Tuesday, November 22, 2016

And you get an All-Time High and you get an All-Time High and you get....


Remember the famous Oprah episode "And you get a car, and you get a car and you get a car...."?  Well, that's the way the market has acted ever since the election 2 weeks ago.  Everything is perfect in a world that was apparently falling apart just two short weeks ago, so of course all four major US stock indexes hit new record highs yesterday.  If you want the same old tired explanation of why this happened you can click over to CNBC but I'll give you an alternative view because apparently alternative news is all the rage these days.

1) Everyone expected a crash with a Trump election so obviously the opposite had to happen.  If there is one consistent theme I've discussed here over the past 8 years, it's that when everyone expects the market to do one thing it does the exact opposite.  While we did get an immediate crash in response to the election results, the overnight buyers turned the tide and that let the computers run amok.

2) The stock market has become a full game simulation. This is another topic we've discussed before, but in the past you would have looked at various policies of Mr. Trump, assigned a likelihood of their implementation and then discounted that back 3-5 years to assign a value to those policies.  So for example, you might say, if every project proposed were enacted it might boost Caterpillar sales by 8% in 2020 which could increase earnings by 5%-10% so maybe the stock could go up 5-10% over the next 4 years.  Instead, the computer run 50,000 of these scenarios overnight and decided that Caterpillar should go up 8% in two days based on some hope of future business opportunities (and ignoring the fact that year over year sales at Caterpillar have now fallen for 47 straight months).

The Trump rally is based on the assumption that he will get Congress to approve more shovel-ready infrastructure projects.  While I question how many more projects like this even exist (it seems like every bridge from Canada to Washington, DC is under construction), remember that we are running a $1 Trillion deficit annually.  Debt levels are at almost $20 Trillion and Trump wants to SPEND MORE and cut taxes (ie, bringing in less revenues).  The best case scenario I've seen is that in Year 1 we'd have a $2 Trillion deficit under the Trump Administration.  Can you assure me that all of the deficit hawk Republicans that railed against President Obama's spending are now going to endorse going even more in the red for the sake of getting some pork in their district?  Maybe, but I'm not convinced.

The second part of this equation is the previously discussed Brexit. The computer based traders need to only look back 5 months to the reaction of the markets after the Brexit vote to find their path.  You can basically lay the chart of the US stock markets on top of the UK markets post-Brexit and you'll see the exact same pattern.  Massive selling followed by panic buying.

3) Is the market really rallying? This is one of the least reported stories but so far the vast majority of gains in the market have been concentrated in the Financial sector.  Wait, didn't Trump get elected as an anti-Wall Street guy?  Not according to the markets which seem to love the concept of less regulation (though I don't know how they could get less regulated), while ignoring things that are going to really cut into earnings like a rapidly rising US dollar and jumping interest rates.

4) No one is noticing interest rates. Despite all of the euphoria over the stock market it's worth noting what's happening in the bond market.  Since June the 10 year bond (upon which all mortgage rates are based) has jumped from 1.35% to 2.25% with about half of that jump hitting post-election.  Mortgage rates have moved up about 40 basis points in the past three days.  To put that into context if you wanted your mortgage payment to remain flat on Thursday of last week you could have bought a $200,000 house.  Today, you could only pay $190,000 - a 5% decline in 3 days. 

Interest rates took a much needed breather yesterday but like every other market they are run by algos trading off charts and the charts for interest rates are very scary.  If we break through a couple of key levels we could looking at mortgage rates in 5-6% or higher range in very short order (every 1% increase in interest rates knocks roughly 10% off the value of your house --- very rough math).  I know none of my readers would say this but about 98% HGTV viewers would say "Wait, what? Housing never goes down in value!!!".  Interest rates remain incredibly low, even at 4% on a 30 year mortgage but if that changes and we revert to historical norms expect many people that bought more house than they could afford to really struggle.  See 2008 for what happens next.

Consider just one industry like farming - the nation's farmers have debt to income levels last seen in the 1980's as farmers have built and expanded in an effort to gain efficiencies of a larger operation.  That's okay if interest rates remain low, but if they start to spike and farm income levels remain low, you're going to see another wave of farm bankruptcies in the coming years that echoed what happened in the 1980's.

5) King Dollar is on top again.   This one made me LOL - One media outlet shouted this headline last week "America is great again as US Dollar hits 14 year highs".  You might want to ask the CEOs of IBM, Ford, Apple or Google what they think of a stronger US dollar.  It makes our products much more expensive in the rest of the world and makes imported substitute goods even cheaper here in the US. The net result of this will be more companies moving jobs overseas and/or declining earnings for US companies unless the markets reverse.


Cheers!

Have a great Thanksgiving and remember to fill your plate with veggies :)






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