Despite fears that a Donald Trump victory in the US Presidential election of 8 November would be a "negative risk-event", quite the reverse has happened. It’s true that there was an initial knee-jerk reaction on stocks markets globally until things calmed. It just highlights even experts can be wrong footed.
The strong performance of US equities of late has brought comparisons to the ‘melt-up’ back in 1999. The current rally appears to be technically driven, as investors chase returns into the year-end.
Whether this is a melt-up or not, you may well ask what does this term actually mean. A ‘melt up’ is a sudden jump in the market resulting from investors rushing in because they fear the regret of missing out of a big rally.
However, as Dr Wallace Wormley, Harvard Ph.D.-educated and founder of private investment consultancy OSPARA, cautions and points out that: “This is a speculative increase in asset prices and thus unhealthy as it leaves the market vulnerable to sharp downdrafts.”
The four main benchmark US indices have hit record levels in November with US small cap stocks being the standout performer, which have enjoyed their longest consecutive-day winning streak since 1996.
This month to 23 November, the Russell 2000 smaller companies index had risen 12.76%. By comparison, the S&P 500 is up a tad under 4% over the same period.
But it should be noted that there has not been an improvement in the economic or company financial fundamentals.
Dr Wormley, who worked in traditional and alternative asset management with firms including Prudential Financial in the US and Japan before starting UK-based OSPARA, which provides a full range of investment consulting solutions institutional clients and family offices, adds: “A previous example was the dotcom bubble that collapsed in 2001 as that melt-up fed on its own gains as investors rushed into the internet frenzy. Then it collapsed.”
Financial stocks have led the rally on hopes of reduced regulation and as yield curves have steepened, with industrials and cyclical sectors also finding favour as they are perceived as standing to benefit from an incoming Trump administration.
Meanwhile, higher dividend paying stocks - labelled ‘bond proxies’ - have lagged cyclicals.
“In an environment dominated by central bank liquidity, equity markets have rallied in lockstep with bond markets in the past couple of years, overturning conventional market correlations,” says David Absolon, Investment Director at Heartwood Investment Management (Heartwood) in London, a subsidiary of Svenska Handelsbanken with assets under management and administration of over £2.8 billion (30 September 2016).
Absolon, who is a member of Heartwood’s tactical asset allocation team and has co-responsibility for heading fixed-income research at the firm, adds: “However, over recent weeks, we have seen a return to the more traditional market behaviour as US treasury yields have moved meaningfully higher, especially since the US election”.
Month-to-Date Return: US Equity Indices (to 23 Nov 2016)
Russell 2000 (smaller companies): 12.76%
Dow Jones Industrial Average: 5.53%
S&P 500: 3.92%
Nasdaq: 3.87%
In recent months, investors have been sitting on large cash piles, reluctant to commit capital in an environment of higher political-risk premia and on concerns that central bank policies are losing their effectiveness.
According performance dispersion and redemptions data from Barclays Equity Research as of 23 November 2016, Trump’s election victory has accelerated flows out of bonds and into equity markets: $27.5bn into equities in the week ending 16 November, and $18.1bn out of bonds.
Absolon, who previously worked at Barclays Wealth and manages client portfolios for Heartwood and runs the firm’s Defensive Investment Strategy, says: “This represents a sizeable reversal of the year-to-date trend of money being put into bond markets away from equities (c.$500bn). It has, however, not been a simple shift into broad-based equities.”
That said, he adds: “Unlike the risk-on/risk-off environment seen in the last few years, there now appears to be greater segmentation between asset classes and sectors.”
Of the total equity inflows, the primary beneficiary has been US equities, specifically smaller companies, financials and industrials.
In contrast, total equity fund flows in emerging markets, Japan and bond proxy sectors (utilities, consumers and telecom) all reported outflows. Moreover, active managers have not benefited, with investors preferring to invest in US equity exchange-traded funds (ETFs).
Indeed, investors have already poured record inflows into ETFs in 2016. “This reflects asset allocator desire to quickly get cheap and efficient exposure to the market. It also means they can pull it out just as quickly,” says Dr Wormley.
Tilting US Equity Holdings
Absolon reveals that the investment house’s focus on “tilting portfolios towards a value bias will continue”. They expect that a Trump presidency will have a “meaningful impact” on sectors where he has stated ambitions: infrastructure, defensives and energy.
“We therefore expect to shift exposure into these areas within our US equity allocation,” he adds. “With the support of a Republican Congress, Trump has a clear mandate to target growth through tax cuts and infrastructure spending.”
Previously Heartwood’s portfolios have been focused on highly liquid US large caps, but they expect that a Trump presidency to take on a more domestically-focused agenda and as such they have “already added to US industrials and US small caps”.
Can US Equity Melt-Up Continue?
Whether the melt-up can continue, “irrational exuberance seems to be the order of the day again” argues OSPARA’s Dr Wormley.
The US national based in London adds: “The high levels of market and security valuations do not deter the speculative investor flows as they chase the flavour of the month. And, even though stock prices could move higher, one would be hard pressed to justify these levels based on rational growth expectations.”
Investors are looking for reasons to invest in what have been fairly moribund markets since the summer. The US election result has prompted a revision of future expectations, shifting according to Heartwood’s Absolon “the narrative of markets to perceptions of reflation and higher growth, fuelled by infrastructure spending and tax cuts.”
Of course, any actual policies have yet to be implemented and little is still known about the incoming Trump presidency. The same might be said for proceedings during the feisty Trump vs. Clinton election campaign.
Though one thing we did learn from a position on the Trump campaign website was that the New York-billionaire wanted to instruct the Treasury Secretary to label China a “currency manipulator” and instruct the U.S. Trade Representative to “bring trade cases against China”, both in the US and at the World Trade Organization.
Still, the Donald has sketched out a policy plan in the first 100 days, which includes, among other things, pulling out of the Trans-Pacific Partnership (TPP), promoting production and innovation and loosening environmental restrictions to boost shale and coal industries.
There has also though been some backtracking from the campaign rhetoric on a number of issues, including Climate Change and locking up Hillary Clinton. And, there has also been talk of the construction of a Mexican wall, but who knows if it will turn out to be more ‘con and fence’ than concrete. Time only will tell.
