Despite fears that a Trump victory would be a negative risk-event, quite the reverse has happened. The four main benchmark US indices have hit record levels in November.
The standout performer has been US small-cap stocks, which have enjoyed their longest consecutive-day winning streak since 1996.
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.
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
Investors have voted with their feet
The strong performance of US equities has brought comparisons to the melt-up in 1999. The current rally appears to be technically driven, as investors chase returns into year-end.
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 worries that central bank policies are losing their effectiveness.
According to Barclays, 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.
This represents a sizeable reversal of the year-to-date trend of money being put into bond markets away from equities (circa $500bn). It has not been a simple shift into broad-based equities, however.
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).
Can the US equity melt-up continue?
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 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.
Trump has sketched out a policy plan in the first 100 days, which includes, among other things, pulling out of the Trans-Pacific Partnership, promoting production and innovation and loosening environmental restrictions to boost shale and clean coal industries. There has also been some backtracking from the campaign rhetoric on a number of issues, including Climate Change.
David Absolon is investment director at Heartwood Investment Management