Trader Talk

Here's why the Trump trade is not over yet

No big changes to the reflation trade

Wall Street traders have notoriously short attention spans, and it's showing in the latest round of whining, this time around the idea that the Donald Trump "reflation trade" is winding down.

It goes like this:

  1. Traders now realize that the Trump agenda — the tax cuts, fewer regulations, the infrastructure spending — are 2018 events for earnings.
  2. At current prices, this leaves stocks dangerously extended, because when you start trading on earnings that are one to two years out, you are in a very speculative market.

Here's a typical example of this kind of concern, coming from Cannacord Genuity: "Should February fail to bring a market pullback, we believe the odds of a bigger correction this spring will mount as the valuation of cyclical stocks prematurely overshoots."

The firm cited high investor complacency, a widening in credit spreads (particularly in Europe due to anti-globalism political developments), and another drop in China's foreign currency reserves, despite various capital controls. They argue that "the 'reflation trade' is tiring" and are neutral on stocks.

Really? It doesn't show up in the markets. A lot of people are confusing short-term trends with intermediate and longer-term trends.

It's true there has been some modest weakness this month. Crude is down. Bond yields are down. This has put some pressure on energy and bank stocks.

Donald Trump arrives for his election night rally at the New York Hilton Midtown in Manhattan, New York, November 9, 2016.
Andrew Kelly | Reuters

But that doesn't mean the reflation trade is over. Just look at the trend since the election:

State of the "reflation trade" since the election
Fundamentals: improving
Rates: up
Inflation: moderate
Stocks: record highs
Leaders: tech, materials, industrials

This is a very definition of what the reflation trade looks like!

In stocks, the "reflation trade" sectors of financials, materials and industrials have been the clear leaders, with defensive and interest-rate sensitive sectors lagging:

Sectors since the election

Financials up 17%
Materials up 11%
Industrials up 9%
Consumer Staples down 1%
Utilities down 1%

This is reflation!

You can get more granular and look at specific stocks. Whether you're talking infrastructure/construction, banks, aerospace/defense, or industrials like Caterpillar, the reflation trade is very evident:

Trump stocks since the election

United Rentals 66.4%
U.S. Steel 61%
JPMorgan Chase 24%
General Dynamics 19%
Union Pacific 18.8%
Caterpillar 10%

So why is there so much whining? Because there have been long periods in the last two months when the reflation trade has just sat there and done nothing. How long? Bank stocks booked virtually all their gains (roughly 25 percent) in the 5 weeks after the election. They've done nothing since then.

Others, like industrials, have broken out since then but have fallen back.

But a consolidation is not a sell-off. There is no selling pressure in the market.

If the market is boring, it's boring because it's had such a strong move and never sells off. The last time we closed down 1 percent or more on the was October 11th of last year.

That's 81 days since the S&P 500 had a down 1 percent session!

So where are we? Legions of traders are waiting for the market to drop 5 to 10 percent so they can buy more. Bullishness has been moderating in some surveys but still remains high.

Today, for example, Investors Intelligence reported that bulls among financial newsletter writers was at 62.7 percent, the highest since 2005, and that bears were down to a measly 16.7 percent, the lowest since July 2015

So until I see MUCH greater price declines and MUCH higher volume that indicates traders are looking to get out, I'm sticking in the camp with ISI's technical analyst, who had this to say about the markets this morning: "The overwhelming body of our cross asset technical work continues to suggest that those uptrends remain intact and that recent countertrend declines to key support should be viewed as a compelling countertrend entry point to add to or establish new longs."