On the Trumped-Up Rally

The power of belief (and repetition) can be funny,^[i] particularly when pundits purport to know the one thing driving stocks. Since November 9, most observers are convinced that one thing is Donald J. Trump, cheering stocks with visions of Trumponomics' corporate tax cuts, lighter bank regulations and $1 trillion stimulus blitz. There is just one teensy little problem with this: It overlooks and underappreciates all the many other reasons stocks are rising.

It's human nature to seek patterns in relationships between events and markets. It simplifies what in reality is a complex system with countless inputs, and the illusion of understanding makes investing less intimidating. But it's also a behavioral error, and myopic. Political factors like the incoming presidential administration setting its agenda can influence stocks, but so do other areas of US and global politics. So do economic drivers worldwide. And so does sentiment.

It does seem fair to say political events are influencing sentiment and helping investors set expectations. For one, just knowing who the next president is reduces political uncertainty, letting businesses and investors plan. For broad markets, we'd argue this factor is largely behind the rally, which really dates back to the correction's end. Regardless of who won, increased clarity probably would have brought relief and made folks more willing to take risk. To quote GI Joe, knowing is half the battle.

Narratives Change, Fundamentals Abide

Then, as analysts pore over every Trump tweet and offhand comment from cabinet appointees, trying to read the policy tea leaves, markets start handicapping the potential winners and losers. This may contribute to the rally a wee bit, but that isn't all or even most of what drives markets. After all, stocks were in a bull market before Trump, and while they endured a sizable correction last year and early this year, they have been rallying since February 11. What people call the "Trump Rally" is just an extension of this longer, bigger move, which was temporarily dubbed the "post-Brexit Rally." And even then, it's a smaller slice of a much broader, bigger bull market that dates back to the Global Financial Crisis' 2009 end. Narratives about the market's movements are different since the vote, but the actual movements themselves aren't hugely changed.

At the highest level, stock prices reflect publicly traded firms' future earnings and how much investors are willing to pay for them. There is a whole private economy out there innovating and growing that, in aggregate, will likely impact earnings globally far more than anything the Trump administration will or won't accomplish. While Trump hogs headlines, the world economy is quietly chugging along and even gaining steam. Among the highlights:

• Earnings growth is accelerating, not because of Trump, but because oil is no longer a drag and economic growth is picking up. While consensus expectations for earnings growth are flat this year (3.6% excluding Energy), earnings growth is expected to be 11.4% (8.4% ex. Energy) next year.^[ii]
• Purchasing managers' indexes (PMIs) for the US and around the world are improving, predating the election. The US Manufacturing and Non-Manufacturing PMIs and the Global Composite PMI are at their highest levels for the year. Forward-looking new orders are also strong.
• GDP is growing solidly in much of the world. Year-over-year growth in Q3 was 1.6% in the US, 1.7% in the eurozone, 2.3% in the UK, 0.9% in Japan, 2.6% in South Korea, 6.7% in China, 7.3% in India, 1.3% in Canada, 1.8% in Australia, and 2% in Mexico. Really the only countries in the world not growing are 1) heavily oil-dependent and/or 2) grossly mismanaged: Brazil, Russia, Argentina, Venezuela, Nigeria and Norway.
• Yield curves are steepening worldwide, and were before the vote. This boosts banks' loan profitability-increasing their willingness to lend and fund productive investments. Yet because rising long rates are steepening the curve, many fear it-they think like consumers, fretting the impact of rising loan costs, and don't consider that banks are more eager to lend when long rates are higher. Like steep yield curves, false fears are bullish.
• High and rising Leading Economic Indexes suggest growth should continue. No recession in the US LEI's 57-year public history began while the indicator was in an uptrend. US LEI is presently moving up. Similarly, LEIs in the eurozone and UK are trending higher.

Industry Group Trends Mostly Unaffected Since Election

Now, some claim the "Trump Rally" is most evident in specific industry groups, suggesting the new administration is a huge game changer for portfolios. Many trumpet, as evidence, several supposed "Trump Industries" outperforming: Banks, which many allege are rallying on deregulation hopes; Materials, to build all those bridges and infrastructure projects;^[iii] Transportation and Capital Goods-old line industries including defense. Technology, which people fear will suffer if Trump limits immigration, is trailing. However, most of the industries outperforming since the election are the same ones that outperformed since the correction ended! Exhibit 1 shows S&P 500 industry group returns since the election and in the period from the correction's end to the election.

Exhibit 1: The Supposed Trump Bump

Source: FactSet, as of 12/06/2016. S&P 500 and S&P 500 Industry Group total returns, 11/08/2016 to 12/06/2016 and 2/11/2016 - 11/08/2016. All figures in percentage points.

Only three industry group returns flipped from lagging the S&P 500 from the correction to the vote to outperforming thereafter (light grey shading): Consumer Services, Telecom and Food & Staples Retailing. Hard to see the material connection to Trump. While some would argue Energy is a Trump Industry, it lagged post-election until the OPEC deal days ago, which illustrates the fact returns aren't all about Trump (nor do we expect the deal to materially change Energy's outlook).^[iv] Banks' outperformance coincides not with the election, but rising long-term interest rates-also a trend predating the election. For all the talk about heavy industry surging post-vote, every relevant industry group outperforming post-election is just doing what it was before November 8. No Trump game changer.

Now, Technology-related industry groups have largely flipped from leading to trailing, which may be a sentiment effect from the vote. However, that isn't assured to continue. It is always a mistake to extrapolate short-term trends, as the Utilities, Telecom and Consumer Staples sectors' returns from early 2016 exemplify. As it pertains to Trump, the initial wave of enthusiasm (or dismay) could eventually give way to the legislative grind, where presidential proposals frequently go to die. Moreover, no administration is inherently good or bad for markets or any one industry. There is a lot of give and take. One policy might be good for a certain industry, and another bad. People are cheering the prospect of lower corporate taxes, but what if they don't happen? Or what if lower tax rates happen, but deductions and other tax policies are tweaked? What if tax shifts are beneficial to corporations' bottom lines, but other policies trump them? What if cyclical economic drivers and global developments end up holding far more sway over future earnings?

To the extent Trump talk has boosted performance for certain industry groups, it's a short-term sentiment reaction above all else, based on words and speculation, not action. But for markets overall, don't believe the hype, and don't overrate US presidential politics. There is so much more going on in the world, powering this bull market.