What Does the Market’s Response to Trump’s Election Tell Us About Investor Expectations?

What I find helpful about investing in the permanent portfolio fashion, is that the assets observed together give you a good big picture overview of investors’ expectations about important macro data such as corporate profits, interest rates, and inflation.

The permanent portfolio consists of 4 equally weighted assets: stocks, gold, long government bonds, short government bonds (or cash).

We observe the following important movements since November 8th:

US stocks are now up about 6.2% since the election:

US Stocks since Trump election

Gold is down about 8.2%:

Gold price since Trump election

Long government bonds are down about 8.5%:

Long bonds since Trump election

On the short end rates are also up a bit as certainty a coming rate hike on December 14th has moved close to 100%:

To summarize: We have seen a selloff in safe haven assets like gold and bonds, and a surge in stock prices.

These are not hard and fast rules, but helpful for speculation:

Gold generally tracks consumer price inflation pretty well historically, but also becomes more desirable as a haven asset when expectations about corporate profits and interest rates on government bonds fall, diminishing the one big benefit that corporate stocks & bonds offer.

Long term government bond rates are a mix between government policy (bond buying or selling programs, future expected policy rates), corporate profit expectations (since high profit expectations encourage a move from bonds into stocks and low profit expectations do the opposite), and inflation expectations. While it is true that theoretically rates on government bonds in a sovereign floating fiat money system are entirely under the control of the sovereign government, most people including high level policy makers are unaware of this due to lots of misinformation on the topic, and we have to speculate accordingly, with that misinformation in mind. More on this in my post Why the National Debt Doesn’t Matter (And Why It Does).

Stock prices generally track investor expectations of corporate profits, but discounted by the rate on risk free government bonds. For example, you can see that since Q4 2014 corporate profits have trended down, yet stocks have actually edged up a bit over the period (even excluding the Trump effect post November 8th):

This can be explained by the observation that the rate on risk free options, namely long term government bonds, have also hit new all time lows in that same period:

Investor Expectations

So in summary, it looks like investor expectations of inflation remain low, while their expectations of corporate profits have jumped significantly, prompting them to sell gold and long bonds, while adding to their stock positions.

You can read more on the components contributing to aggregate corporate profits in this post about the Kalecki equation, which basically reveals that mathematically aggregate corporate profits can only be derived via the following spending/saving decisions made by different entities:

Corporate Profit = Investment + Dividends – Household Saving – Government Surplus + Export Surplus

There are several reasons why investors expect boosts to corporate profits, just to name a few:

Donald Trump has promised a significant corporate tax cut, which, all else being equal, will boost corporate profits noticeably. (In the equation above it would manifest itself in the form of a smaller government budget surplus or a larger deficit).

Furthermore, the elimination of arbitrary and scientifically unwarranted CO2 emission restrictions will likely boost domestic investment in oil, coal, and natural gas, which again, all else being equal, constitutes a net positive for corporate profits. (In the equation above this would affect the “Investment” component.)

It remains to be seen where household saving is headed, and also what happens to the trade balance, and other government spending programs which, if unmatched by tax hikes, could provide a further boost to corporate profits.


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