In The Wake Of Trump

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Douglas Adams


  • Mr. Trump's surprise electoral college victory is a multi-sigma event that fell into the well-known unknown area of Value-at-Risk modeling. Markets responded in-kind with a 5% drop in S&P futures.
  • By next morning, a second multi-sigma event had transpired with the S&P futures flipping a 5% drop by mid morning Wednesday on signals as inflation expectations began to rise.
  • Rolling back of regulatory oversight in healthcare and financials coupled with tax cuts at all levels signaled increases in spending and heightened economic growth is in the offing.

Well before his early Wednesday morning victory, Donald Trump was viewed as the penultimate "tail" candidate-first in the primary cycle and again as the official nominee of the Republican Party. His candidacy never faltered from the now prescient classification.

Statistics tells us that in a normal distribution, 68.2% of all observations will fall within one standard deviation of the mean. Beyond this threshold, further increments from the mean are measured in sigmas with a one sigma move incorporating 95.6% of observable data while two sigmas from the mean includes 99.7% and so on.

Multi-sigma events are well-known unknowns in value-at-risk modeling as the predictability of such events become less and less determinable with the usual market reaction coming in the form of indiscriminate selling as investors lower their market exposure. Donald Trump's breach of the 270-vote Electoral College threshold in the beginning hours of Wednesday morning was no exception to this rule. S&P futures netted a 5% loss as assets across the developed world plunged on the news. The euro, yen and the pound all surged against the dollar which fell almost a full percentage point in the last four hours of Tuesday's election night. The yield on the 10-year Treasury note spiked as the states of Florida and then Pennsylvania went red as the yield fell a whopping 8.40% since early evening. German Bunds, British Gilts and Japanese government notes followed suit as the US electoral vote was becoming known worldwide. The Mexican peso, a proxy for the ebb and flow of Mr. Trump's presidential hopes throughout the campaign, was brutalized as the evening wore on falling to record territory against the dollar. The peso was not alone-Turkey with its outsized current budget deficit financed largely in dollars saw its currency fall into record territory against the greenback as well. The renminbi dropped to a level that saw all of its gains against the dollar since 2010 finally disappear. Overnight odds on a December increase in the federal funds rate dropped by half. A Brexit replay was the obvious point of reference.

And then a second multi-sigma event came to the fore-this early flight to the traditional safe harbor vehicles of the developed world simply flipped. The S&P 500 Index futures erased its 5% drop in the early morning hours of Wednesday with the confirmation of Trump's surprise victory in one of the most derisive US electoral contests on record. There have been other such reversals of futures fortunes, most notably in the final months of the 2008 and earlier in October of 1987, according to Bloomberg data. The pace of reversal in investor sentiment however was curiously quick and pronounced. The yield on the 10-year Treasury added 43 basis points by Thursday's market close while the dollar strengthened against the euro, the yen, and the pound. The price of gold dropped just over 8% by week's end. Breaking the pattern, the peso remains close to record lows while emerging markets continue to be pressured. What changed investors' sentiment to produce such a change in heart?

The cause of the initial plunge in S&P futures is well-known:

  • Mr. Trump is likely the most avowed protectionist to be elected to the presidency since Herbert Hoover. His campaign rhetoric envisioning steep tariff regimes directed toward China and Mexico echos the Smoot-Hawley tariffs that followed the 1929 market crash that made the depression of the Hoover years all the more onerous;
  • His relentless attacks during the campaign on major trade pacts including North Atlantic Free Trade Agreement (NAFTA), of his threat to pull the US out of the World Trade Organization (WTO), his adamant opposition of the Trans-Pacific Trade (TPT) agreement and the Trans-Atlantic Trade & Investment Partnership (TTIP) would wreak havoc on US exports, corporate revenue and overall GDP growth;
  • That the confirmation of Trump's victory came on the 27th anniversary of the fall of the Berlin Wall whose aftermath was noted by optimism and an expansion of globalism now seems out of place with his "America first" credo. This is a slogan that harps back to another political outsider, Ronald Reagan.

The latter point is perhaps not lost on investors. After all, Ronald Reagan was indeed a political outsider whose eight years as a hands-off governor of California also had detractors decrying his lack of experience. Reagan also cut taxes and spent lavishly on defense while tirelessly upholding the mantel of limited government as the ultimate freedom. Many investors trace the beginnings of the current equity bull market to Reagan's tax cuts and defense buildup. The deficit soared during his tenure.

Mr. Trump also promises severe cuts of both personal and corporate taxes without a lot of detail on enhanced revenue gathering offsets. He also promises to spend $1 trillion on infrastructure projects across the American divide. While the derisiveness of the campaign was unprecedented in recent memory coupled with the equally unprecedented dearth of policy initiatives coming from the Trump campaign, investors have curiously hung much hope on frequent off-the-cuff "policy" statements made throughout the campaign. Mr. Trump's promise to unravel the Obama legacy programs such as the Affordable Care Act (ACA) and the Dodd-Frank Act, both being passed under a Democratic controlled Congress, portends a rollback on governmental regulation is likely in the legislative offing with both houses of Congress and the Executive branch now under Republican control.

