Market Strategy Radar Screen Weekly November 14, 2016

  From Election Night Swoon to Post-Vote Honeymoon

What’s next? “Let’s Make a Deal” moves to Washington

Taking a glance under the hood at the week’s rally

For all the headline attention on how far stocks rallied last week post the election night swoon, we find it curious that the Dow, the S&P 500 and the Nasdaq each posted their best daily gain for the week on the day prior to the election—rising respectively 2.08%, 2.22% and 2.37% on Monday. Talk about the stock market as a discounting mechanism—or was it the news that the FBI wasn’t planning to reopen its investigation that provided markets with such relief the day before the election? Probably the latter but we’ll likely never know for sure.

With the election now in the rearview mirror, investors are parsing details of the transition taking place in Washington D.C. on a moment-to-moment, “tweet by tweet,” day-to-day basis. The words, the body language of the participants, the headline outcomes of key meetings, and the names being considered for appointments to fill cabinet and agency posts of the new administration—all are key items on the markets’ radar screen for now.

Demonstrations in cities protesting the outcome of the election have so far served to remind those from both sides of the political aisle that this was a highly dramatic process for all and a heartfelt loss for some.

The President, the President-elect, and the former Secretary of State each have shown their mettle in urging one and all to gather under the Flag and move ahead for the sake of the greater good.

From our perspective as strategists we were as surprised as many others by the outcome of the election but not quite as shocked as some have professed.

As global investors we had felt well prepared for a surprise outcome based on the precedent set by the Brexit vote in the UK in June of this year.

From our perch today on the radar screen it appears that the transition taking place so far is progressing even better than one might have expected considering the highly contentious nature of the electoral contest just ended.

Beyond the political knock-off effects on the markets of the election and transitional process under way, prospects that policies of the new administration built around election issues and promises could begin to stimulate the economy sooner than later are having an effect on the bond market as well as the stock market.

While growth prospects have supported stateside equity prices nicely the bond market has suffered a bout of what some are seeing as a parallel to the “taper tantrum” the bond market had post Ben Bernanke’s comments in May of 2013 when the Fed began to think the economy was getting strong enough to warrant a “tapering” and eventual end to the Fed’s monthly bond buying program of the time.

From early May 2013, when Bernanke first intimated a tapering might be warranted, through December of that year the bond market moved yields higher in anticipation of the Fed taking action that ironically didn’t take place in 2013 but in 2014.

From a low of 1.69% in early May the yield on the 10-year rose to 3.03% by the end of 2013. Bond prices took a drubbing as yields rose.

And then, when the anticipated rate of growth and inflation that the market had extrapolated from the Fed’s announcement of tapering didn’t occur, and growth and inflation remained fairly subdued, the yield on the 10-year Treasury slid some 30%, moving from a yield of 3.03% at the start of 2014 to 2.12% at the end of that year. Ironically the great conviction the bond market had exhibited in pricing inflation concerns from early May 2013 to the end of December 2014 turned early in 2014 to worries (also eventually unrealized) that the economy would slow and even fall into a recession sometime in 2014.

While growth boosters including tax cuts for individuals and corporations along with a much needed sizeable investment towards building and upgrading infrastructure nationwide appear high on the incoming administration’s agenda, the path from planning to initiation, implementation and eventual execution is some distance away on the horizon and then some time before these items gain enough traction to actually move the needle on the economy.

We can’t help but think the bond market may have gotten somewhat ahead of itself in projecting yields much higher than where they stand today over the next 12 months—particularly those on the 10-year Treasury.

While many market participants and observers have made much of the recent rise in yields as signaling further jumps in rates in the near future for the Treasury benchmark notes with maturities ten and 30 years ahead, we are reminded that when 2016 began the 10 and 30 year notes had respective yields of 2.27% and 3.0% and at the time expectations were for the Fed to raise its benchmark overnight rate several times.

The market had taken its cue early this year from Fed Vice-Chair Stanley Fischer’s when he suggested the Fed would raise its benchmark rate four times in 2016.

Last we looked Fed Funds Futures per Bloomberg data as of last Friday showed an 84% chance that the Fed will raise once this year and by 25 bps in December. Curiously, on January 1 of this year, the Fed Funds futures indicated there was a 93.3% chance that the Fed would raise its benchmark rate 3 on December 16th. To mix a metaphor, “Rome wasn’t built in a day.”

At most through last Friday the 30-year Treasury yield had pretty much made a round-trip back to where it started this year and the 10-year yield was close behind. Considering the round trip back to where yields started the year the sell-off in bonds and even some bond proxies may be somewhat overdone.

Global trade and currency relationships notwithstanding populism and tweaking of trade agreements along with the effects of technology (algorithms in the offices and robotics on the factory floor which keep wage inflation in check as well as lower barriers to entry for competition worldwide in a myriad of businesses) challenge prospects of interest rate normalization becoming as disruptive as some portend this early in the process of rate normalization.

The process of reflation is more likely to vary in pace as it occurs dictated not by arbitrary desire for higher rates on Main Street, in Washington, DC or on Wall Street, but by rates of inflation that are capable of sticking—thus justifying rates to move and stay higher.

For now, it appears highly practical for investors to avoid getting too giddy when markets move higher or too nervous should markets pull back to test current levels. We’ll stay the course for now.

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