Investing In A Six-Sigma Market

| About: iShares Nasdaq (IBB)


Is this rally abnormal?

Is it due to Trump elected or is it an independent event.

What do investors need to watch out for?

(Disclosure: I did not like either candidate, however this is about what might happen to the markets over the next three months or so.)

There has been much written on SA and other sites and publications about the 'Trump Rally'. This is not accurate, although for identification purposes historically it will be recorded as such. What it is, is a typical post-election rally, that had acceleration based on two important facts: first, the 700 point drop in the Dow on election night in the overseas market - a six-sigma event that has not been seen since the Great Depression; second, a huge number of investment advisors who carried extremely high levels of cash ahead of the election (typical, but much higher than usual due to the contentious nature of this election).

Much has been made of the 2 million vote lead of Clinton, but it is only the electoral vote that counts. As prescribed under the 12th Amendment, which is very vague, the Electoral College meets on the second Monday following the first Tuesday in December (go figure). Ballots are submitted to the governor of each state for certification and then submitted to the Office of the Federal Registry, which every four years becomes the electoral college. That date this time is December 19th...these are in chronological order, not by probability.

While some states are 'all or none', most apportion electors, but the electors are not bound to vote for anyone. An elector voting against, the constituents is a 'faithless' elector and nothing more. There have been few of these in history but the most notable was when the entire Virginia delegation (23 votes) voted against their constituents. While it would be a stretch, there have been so many anomalies in this election that it is not inconceivable that 37 would vote 'faithless'. That would leave it at 269 for Trump, where the other votes go is anyone's guess. So this too would be a six sigma event. Let me make this clear: it is not at all likely but not impossible. Imagine the chaos should that happen.

How long would it continue? Until the House of Representatives votes to select a president which would be a Republican of course, but not likely Donald Trump. I am not hoping for this to happen because pent up anger could result in massive rioting. Still it is an event the stock market has to concern itself with.

The main reason for this is many (most?) managers were holding large, even record amounts of cash and the aforementioned 700 point drop in the Dow, forced them to cover. Note that in December the wrong bet could destroy one's performance for the entire year, and for some has done so already.

Although the reasons for it are different, from around November to year end, in any year, there are managers who want to own the winners of that year - for window dressing purposes. This perpetuates the rally in those stocks, or sectors (this year it is financials where nearly everyone had to rush to get to market weighting), creating an overshoot to long the sector.

So the next key date is of course 12/31. Where managers end the year when there has been a rally like this, in an otherwise lackluster year, is anyone's guess, but it is more likely that there will be more sellers in January, as they struggle to achieve flexibility. We saw this last January. This year January 20th is the inauguration. What will Trump say in his speech? Would you be willing to bet what the tone is going to be?

It's not over yet because sometime in the last half of January or first part of February will be his first State of the Union Address. Again, good luck on predicting how that will go.

The point is to not become too complacent especially if you are long. Note also that with a high probability of a tax cut in 2017, gains should be postponed and losses taken now to get the most bang for the buck. That could perpetuate selling in the new year.

But will tax cuts turn the economy around and accelerate GDP growth? According to Paul Kasriel, retired economist for Northern Trust Company, there is always the fatal flaw of Keynesian economics.

It isn't difficult to see which sectors will thrive under a Trump administration...IF Congress goes along, and although both houses have Republican majorities, it is by no means certain how much support he will have.

Beneficiaries: Finance (but has most of the benefit been realized by the stock market, especially if the Fed only raises rates slowly?); Defense, for obvious reasons; Pharma, less regulation but absorbing a higher proportion of household income; Construction (perhaps).

Losers: Real Estate (except high-end); Mainstream Media (Internet may be the beneficiary); Retail (consumption taxes ?)

Those are just some thoughts, it will take months, perhaps more than a year for it to play out, especially tax reform, which is easier to propose than to beat the lobby of accountants, tax lawyers, and tax preparers, who won't give up easily. That said, will the changes be positive for most Americans, or only a few as the two Bush tax cuts were. We know where Trump's interests lie...will they align?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.