Separating Markets from Politics, Is It Really A "Trump Rally"?

Rising equity prices and bond yields pose a puzzle for investors. Given equity valuations, some investors question whether the rally is peaking. This month, we examine the fundamental underpinnings of a steady economy, growth of company earnings and revenue, and pent-up consumer spending. We also look at equity prices in the context of a host of other investment options, all of which implies support for the rally to continue.

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We are now two months into the new year, a month or so into a new administration in Washington, and nearly four months removed from the fall presidential election. During that time, equities have risen steadily, and to a lesser extent, so have yields on U.S. government bonds. The strength of equities has been a source of puzzlement to many, and not a day goes by without major voices in markets and Wall Street questioning when the so-called “Trump rally” will run out of steam.

The widespread assumption is that the strength of markets—equities and yields both rising—is largely a byproduct of the election. Take this recent headline: “Investors may be banking too much on Trump lifting earnings.” One can find similar sentiments expressed daily. This framework, however, may be misleading. In fact, one can make a sound argument for equity strength based on solid fundamentals that are now more in focus with the noise and uncertainty of an election year that is in the rear-view mirror. And one also could make a case that some rise in bond yields and a tapering of the bond bull market has been long overdue. It’s time to separate the markets from politics, which the markets themselves appear to have already done.

Fundamentals anyone?

Let’s say, for the sake of argument, that there are two possible reasons that stock and bond yields have been going up: expectations of gains for certain sectors because of new policies in Washington, and solid company fundamentals. The two, of course, are not mutually exclusive. What if we remove Washington from the equation, what actually changes? Expected changes in infrastructure spending, or substantial financial industry deregulation, or reform of healthcare may amount to less than expected, or perhaps to nothing at all. With Washington out of the picture, we can even make a solid case for why stocks are doing well.

And they have done well, with the S&P 500 up about 5.7% through late February, and up more than 10% since Election Day November 8, 2016. Small caps stocks have been even stronger. Global equities have performed well too, with emerging markets showing double-digit gains. Sectors that are perceived to be tethered to Washington’s potential policies surged in November, such as Financials and Industrials, but recently Healthcare, Information Technology, and Consumer Discretionary names have made up for their lag. The only sectors that have performed poorly are Energy and Utilities.

Financial stocks are widely assumed to be doing well, based on the presumption that Dodd-Frank regulations that had supposedly been stifling lending with higher capital requirements would be rolled back. Perhaps. But one can make a cogent case that financial services stocks in general, and bank stocks in particular, have been trading at a steep discount to the market based on years of low interest rates. As the Federal Reserve (Fed) signaled its intent to continue raising short-term rates after years of zero rates and quantitative easing, it makes sense that investors would take a renewed interest in inexpensive bank stocks that are poised to reap more profit from higher rates and less compressed yield spreads. In addition, after a long period of companies’ delayed capital spending and consumers’ purchases of bigger ticket items, some new spending was almost inevitable. And that means more credit creation and, presumably, more borrowing and lending— also good for banks.

In short, financial stocks may have been due for a rally no matter who won in November. The fact that it was Trump who won does not, therefore, imply a Trump rally any more than a similar rally after a Clinton victory should have been dubbed a “Clinton rally.”