The “Trump trade” in U.S. stocks that was spurred by President Donald Trump’s November election has come and gone, according to Tony Dwyer, Canaccord Genuity Group Inc.’s chief market strategist.
As Bloomberg reports, Dwyer compared a “pro-Trump” indicator of the S&P 500’s financial, industrial, materials and energy indexes with an “anti-Trump” barometer, based on the benchmark’s health-care and technology groups, in a report Wednesday. The ratio between them climbed 16 percent between Sept. 27 and Dec. 8, a month after Election Day, and then gave back almost the entire gain.
Which made us wonder, as ConvergEx's Nicholas Colas asks "what would US stocks do if President Trump suddenly resigned?"
Based on recent price action the answer is clear: rally 3-5%, at least, over a day or two.
The reasoning here is simple. US equities see through the headlines (like the Comey firing) and essentially believe two things.
- First, corporate earnings are growing nicely.
- Second, the Republican-led Congress needs to pass tax reform by the 2018 midterm elections.
As for who sits in the White House, markets will favor anyone who can push item #2 to a speedy conclusion while not screwing up #1. OK – one more (half a) thing: long term interest rates are going nowhere, fast. As long as markets believe those 2 ½ drivers remain in place, US stocks will (very) slowly grind higher. And it isn’t just the market’s response to Tuesday’s headlines that make us say that. Our monthly look at sector and asset price correlations supports the thesis. Average S&P large cap sector correlations dipped in the last month and are averaging just under 60% YTD. That’s a clean 20 points lower than the 2009 – 2016 experience and shows fundamentals now matter again. But you don’t need a “Trump” card to play this game.
I am going to let you in on my most valuable “Life hack”: micro-expressions. These are the little twitches that the human face makes and they accurately betray stress, happiness and every other emotion common to our species. It’s why poker players wear sunglasses and your best friends/spouses/partners seem to always know when you are lying. They know the signs, even if they aren’t aware that they do.
Fair warning: the science behind micro-expressions is imperfect and controversial. A few points here:
The godfather of the discipline was a brilliant but quirky researcher named Silvan Tomkins. While at Harvard in the 1930s he lived a lavish lifestyle working as a sort of “Horse whisperer” handicapper for a racing syndicate in New York. He could tell what crimes someone had committed by just looking at their mugshots. To him, no human could hide their true persona as long as he could watch their face.
Tomkins eventually codified human emotion into a handful of “Affects”, essentially mental states. By linking facial expressions to those affects, you know what someone is feeling. It is as simple and as complex as that. See here for the last chapter of Malcolm Gladwell’s “Blink”, which is all about Silvan Tomkins and his unique gifts (a short read): http://gladwell.com/blink/the-mysteries-of-mind-reading/
One of Tomkins’ students, Paul Ekman, has spent his academic career studying micro-expressions and looking for people that use them to become human lie detectors. He and a colleague ran something called the “Wizards Project”, testing 20,000 people for their ability to spot deception. They found 50 people who could spot liars 80% of the time or more.
You probably don’t want to talk to one of those 50 people in their professional capacities, because the vast majority are in law enforcement. A woman named Renee Ellory is one of the few who is not. She has a few tips on how to spot a liar here (short read, and well worth it): https://www.psychologytoday.com/blog/the-personality-analyst/201601/how-...
You can go to Youtube for some basic tutorials on identifying micro-expressions, but just learning those is not my motivation for presenting this to you.
Instead, consider three final points. First, be keenly aware that how somebody says something is just as important as what they say. Second, watch faces intently and constantly because the truth is in there somewhere. Finally, understand that many people (not just in law enforcement) have some level of skill in reading your emotions even if it isn’t at the 80% lie detection level from the Ekman survey. Someone operating at 60% is still notable versus the base population of 50% (coin flip accuracy). Either make those people your closest friends, or run away.
Life lesson over, but the concept of micro-expressions also neatly carries over to the analysis of capital markets. That is because asset prices twitch in response to external stimuli just as human faces betray the emotions inside of us.
