When economic data is good and consumer confidence reaches its highest level since 2001, U.S. equities have momentum on their side. Last week the S&P 500 Index climbed 0.7% as the ISM non-manufacturing index showed that business activity and employment trends are improving. As the economy improves, the Federal Reserve will likely move interest rates higher later this month. Investors are cheering this environment but we believe equity markets have gotten ahead of themselves.
Heading into the election, headlines pontificated a huge sell-off (following a Trump win). Stocks closed at record highs last Friday, with gains of 0.5% for the Dow Jones Industrial Average, 0.4% for the S&P 500, and 0.3% for the Nasdaq Composite. Year-to-date gains are now 6.5% for the Nasdaq, 3.5% for the S&P 500 and 2.6% for the Dow Jones Industrial Average. Equity markets have rallied since the election, leaving some question whether markets have come too far, too fast. Even worse, are stocks in a bubble?
America was highly attuned to the U.S. political backdrop last week as Donald J. Trump was sworn in as the nation’s 45th president. Investors are betting that President Trump will deliver on some of his pro-growth policies. He is focused on several things, taxes being at the top of that list. Still, financial markets were rattled (only slightly) by his comments that some parts of the tax plan are “too complicated” and the U.S. dollar is “too strong.” Nevertheless, 8 of the 11 sectors in the S&P 500 Index traded higher last week.
Heading into the holiday weekend, stocks rose slightly on Friday amid low volume, the Dow managed its seventh consecutive weekly gain. Only three days of trading remain in 2016 and investors are optimistic for a solid finish without sizeable deterioration. In recent weeks, however, the market has moved into what we call a bullish pennant formation. This setup usually resolves in prices moving higher but our medium-term indicators are overbought and seem to be flashing a sign of caution. A pause or pullback should not be ruled out at this point. Perhaps the most asked question is what is driving this market?
Last week was another display of improving Investor sentiment which helped equity markets rally sharply. The S&P 500 Index surged on promises for better economic growth, tax reform and potential fiscal stimulus in 2017. Sectors have rapidly rotated throughout 2016 and post-election has been no different. In the last trading week, small caps and financials continue to lead the way.
Stocks had one of their best performances in years, with increases of 5.4% for the Dow, and 3.8% for both the Nasdaq and S&P 500, following the election of Donald Trump as U.S. President. Widespread pre-election forecasts from investment banks were nearly universal for sizeable losses following a Trump victory; built on the premise that tariffs and scrapped trade deals would hurt the U.S. economy. While futures sold off hard during the election and into the early hours of the following day, losses were quickly erased. Pundits from everywhere were puzzled by the outcome and the so-called “Trump Trade”. Nevertheless, the surprise Republican sweep as well as toned-down rhetoric on the part of both candidates, appeared to be behind the market’s bullish tone. Perhaps the largest disappointment among investors is the unevenness of sector participation.
Election 2016 is in the rear-view mirror and, unexpectedly, Donald Trump was successful in his bid for the White House. This election was unique in many ways; unusually consequential in that it challenged the Washington status quo. Additionally, it seems that America is trying to say something about the condition of our balance sheet. In many ways, we should not be surprised by the outcome of this election. In her concession speech, Hillary Clinton said “Last night I congratulated Donald Trump and offered to work with him on behalf of our country. We owe him an open mind and the chance to lead. Our constitutional democracy enshrines the peaceful transfer of power, and we don’t just respect that, we cherish it.”
Low Rates Likely to Persist
A surge in global bond yields is contributing to the rotation into riskier assets. As little as a week ago, however, bond investors and traders were once again dealing with volatility across the maturity spectrum. Yields plummeted in the wake of Brexit and the fall continued through last week. Generally, when yields fall (bond prices rise), it is a sign of risk aversion as investors pile into the safety of government backed securities. This time around, stock prices rallied simultaneous with bonds. This is an interesting divergence and one that warrants our full attention. Additionally, spillover investing from other countries is part of the low yield continuation.