Trump Rally or Catch-up Rally?

Based on prices as of November 11, 2016; views effective November 21, 2016

The press has been talking about a Trump stock market rally. Trump’s election roughly coincided with the beginning of sharp increase in stock prices over the last week. Is this really a Trump rally? Or was Trump’s victory associated with a move that would have taken place anyway?

According to the Market Resilience Indexes (MRI) developed by Focused 15 Investing, the stock market’s inherent resilience started to move higher a week before the election, as published on Nov 1. The markets moved up, as anticipated, beginning Monday, Nov 7, the day before the election. Monday’s price move coincided with polls suggesting Clinton was ahead. The rally continued through the rest of the week after Trump won the necessary electoral votes. It has been a catch-up rally.

The appropriate way to think of the last couple of months is that prices were abnormally depressed prior to the election. On the 7^th, the depression began to ease.

Recent Malaise

Over the last few months, the bounce off the March trough of the phantom bear market has been weak. We had rally-like MRI levels and behavior… but not rally-like price behavior. In past commentaries, I described the last few months as a malaise and an anemic rally. This weakness may have been the result of some or all of these factors:

1. The fact that the phantom bear market did not produce price declines in the US, and there was no capitulation, which meant there was no real bear market and therefore no reason to rally
2. The fear that our last remaining monetary tools were not boosting growth
3. The global markets were struggling to come to terms with the massive decline in oil prices and what that meant for global growth (and its subcomponent, struggling to assess the impact of the Saudis’ focus on market share rather than price)
4. Concern about US election uncertainty

Last week’s move caught the market up to roughly where it should have been based on its own inherent resilience, regardless of whether Trump or Clinton won. The catalyst was a natural inflection point in market resilience. It does not appear to be a market verdict on the US election.

A possible qualitative rationale is that both candidates would likely increase spending on infrastructure, taking heed of suggestions by economists and the central banks. The prospect of moving forward on spending and infrastructure programs and having the election behind us may have been a relief.

If we accept that we have had a catch-up rally, we gain some perspective on the near-term future. Going forward, the current situation suggests that prices still have an upside. The Micro MRIs, those with a 6 to 12 week horizon, for most equity markets are still clearly positive and are likely to be for several weeks. Thus, we are still early in the rising trend. Continued exposure to the US stock market is appropriate.

How About a Price Reversal?

After a period of strong returns, the market sometimes experiences losses. The Dow Jones industrial average was up about 5% election week. This return is abnormally high for a one-week time period. The idea of a reversal suggests that the market has moved too far and overshot the “appropriate” price level. Prices may fall back to where they started, or even further.

We evaluated over 100 years of market history for the DJIA and almost that for the S&P, plus the full histories of the TOPIX (Japanese Stocks) and Russell 2000 to determine the circumstances when price reversals typically occur. It turns out that some markets do experience price reversals that can be predicted systematically. However, the current situation does not appear to be one of the classic situations where a price reversal typically occurs.

Price declines can certainly happen over the next few weeks, but they are likely to be mild and/or short-lived. Further increases in resilience should ultimately lead to stronger support for stock prices. The best strategy at this time is to hold tight. Accordingly, the Focused 15 Investing portfolios have had relatively high allocations to their stock ETFs prior to the election, and this will continue.

Bond yields (10y) continue to have positive Micro and Exceptional Macro MRI ratings — suggesting higher rates. However, the Macro for the 10y bond is still stubbornly negative, suggesting that a longer-term trend for higher rates has not started. Short term, however, markets will fear rising rates. 

Election Week Update

The philosophy of Focused 15 Investing is to make bets based on the resilience of the markets rather than on the outcome of future events. Resilience is easier to measure and evaluate systematically than varied future events. This week’s presidential election is a prime example of how that philosophy can play out. Many investment strategists expected the markets to decline after a Trump victory (and to rise after a Clinton victory). My work suggested markets would trend higher regardless of the winner. On November 2, I wrote:

For the week of November 7, US stocks have a resilience rating of 2, up from 1 the prior week. This higher rating is because the Micro Market Resilience Index MRI has turned positive and is now gaining strength. This is an important shift and could lead to higher prices, barring strongly negative news or events. 

The effective date for this rating is 11/7/2016. The US presidential election will be held the following day. Resilience will be higher that week regardless of which candidate wins. Some observers will say that the markets are rendering a verdict on the winner, but my statistics suggest that it is simply the beginning of a normal short cyclical move providing support for higher prices.

