Why the Trump Bump?

Dec 27, 2016 by

Donald TrumpStock investors appear to be in love with The Donald. Since U.S. Election Day, the S&P 500 is up 5.8%. Are happy days here again? Please offer your opinion in the comments, but here are my observations and opinions:

The Biggest Reason for the Post-Election Stock Price Rise

First, nobody knows why stock prices do what they do, especially over a relatively short period of time.

Little reported compared to stocks’ run since Election Day is the tremendous crash in the bond market that’s mirrored, in reverse, stocks’ rise.

To update the post I published November 21, “Bonds’ Trump Thump”: Since November 8th, the yield on the 10-year Treasury bond has risen a mammoth 37% from 1.86% to 2.54%. That translates to a trillion dollar plus hit for bond investors over just six weeks.

Naturally, bond investors collectively have headed for the exits. And where have they put the cash they’ve taken out of bonds? Yep, stocks.

Now, you understand how supply & demand works, right? Let’s review: In a free market, the price of anything reflects an ever-changing balance between supply and demand. The same applies to stocks. In my opinion, a big part of the reason for stocks post-election jump has been simple supply & demand economics: the abrupt crash in bond values has led and is leading to huge bond disinvestment, and much of that fresh cash found is finding its way into stocks.

No change in supply + a sudden big increase in demand = a rapid, big price rise

For the portion of stocks’ price rise attributable to nothing more than a significant, abrupt increase in demand, the question then is not why do stock investors love Trump but rather why to bond investors hate Trump? The election outcome had a direct affect on long-term interest rates and only an indirect affect on stock prices.

So why have long-term rates jumped so dramatically?

In general, a bond’s current yield reflects two factors:
1. Default expectations
2. Inflation expectations

Therefore we may conclude that bond investors as a whole believe Trump’s policies and programs will a) boost the chance the U.S. government will default on its debt, and/or 2) boost the inflation rate.

Despite the typically bombastic campaign rhetoric by Trump to the contrary, I don’t believe bond investors as a group believe the federal government is significantly more likely to default under Trump than it would have been under Clinton.

My conclusion: bond prices have crashed, and stock prices have jumped, mostly because bond investors believe a Trump presidency will lead to higher inflation. That instantaneous change in expectation has driven investor cash from bonds to stocks, driving up stock prices.

The Rest of the Reason for Stock Prices’ Rise

Though I believe the bond thump is the biggest cause of the stock jump, I do think more is at work than supply & demand:

  • A card-carrying unfettered capitalist, Trump will likely do a range of things—from approving the Keystone pipeline to eliminating regulations to promoting fossil fuel development to cutting corporate taxes—that will lead to higher corporate profits.
  • Undoubtedly Trump and Paul Ryan will cut taxes for people in their brackets. These people tend to be equity investors, and the prospect of lower taxes makes them giddy and keen to buy stocks.
  • Trump aims to do a number of things that will juice the economy. The juice-money + more (given the tax cuts planned) will all be borrowed (another reason for the T-bill rate jump—swamped Treasury auctions mean higher yields, again a supply & demand phenomenon), but few seem to care anymore about the federal deficit and debt.

What are your thoughts on post-election action in bonds and stocks?

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  • Be Net Worthy

    It is interesting and difficult to predict why the stock market behaves the way it does. I think another piece is the expected corporate tax cut which will increase corporate profits and dividend distributions if passed. That makes stocks more valuable.

    As for me, I’m not worried about the record highs. I’m sticking to my strategy of regular investments into my portfolio of (primarily) index funds and riding out the highs and lows. I’ve still got around ten years until I’m out, so I’ve got time to ride things up and down for a while yet.

    If nothing else, it’s going to be an interesting four years…and hopefully not eight!

  • Ian Bond

    Time will tell, but all of the talk of fiscal stimulus is certainly pleasing for equity investors. In fact, “Make America’s Small Caps Great Again” is now making the rounds on the ‘Street!
    Great piece Kurt!

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