If you have ever seen a great trader at work, you know what I mean. They catch small signals the rest of us mistake for noise and profit from the observation. Watching them is like watching one of those human lie detectors; in a prior age they would have been burned as witches.
Now, you might say “Even if the capital markets have a face, it is so full of Botox from central bank interventions that no one can see behind that mask”. And up to November 2016, I would have agreed. But not now.
The proof that the Botox has worn off comes in the form of asset price correlations, something I have discussed in these notes since 2009.
Average sector correlations for the 11 industry groups in the S&P 500 were just 59.4% last month. The YTD average is just below 60% (59.3% to be precise). No industry group has correlations to the S&P 500 of over 90% (Tech and Financials are closest at 88.1% and 89.5%), and several (Staples, Utilities and Real Estate) are below 50%.
Compare that to the 2009-2016 experience, when average correlations cycled around the 80% mark. This means that since the start of the year, fundamentals have taken over from the “Risk on, risk off” market dynamic of the post-Financial Crisis period. Recall that pre-Great Recession, sector correlations were +/- 50% over a cycle.
I think two things have sparked this change.
- First, the Federal Reserve is now in a tightening cycle rather than in “Save the world” mode with zero interest rates and bond buying. To the degree they continue to feel comfortable normalizing rates, stock markets will act more normally as well.
- The second is Donald Trump’s surprise victory last November and the hope that he (with the help of a Republican Congress) will lower taxes and spur economic growth. Against that backdrop it makes sense to pick winners and losers again, rather than just blanket-buy equities.
Now, let’s talk about the way US equity markets responded to the firing of FBI Director James Comey. In short, they didn’t. The S&P 500 rallied 0.1%, the NASDAQ was up 0.14%, and the CBOE VIX Index crawled its way back over 10, to close at 10.2. If you hadn’t read the headlines for 24 hours, you wouldn’t know anything unusual had happened in Washington or anywhere else.
You could shout out a dozen reasons why US stocks should have fallen today. Political turmoil makes passing tax legislation more difficult. The old “where there’s smoke there’s fire” about Russian election meddling allegations. President Trump’s unpredictable management style. The list goes on and on.
The fact that stocks did nothing is a whopper of a micro-expression. Here’s what I see in it:
The “Trump Trade” is now a “GOP wants to hold Congress in 2018 trade”. Equity valuations have room to run if we get a corporate tax revamp anytime between now and a year from now. And Congress is well-motivated to deliver, regardless of (or perhaps because of) anything else going on in Washington.
The “Trump Trade” has morphed into a “Wow, corporate earnings growth is really solid trade”. While we haven’t seen any major brick and mortar retailers report (that’s next week), FactSet is showing a 13.5% growth rate for Q1 2017 S&P 500 earnings versus last year. That’s the best comp since Q4 2011. See the latest report here (always a great resource: https://insight.factset.com/hubfs/Resources/Research%20Desk/Earnings%20I...)
The fixed income part of the “Trump Trade” has fallen apart, leaving long term interest rate low and equity valuations reasonable. The US Treasury 10 Year started the year at 2.45% and closed today at 2.41%. There are myriad reasons for this move, from still-low Eurozone rates to the Federal Reserve’s hawkish plan for US rates, but the upshot is the same. Low long term rates – something not many investors expected 90 days ago.
You get the idea: there is no “Trump Trade” in US equity prices. In fact, it is a useful thought exercise to ask the purely hypothetical question, “What if President Trump suddenly resigned?” Based on the construct I just outlined, it would be reasonable to expect US equity prices to rally 3-5% over a day or two. Why? Because you get what we used to call the “Trump Trade” in its pure form – tax cuts and other pro-growth economic policies – with less of the distractions that seem to pop up all too regularly.
Do I think that will happen? No. I do not. Being President may be the toughest job in the world, but by any objective measure it is also one of the best.
But playing through that scenario does let us see the truth behind the market’s face.