Inflation expectations have responded favorably-however scant the supporting policy details-as investors anticipate large increases in personal, corporate and government spending which now appear to be at the heart of the Trump agenda. What Mr. Trump knows best from his long career in commercial real estate is the strategic use of debt. If his plans for a fiscal stimulus package that includes increased government spending and tax cuts for both individuals and business, US debt issuance will likely increase dramatically driving bond prices down and yields up in what could be the making of a bloodbath for the bond market. The US yield curve is already steepening, suggesting strongly that investors fully expect a Trump administration to deliver on such spending-spending the market is currently pricing in by rising yields and buoyant equity markets.

Further piecing together the heretofore cryptic agenda of a Trump administration, pharmaceuticals and financials are current favorites as regulatory restrictions appear to be coming out from under the cosh. Healthcare insurers like Aetna (AET) and Humana (HUM) who have parted ways with the exchange marketplaces have attracted a good deal of renewed investor attention. Similarly, Cigna (CI) have become part of this growing trend. Pharmaceutical companies like Gilead Scientific (GILD) and Biogen (BIIB) as well as biotechnology companies on the cutting edge cancer research like Juno Therapeutics (JUNO) and Kite Pharmaceuticals (KITE) are advancing with the trend. The NYSE Biotech Index (BTK) is up over 17% since the election. Hillary Clinton spent the full part of a year on the campaign trail railing against skyrocketing drug prices and produced policy statements and white papers on how a Clinton administration would rein in drug prices. Mr. Trump has been just as vocal in his silence on the issue. His lone policy initiative of sorts on the topic of drugs during the campaign included a suggestion of allowing consumers to purchase drugs directly from foreign producers and retailers.

Financial stocks could benefit by certain relaxation of rules stemming from Dodd-Frank, including perhaps loosening the so-called Volcker rule which separates investment banking, private equity and proprietary trading. The Department of Labor's "client first" rule on retirement accounts slated to come into effect in April 2017 could now be watered down, pushed back or even discarded entirely. Banking behemoths such as Bank of America (BAC), JP Morgan Chase (JP) and Wells-Fargo (WFC) have all benefited from the possible pushback in banking regulation. Mid-sized banks such as M&T (MTB) and First Financial Bank Shares (FFIN) are also part of the trend as are bank holding companies such as Goldman Sachs (GS) and Morgan Stanley (MS).

Technology stocks have not fared as well as concerns of a Trump administration's protectionist tilt could spell trouble with Asian and South Asian supply chains where much of the electronic gadgetry for Apple (AAPL), Intel (INTC), Microsoft (MSFT), Hewlett Packard (HP) and chip maker Qualcomm (QCOM) is produced. Similarly, a more inward looking America could spell lost export revenue for companies like Proctor & Gamble (PG), Boeing (BA) and other Fortune 500 companies where a majority of companies in the Index derive up to half of their annual revenue from sales in foreign markets.

Material stocks have benefited from the presumed political alliance across the aisle for some form of enhanced government spending on infrastructure. Infrastructural commodities such as copper and steel enjoyed a good week hitting a YTD high on the news despite weak demand and outsized supplies of commodities in China. Caterpillar (CAT), Cummins (CMI) and General Electric (GE) are all stocks to watch. Mining companies such as Southern Cooper (SCCO), Rio Tonto (RIO), BHP Billiton (BHP) and Cliff Natural Resources (CLF) all come into play as infrastructural bets.

The Reagan-Trump analogy can only go so far. Mr. Reagan's commitment to limiting the size and breadth of government is well-known. Mr. Trump's commitment to this long-standing Republican plank is unknown at this early juncture. The Reagan presidency was outlined by some of the highest interest rates in US history. By contrast, Mr. Trump begins his presidency after years of some of the lowest interest rates on record. US corporations have gorged on cheap debt often times borrowing for such unproductive, short-term purposes as funding share buyback programs and enhanced dividend payouts. Corporate debt is currently at heightened levels. Rising rates, especially in rapid succession, could put severe limits on corporate spending in an expansionary economic environment.

With an increase in government spending by a Trump administration, the growth patterns that characterized the Reagan years could be repeated, applying upward pressure on prices in the greater economy which would likely push the Federal Reserve into a more aggressive stance on interest rates. A faster program for increasing the federal funds rate will put upward pressure on the dollar creating headwinds for US exports even beyond the protectionist tilt of the pending Trump initiatives. The emerging markets of China and Mexico, not to mention those of Brazil, Turkey and South Africa are already feeling the pressure of a strengthening dollar on their fledging currencies which could get worse over the medium term and longer as yield-seeking investors of old redirect capital flows away from emerging markets investments.

No historical analogy creates an absolute mirror on what is legislatively in store from the emerging Trump agenda. Much of this agenda has yet to be articulated and much of the current market thrust could change with time. Still, after years of anemic growth within the confines of a low interest rate environment, investors appear ready to embrace the modicum of change that does appear to be coming down the pike, political or otherwise.

This article was written by

Douglas Adams profile picture
Douglas Adams specializes in macro-economic research and turning theory into practical portfolio applications for clients over the past seventeen years. Mr. Adams recently formed Charybdis Investments International based in High Falls, New York where he is the managing director of a fee-only investment advisory practice with clients throughout the United States. As an author, Mr. Adams has commented widely on a diverse array of topics from Brexit to monetary policy to forex to labor productivity and wage growth. He holds an undergraduate degree from the University of California, a master’s degree from the University of Washington and an MBA in finance from Syracuse University.

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.

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