by Oliver Donaldson
The Election of Donald Trump spurred an extended buying frenzy in stocks and commodities, sending the Dow Jones Industrial Average (DJIA) sky high. The Dow broke multiple new records nearing 20,000 points and rose 8% since the election causing an exuberant optimism and bullish sentiment that felt outright unnatural. This unfettered bullish run should indeed seem out of place, as there is little to no basis for this blind optimism. Donald Trump hasn’t even spent one day in office and there is no telling what the actual effects of his fiscal policies will have on the American economy. Though his fiscal expansion could be grand, this bullish sentiment is obnoxiously over optimistic and is due for a sharp correction, even before Donald Trump is set to take command on January 20th.
The legitimacy for this bullish rally is especially problematic as it is commencing in a time of an unprecedented change in economic fundamentals. For the past 8 years, American economic growth has been built on the back of cheap money from an extremely low interest rate set forth by the Federal Reserve. Since the first-rate hike in December 2015, Janet Yellen and her team of economists have slowly signalled to the market that monetary policy is no longer the only driver of the markets and that aggressive fiscal spending by a Trump administration will take on some of the slack.
For one, it’s extremely optimistic for the market to price in that there will be a smooth and uneventful transition from monetary drivers towards fiscal economic drivers. It is only natural there will be bumps in the road and unforeseen events that can rattle this transition into uncharted territory. This blind optimism is made worse as we are reminded that the success of these fiscal drivers is still based ONLY ON SPECULATION on what Trump can accomplish in a politically gridlocked Washington.
The market is pricing in that Trump can write a blank cheque for all of his infrastructure projects, tax cuts and trade deals while forgetting how much opposition the former celebrity faced during the campaign, especially from his own party. There is a big risk that the support behind this bull rally will come crashing down. And with daily record highs from the Dow, it seems that investors will soon face a hard reality check once the actual transition begins.
Copper, an important indicator for overall global economic sentiment, is already facing this reality check as the red metal faces its own come down off the post election high. Copper is experiencing a retreat in price this month as doubts on the effectiveness of fiscal policy come into play. A large increase warehouse stockpiles is displaying the consequences of this over optimism and driving the price of the metal down. Prices found some support from data showing positive consumer data out of China, one of the world’s largest copper users.
Positive Chinese data however is very little cause for celebration and can at times be misleading. The Middle Kingdom showed encouraging numbers on retail, manufacturing and fixed asset investment numbers only to reveal the next day lending data has also increased. The Yuan is facing similar troubles, as the Chinese currency is at its lowest level in 8 years despite spending $56 billion FX reserves in in November alone. The Chinese market is being artificially propped up by debt, and there is no telling when a large correction out of China will rattle the markets and destroy all bullish sentiment.
Disaster is indeed looming if the market corrects more than 10%. As seen in the chart below, investors are NOT PROTECTING DOWNSIDE RISK by purchasing more call options than put options. When the market eventually corrects itself, investors will be exposed to a decline in prices and will be left scrambling in a global sell off. “It is a little scary to see such optimism,” said Randy Frederick, vice president of trading and derivatives at Charles Schwab, continuing “The only thing I’m worried about is that it seems like nobody is worried about anything right now,” Frederick said. The imminent correction will hurt many who have placed complete trust in the Trump rally while not hedging their risk with puts or stop losses.
For now, gold is already being eyed up as a safe-haven asset as investors flocked to the precious metal in the first day of trading since the holiday. Whether it be Gold, the Swiss Franc or any other safe asset, we recommend that you outsmart those caught up in the false pretenses of this recent bullish rally and protect your capital.