Since the market’s close last Friday, the Dow Jones Industrial Average is up about 4%. I believe that I would be saying essentially the same thing if Clinton had won. The magnitude might be more or less, but I believe it would still be positive.

Looking forward, the market may decline and give back some of these gains. However, the positive trend is likely to continue. Many of the major stock markets around the world are experiencing greater resilience, not just the US markets. This also would have taken place in the short term, even if Clinton had won.

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Overview of market resilience ratings for stock, bond and commodity markets for the next few weeks. #marketResilienceIndexes #marketOutlook #InvestmentResearch 

Week of 11/7/2016 - Market Resilience Index Ratings

Week of 11/7/2016 – Market Resilience Index Ratings

Both the US stock and bond markets have been through a period of heightened vulnerability over the last several weeks. For the week of November 7, US stocks have a resilience rating of 2, up from 1 the prior week. This higher rating is because the Micro Market Resilience Index MRI has turned positive and is now gaining strength. This is an important shift and could lead to higher prices, barring strongly negative news or events.

The effective date for this rating is 11/7/2016. The US presidential election will be held the following day. Resilience will be higher that week regardless of which candidate wins. Some observers will say that the markets are rendering a verdict on the winner, but my statistics suggest that it is simply the beginning of a normal short cyclical move providing support for higher prices. Of the 5000+ weeks since 1919, 87% had a higher Micro Resilience level than last week’s level, which means it is currently near the lower extreme. Since the Micro MRI is particularly rhythmic in its movement up and down, it is a good bet that it will move higher over the next several weeks and provide support for prices.

Should the stock market decline after the election, possibly in reaction to the winner, the decline is likely to be short-lived. There will likely be a rebound, and "market concerns" will seem to pass quickly. Coincidentally, the level of the Micro MRI now is very similar to its level at the time of the Brexit vote. After Brexit, there was a decline in the US stock market and then a meaningful recovery.

In an earlier market (link) overview, I mentioned that the period of March 2015 through January 2016 was a bear market in terms of MRI levels, but one that failed to produce large-scale declines, panic or capitulation. As 2016 has progressed, the resilience measures indicate that we are rebounding off the bottom of our phantom bear market. However, that rebound is not as strong as is typically the case just after bear markets that are expressed as major price declines. This mid-term malaise is detectable in the US stock market’s MRI levels and is evident by the current lack of the Exceptional Macro MRI. In a typical rebound, the Exceptional Macro MRI persists for several quarters. In this one, it lasted just a few months.

The anemic rebound may be a reflection of concerns about global growth, US election uncertainty, and conflicts in the Middle East. Thus, while we can expect higher stock market resilience (which supports higher prices) through the end of the year, the New Year could bring a change in the overall character of the market.

Global Stocks

The European stock market has a rating of 1, unchanged from last week. Out of the major equity markets, this one shows most stress. Its positive Exceptional Macro Resilience MRI has failed to result in a positive Macro MRI, which would be expected over the next few weeks.

The Japanese and Chinese (Shanghai Composite) stock markets are beginning to show more resilience, with ratings of 2. Emerging Market stocks continue to be resilient (rating 3).

The global stock as a whole appears more resilient. The rating of the MSCI World stock market index is 2. I believe that rating will increase to 3 over the next few weeks.

I analyzed the relative resilience between Contrarian mutual funds (funds that buy low quality company stocks) and Quality Growth stock mutual funds. Over recent months, the low quality stocks have been favored over high quality stocks. It appears that this will continue for the next several weeks, and may even be more pronounced.

Commodities

Commodities in general continue to be resilient, with the exception of Gold. Its resilience is deteriorating. Gold has declined in price recently and there may be a temporary stabilization of Gold prices. Mid- and longer-term, however, it appears that its resilience will be weak. It is currently rated 1.

Crude Oil is currently rated 3, the highest resilience rating. I expect it to drop to 2 in the next few weeks. Price increases may not occur or may be more muted at that time. At the moment, the Macro and Exceptional Macro MRIs are positive and strongly so.

Bonds

Resilience in bond markets in general is deteriorating. For example, the US High Yield bonds market is rated 2, down from 3 the prior week.

Finally, global inflation-linked bonds are more resilient than global bonds. This reflects heightened inflation concerns. Based on the MRI ratings, I expect inflation-linked bonds to continue to be favored for the next several quarters. Of course, a shift toward higher inflation has been expected for some time, and there have been several false starts over the last three years.