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The markets are grappling with the reality of a Donald Trump victory, which includes:
1) Lower stock indexes, but some clear winners. A drop of 5 percent or so is certainly expected, and there is still the risk of a longer fat tail, but not all stocks are dropping. Defense stocks like Raytheon and Lockheed Martin are likely early beneficiaries. Copper is up 2 percent, along with Caterpillar and Vulcan Materials, a sure sign that infrastructure plays will likely rally as well.
2) Less regulation. Early beneficiaries are likely to be industries that were threatened with heavier regulation under a potential Hillary Clinton presidency. That would principally include pharmaceuticals, but it may also include banks and even oil stocks, since its possible that lower support for renewable energy could benefit Big Oil.
3) Emerging market stock under performance. Developing economy assets are likely to remain under pressure for some time on currency issues, and concerns over trade.
4) Flight to "safety" to currencies like the Japanese yen and the Swiss franc. Both those currencies did strengthen, though both gave back much of their gains. This may force central banks to lower rates even more, or in the case of the Bank of Japan, deeper into negative rates. The European Central Bank may extend its quantitative easing (QE) program, now scheduled to expire in March 2017.
5) Lower chances of a Fed rate hike. With volatility up, the chances of a rate hike in December by the Federal Reserve diminish, though most traders feel the Fed could still make a case for a rate hike—though likely making clear the "glide path" would be even more shallow than it had previously indicated.
Everyone knows that the markets have been pricing in divided government. Market watchers see a Clinton win with the House staying Republican.
The S&P 500 dropped 3 percent in nine straight days of losses in the last two weeks as the presidential election polls narrowed, and on Monday regained more than half the losses. It comes after FBI Director James Comey said a review of new Clinton-related emails did not change the agency's July decision not to recommend charges related to her handling of classified information.
Is any rally on a Clinton victory a doomed rally? At the end of last week, Nomura implied that it was.
"[I]t's completely plausible that if Clinton wins, any sort of relief rally in equities is faded as a lot of technical damage on the charts has happened and because markets also might be coming around to the idea that her administration could be bogged down by the House and the overall environment can remain contentious and therefore volatile," Nomura said.
Roberto Friedlander at Seaport Global argued that this "Comey Rally" was "similar to the knee-jerk Brexit reversal where we saw a plunge, followed by a failed rally."
"Don't be surprised to see this Comey Rally fade late today," he added.
"Fade the Clinton rally" is having its moment.
Man, this is a strange market. We have:
1) Generally positive economic news. Continued job growth. U.S. car sales beat expectations for October. Personal spending was also stronger in September. Even China reported better-than-expected manufacturing numbers. Sure, sub-2 percent GDP is a drag, but there's mostly more good news than bad.
2) Better-than-expected earnings reports (with 85 percent of the S&P 500 reporting, earnings are up 3.9 percent from the same period a year ago, the first positive quarter since the second quarter of 2015).
Those two factors would typically lead to a higher stock market.
1) The election: The presidential vote is the biggest "known unknown" the markets have had to deal with since Brexit. Fortunately, it will be over soon.
The current thinking is that a "status quo" result — Clinton win, House stays Republican — will result in a modest 3 percent or so rally. If Trump wins, House stays Republican and Senate swings to the Democrats, most believe stocks could move down perhaps 5 percent, but the conviction is not high on this. Remember — this week the market already began the process of factoring in a Trump win.
2) The Fed: Few have noticed that while the election has roiled the markets this week, the Fed has had a profound influence on stocks for the last several months. Interest rate sensitive groups have been sold. Banks have outperformed. Ten-year bond yields have moved close to 50 basis points since bottoming in June, two-year Treasurys have moved more than 20 basis points. The markets are already doing much of the work for the Fed.
Barring some exogenous shock, the Fed is almost certain to move in December.
A 161,000 increase in the U.S. nonfarm payroll report was more than enough for the Fed to raise in December.
Remember, the Fed appears to have set a very low threshold for a rate hike. In its most recent FOMC statement, where it said, "The Committee judges that the case for an increase in the federal funds rate has continued to strengthen but decided, for the time being, to wait for some further evidence of continued progress toward its objectives." That one word — "some" — would seem to indicate it won't take much to hike.
While there is still more data in front of us — we will have the November jobs report before the December Fed meeting — it's hard to imagine the data falling apart so much the Fed will demur on this one.
What other factors might derail a hike? Perhaps a Trump victory.
3) Oil. The $50-$60 trading range everyone was expecting going into 2017 is now greatly in doubt. With oil down 10 percent in the last week and back in the $40-$50 range, this is having two negative effects: a) raising doubts that oil company earnings will finally turn the corner in Q4, and b) because oil is a proxy for global growth, it's again throwing a spotlight on poor prospects outside the U.S., something that several U.S. Industrial companies have already highlighted.
