By Ivan Martchev
In conversations with investors over the past month, I sensed an unusual worry coming from the anticipation that a Donald Trump victory would mean a large selloff in the stock market, as he was clearly the less-predictable choice. My response then — that the market usually rallies after an election when there is no recession — was repeatedly met with skepticism. I think the market would have rallied if Hillary Clinton had won, too. The only difference is that different type of stocks and sectors would have been the leaders.
Nevertheless, we saw a large selloff in the Treasury market. The 10-year Treasury yield /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y +8.26% has been as high as 2.28% after the election. Keep in mind that we registered all-time Treasury yield lows at 1.31% just after the Brexit vote (see chart ).
Junk bonds didn’t get the memo
The idea behind the selloff in Treasurys is that pro-growth policies of the new Trump administration will create inflation and growth, so risk assets will benefit. That is what the political victors would like you to think. The junk-bond market has not been getting that memo, as it declined three days in a row after the election. If accelerating growth prospects were the cause of the Treasury selloff, junk bonds should have been up.
Clearly, it is not only economic growth prospects that are driving the Treasury selloff. It could be that Trump's policies may expand the federal deficit, as he has stated the need for tax cuts and more spending at the same time. This is somewhat reminiscent of Ronald Reagan, but the difference is that the former president cut taxes from much higher levels in the 1980s, and the overall indebtedness of the federal government — and the U.S. economy for that matter — was a lot lower.
Besides the selloff in Treasurys, another "Trumpnado" repercussion in the stock market was the vicious rotation into industrials and financials. That rotation can be seen in the action of the Dow Jones Industrial Index relative to the Nasdaq 100, using their popular ETFs. On the Thursday after the election, the Dow Jones Industrials /zigman2/quotes/210598065/realtime DJIA +1.87% reached an all-time high, while the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +1.17% was flat and the Nasdaq 100 /zigman2/quotes/210598364/realtime NDX +0.85% was down notably.
The vicious rotation last week reminded me of the year 2000, when the same sort of action lasted for weeks at a time. Leading up to the Nasdaq top in March, we had many days when the Dow was down, the S&P 500 was flat, and the technology sector was up a lot. That was a vicious rotation into technology. After the tech bubble burst in March 2000, alternatively, we had many days where the Dow was up a lot, the S&P 500 was again flattish while the Nasdaq was down notably — similar to what we saw last week (see chart ).
What financials mean here
That said, I think the overall stock market is headed higher, probably in a less chaotic manner than we saw last week. The monstrous heavy-volume moves in the financial sector suggest so. Financials are going up because of speculation that the new Trump administration will repeal Dodd-Frank, and deregulate the industry. While a lot of regulation is not good, not enough regulation — as was seen in the decade leading up to 2008 — can be detrimental, too, as the boom in collateralized debt obligations and leverage nearly wiped out the financial system. Let's hope the new administration remembers this recent experience.
If the financial sector was one of the biggest winners last week, large investment banks had even bigger moves. Investment banks are more leveraged to the performance of financial markets than more diversified money-center banks, which, incidentally, registered an all-time high last week. Given this action in the financial sector, I would think that the overall stock market will have a strong finish to the year (see chart ).
Stock-market investors can have quite a ball when they imagine the profits that a Trump administration could bring, particularly when no cabinet posts have been announced and no real initiatives have been officially put forward. If such positive changes don't materialize, share prices are unlikely to remain at present levels. This is particularly true for the industrial sector, which is battling a weak global economy.
Major worries in emerging markets and crude oil
One part of the investment world that clearly does not believe it will benefit from Trump's pro-growth policies is emerging markets in general, and the energy sector in particular. Both sectors, as well as the price of crude oil, were down notably after the election results were announced.
The decline in the price of oil /zigman2/quotes/209723641/delayed CLF27 +0.69% is understandable as there is too much supply globally and not enough demand. Oil is very weak seasonally in the September-March period, as most of Earth's population lives in the Northern Hemisphere, but the current oversupply makes the seasonal factors much worse. Troop movement in the Middle East was the sole factor that kept the price higher, in my view, so the notable weakening to $43 per barrel is not surprising as news from the war zone disappeared from the headlines. I would not be surprised if we revisit the 2016 oil price lows in 2017 as the oil market is out of balance.
More interesting is the emerging-markets sector, which sold off for three days in a row after the news of the Trump victory. Emerging markets had been diverging from the price of oil this summer (see Aug. 11, 2016, colunm, "One of these two risk assets is sending the wrong signal — but which one is it?"), but the Trump victory quickly established that correlation (see chart ).
The trouble is that the president-elect's statements sound rather protectionist and anti free trade. Tariffs do not increase economic growth, but rather lower it notably, both domestically and in the country subject to the tariffs. Since China is the largest emerging economy that the new Trump administration threatens to name as a "currency manipulator," 2017 could be a volatile year in the emerging markets.
I think a trade war with China and/or Mexico (courtesy of the big investment in manufacturing capacity south of the border) is unlikely to be productive for economic growth. The Chinese have much bigger problems domestically — like dealing with the effects of a busted credit bubble — so any threats from the Trump administration are only going to make those matters worse.
With or without being named a "currency manipulator," I believe China will opt for a hard devaluation of the Chinese yuan as capital flight out of China is accelerating again (see chart ). The Chinese will feel they have no choice but to devalue the yuan, as part of the normal credit-intermediation process in the Chinese economy is not working well. As the Chinese economy grew elevenfold in the past 16 years, the total debt-to-GDP ratio grew from 100% to 400%, if one counts shadow-banking leverage. Now that the economy is slowing down, that mountain of debt is suffocating it and monetary stimulation from the PBOC is not working.
Because a hard devaluation (similar to the 34% devaluation they engineered in December 1993) acts like an adrenaline shot to the heart of the Chinese economy, bypassing the financial system, the Chinese are likely to devalue the yuan as they may feel they have no other choice. A hard yuan devaluation is highly deflationary for the global economy given the size of China's GDP, which is why I maintain my 1% target for the 10-year Treasury note yield, despite the bond market's "Trumpnado" last week.
Ivan Martchev is an investment specialist with institutional money manager Navellier and Associates . The opinions expressed are his own. Navellier and Associates holds no positions in any investments mentioned in this article. This is neither a recommendation to buy nor sell the securities mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell the above mentioned securities. Investing in non-U.S. securities including ADRs involves significant risks, such as fluctuation of exchange rates, that may have adverse effects on the value of the security. Securities of some foreign companies may be less liquid and prices more volatile. Information regarding securities of non-U.S. issuers may be limited.