Political analysis in context of markets is always difficult and fraught with interpretation issues especially as everyone has their own lens of things and the current political climate is highly tense and extremely divided.
Hence I’ll try to keep this article focused on substance and assess relevance in this context.
Why are markets rallying following Donald Trump’s speech to Congress last night? Not because of any specifics that were offered in the speech, but rather because of the same factor that caused a rally on election eve. The speech was filled with promises without specifics and more acceptable to a larger audience than the candidate or the person behind the tweets and the world rallies with a sigh of relief. Indeed by most accounts the speech received a very positive grading in its tone and Donald Trump should enjoy a bump in the polls.
He accomplished what he needed to accomplish and that is take the largely self inflicted tension levels down and by doing so bought himself critical time as he desperately needs Congress to pass legislation supporting his agenda.
But here’s what markets are perhaps missing altogether: The self evident shrinkage of the substance. Donald Trump came out guns blazing following his election and made promise after promise after promise. He did again so last night, but it actually is starting to sound a bit more subdued. Why? Because reality is slowly creeping in. He’s gotten pushback from the courts on immigration so his team needs to tone it down and a new order is coming out taking perhaps Iraq off of the 7 country list for example.
And even the promise of throwing out millions of illegals started to shrink with a new focus on only those with criminal records implying perhaps amnesty for the vast majority. That’s a vastly different take then the previous rhetoric.
And the president is getting pushback even from his own party as to the reality of what he can get through Congress and what he can’t. Take the proposed 37% cut to the State Department budget yesterday. A non starter Lindsey Graham called it. And never mind Democrats who by the sheer impact of Donald Trump’s poor polling data among their constituency are virtually prohibited from agreeing with him on anything.
From my perspective the summary judgement remains: The aggregate of his promises can’t be reconciled with reality based math. And I suspect his team knows this as well and hence they are forced to rely on revenue projections based on economic growth that is not rooted in productivity data and demographic facts on the ground. You can’t bemoan high debt levels on the one hand and then promise massive increases in military spending and massive tax cuts plus a $1 trillion infrastructure bill at the same time without something in between. and I’ve previously discussed this in detail in Empty Promises.
Health care, taxes, infrastructure spend and budget cuts are a complex weave of entitlement spending and local district commitments and a global economy at large and simple real world reality doesn’t match up with the rhetoric. This is why specifics are lacking and will continue to lack until agreements can be negotiated. Recall Donald Trump can’t pass a single law. Congress passes laws. The president can veto them if he doesn’t like what he gets back from Congress. That’s how the Constitution works. And, as recent days have made also clear, even Republicans won’t just rubber stamp anything he proposes.
So Donald Trump, who is not a policy wonk on any level, is finding his own rhetoric shrinking to the reality of the world around him and he needs Congress to work with him. Hence the tone of the speech not only made sense but was needed. A president can’t govern by Executive Order only. No doubt he will keep using big words such as fantastic, amazing, well oiled machine etc. I suppose he will use these words no matter the results. After all he is a marketer, a showman. That’s what he does. And perhaps he will start to tone down his aggressive rhetoric toward others as he seemingly started to do in the days leading up to the speech.
But the reality of the math will be the breeding ground for disappointment in the months ahead. And indeed we have witnessed an upside crash in positive sentiment and expectations as evidenced by soft economy surprise data. Yet the hard data is sorely lacking and this creates a gap and, as history suggests, such a gap tends to revert to the downside:
Now as far as markets are concerned none of this has mattered so far as records are broken day after day and week after week and prices keep drifting higher. But here we are now less than 1% away from $SPX 2,400, meaning markets have reached the vast majority of analyst 2017 year end targets a mere 8 weeks into the year.
What were those projections based on? Earnings growth acceleration in large based on massive tax cuts being implemented, repatriation of profits, etc. Well folks, fact is and even increasingly acknowledged by Trump’s team, hardly any of this will either happen or be in effect in 2017, and the actual size of all this remains within the foggy bottom of imagination.
So stocks continue to disconnect from fundamental underpinnings and get increasingly more expensive by the day. Retail is on autopilot allocating assets into passive index funds buying the most expensive market in years while insiders and institutions are selling with markets disconnected far above key moving averages and remaining completely uncorrected.
And now even Wall Street is left befuddled by the relentless action toward the upside as we are now on week 9 of consecutive gains in the $NDX 100 in 2017. There has not been a single down week in 2017 highlighting how one sidedness of the action. The lack of connectivity to any underpinning in fundamentals is causing firms such as BofA to capitulate and raise their target prices:
“These changes reflect an increasing likelihood that we are entering the typical later stages of a bull market, during which fundamentals typically take a back seat to sentiment and technicals. We think the market still has the potential to move higher as investors capitulate into equities….Typically, in the later stages of a bull market, corporate earnings are cyclically elevated and the multiple that the market assigns to those earnings is often elevated as well. As a result, market prices can become significantly overvalued relative to their intrinsic fair value.”
From our perspective these disconnects, coupled with extreme sentiment data, retail inflows & singular price direction are laying the foundation for the coming bear market.
Today’s gap offers another open gap that demands filling sooner rather than later. The continued insistence of this market to not fill the many gaps below are its achilles heel that will demand eventual penance. Especially when the reality of coming shrinkage will be sinking in.