & discipline will be important.

 

[Goldman Sachs provided a detailed Q&A on specific policies, actions, and expected timelines. Click here to read it.]

Friday, November 11

The stock market continues to cheer the surprising Donald Trump victory. The "excellent" meeting (their words) between President Obama & President-elect Trump moved the market significantly higher while interest rates continues to shoot higher. Emerging market stocks and bonds were hit hard once again.

 

Despite the enthusiasm, our trading systems are getting nervous. We sold our remaining high yield bonds inside our trend following system yesterday. On the stock side we are back to only US investments and our Price Divergence System went to a "neutral" reading due to the fact the S&P hit the upper trading band while the "breadth" of the market has not confirmed this (meaning the futures market is driving prices higher not actual investments).

 

The nervousness is justified in my opinion. While certain leaders in the two parties are trying to build a bridge between the massive gap between the two sides, the extreme far left and extreme far right are only serving to ignite more dissension. The violent protests and calls for lawsuits, the Electoral College to not vote the way they are supposed to, and continued interference of any reconciliation could spread. The sharp jump in interest rates is also a concern.

 

As I said yesterday, expect volatility, which often means significant downside moves.

 

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