Fortunately, the elections and the Fed should be over in a month, and there will be a 2017 to focus on. Barring some unlikely outcomes, the main story next year will likely revolve again around central banks and how they will extricate themselves from the low interest rate environment.
As long as the economy continues to improve, and we don't have instability, the Fed could even hike twice next year. Throw in a little inflation, and you have a steeper yield curve. That would play into corporate funding costs. And who knows? The ECB may even finally start tapering its own bond purchasing program.
Hey, you can always dream.
The CBOE Volatility Index (.VIX) just passed 20, its highest levels since June. What's it all mean?
The immediate source of the rise is concerns about the presidential election. You can see this clearly because the cash VIX, at roughly 20, is much higher than the VIX futures contracts: 19.10 for November, 18.50 for December and 19.35 for January 2017. When the cash contract is higher than near-term futures contract, it means investors are anticipating a near-term event that will move the markets, then subside.
That's clearly related to the election, no?
Yes, the moves in the last couple days are related to the election, but there's some longer-term trends happening as well.
First, volatility almost always rises this time of year, starting in September.
The economic outlook, while still mixed, is broadly improving. GDP is higher in the second half than the first half. The job outlook is still strong. There's been low inflation, and bond yields have been depressed.
All of that has contributed to a strong outlook for equities. But that is now changing.
Monetary policy is changing. Yields are now steepening. Inflation readings are rising. In other words, several of the factors that supported higher stock prices are now no longer there.
That, logically, would mean volatility should rise.
It may also mean that P/E ratios will be under pressure.
Where will this end? Given the election and the Fed, it's remarkable the VIX has been so quiescent. We haven't moved much: The average level is still well within the normal range of roughly 15 to 20.
Surprised by this? You shouldn't be. This is the way human beings are. We aren't that good at planning. We don't tend to focus on something until it is staring us in the face.
The same thing happened with Brexit. Everyone knew Brexit was a potentially big market-moving event, but the VIX was below 15 for almost the entire event. It wasn't until about 10 days before, when polls started showing the race was tighter than expected, that the VIX started moving up.
While volatility is not welcomed by long-only investors (it usually means "down") I can tell you my trader friends are absolutely delighted. Volume has picked up this week, offering one of the few bright spots in an otherwise miserable year (again) for the trading community.
If you doubt how much trouble the trading community is in, take a look at stocks associated with trading activity, like Virtu (down 44 percent year to date), BGC Partners (down 14 percent), or KCG Holdings (down 20 percent in the last two weeks after earnings).
The Fed once again failed to send an unequivocally clear signal that it intends to raise rates in December. Still, the key sentence is here: "The Committee judges that the case for an increase in the federal funds rate has continued to strengthen but decided, for the time being, to wait for some further evidence of continued progress toward its objectives."
That one word — "some," which was not in the prior statement — at least indicates that the threshold for a rate hike is getting lower and lower.
If the Fed needs evidence the economy is strengthening, it seems to be there. GDP growth is improving, jobs are plentiful. Inflation is picking up. Heck, there's even modest wage growth.
And the market sure is acting like there is going to be a rate hike.
Stocks have already adjusted. The S&P 500 is 80 points (about 4 percent) off its historic high. The small-cap Russell 2000, which is more sensitive to interest rate hikes, is 10 percent off its historic high.
What's up? There are two problems:
1) The weaker markets are impacting the overall IPO market. With stocks trending down in the past week or so, we have been in a bit of a risk-off IPO market in general. Only 40 percent of the 20 IPOs that have gone public in the last month are above their IPO price, according to Renaissance Capital. That includes high-profile names such as Quantenna and ZTO Express.
2) There are some very specific concerns about the Chinese economy and Chinese companies. Last week, parcel delivery service ZTO generated excitement because it offered to the Chinese consumer and to Chinese e-commerce business. It fizzled, largely around uncertainty on growth prospects.
Today, GDS Holdings generated interest because it was a pure tech play in China. But again, there appear to be some concerns on the 50 percent-plus growth rate claimed by the company, according to Kathleen Smith at Renaissance Capital.
"We are trying to project returns in the future, so you have to be confident in your model," Smith explained. That's a lot tougher to accomplish when you're dealing with Chinese companies, so the uncertainty factor is much higher.
There's also some company-specific issues. "The company as a relatively small customer base. Five companies are two-thirds of their revenues. They also have high capital expenditures," said Smith.
That's not surprising, since they run data centers, but you get the point: Lots of pushback when you have a jittery market and uncertainty around the numbers.
The GDS CEO, William Huang, will be on Power Lunch today at 2:30 p.m. ET.
The hedge fund manager echoed many in the business community who are optimistic about the Trump administration's policies.
Right now we have 12 deals in the pipeline, according to Renaissance Capital.
Advocacy group, American Progress Action Fund, ACAWorks.org, has already collected more than 3,000 testimonials since it soft-launched after the election.