Despite the repeated warnings by websites such as this one that the polls showing Hillary Clinton ahead of the election were rigged and manipulated, misrepresenting the real popular support of the two candidates, and that the likelihood of a “shock” Trump victory is far greater than anyone was willing to admit, both traders, the media, and the punditry were stunned by the outcome which, just like Brexit, few had actually anticipated. The result, at least in global capital markets, has been an unprecedented repricing of risk assets.
As we reported before, while stocks soared and the Dow Jones hit two consecutive days of record highs after Trump’s victory, despite predictions of a crash, on belated hopes of a multi-trillion debt funded fiscal stimulus (one which may very well not happen), bonds crashed.
As JPM calculates, the sharp rise in yields inflicted a big loss in the value of the global bond universe. The dollar value of the universe of tradeable bonds globally lost $1.2 trillion over the past week falling from $54.2tr at the end of last week to $53.0tr as of cob November 10th. Most of the loss was driven by government bonds the value of which declined by $0.8 trillion globally.
Partially offsetting the massive fixed-income losses, at the same the value of global equities increased by $0.8 trillion over the past week, rising from $51.5 trillion at the end of last week to $52.3 trillion as of November 11th.
And while the attention of shocked US traders remains largely focused on hopes for a “bening” inflation spike, the reality is that between the soaring dollar, the unprecedented hit to emerging market currencies and the imminent surge in FX outflows, not to mention the spike in yields which will grind the stock buyback machinery – according to Goldman, Barclays and SocGen the only source of equity upside in recent years – to a halt, likely unleashing the next leg lower in stocks as Deutsche bank warned overnight.
In any event, here are some further observations from JPM on the similarities of Trump’s win with Brexit which it says “are clear in terms of the political causes of the win and the failure of pollsters to capture voters’ intentions. However, JPM notes, “the market reaction has been different to that seen after the Brexit referendum, or at least it happened much faster. While a V-shaped equity market reaction took place over a period of a week or so after the Brexit referendum, a similar market reversal took place within hours post this week’s US election. Equities sold off by almost 5% in early trading before finishing Wednesday up by more than 1%. Perhaps a measured speech by the new president-elect played a role for the much faster market reversal, compared to the power vacuum that followed Brexit.”
What may explain the dramatic rebound from the overnight lows on Wednesday morning?
Alternatively, market participants, who similar to pre-Brexit referendum have been also de-risking ahead of the US election and have been expecting a dip in the case of a Trump win, may have rushed to quickly buy the initial dip on the fear of being too late and missing out as they did with Brexit. In turn, this rush to buy the equity market dip caused a much faster market reversal relative to Brexit.
It wasn’t just the debt vs equity divergence that was remarkable. As JPM’s Nikolaos Panigirtzoglou writes, the market reversal was spectacular in flow space with both institutional and retail investors rushing to buy the dip. $22 billion poured into US equity ETFs over the past three days, which is not only three times larger than the outflow seen in the previous week before the election, but it presents the strongest 3-day buying streak since last January.
Within US equity ETFs, there was spectacular divergence across sectors, as shown in Figure 2, as market participants rapidly priced in Trump’s main policies: fiscal expansion via tax cuts and infrastructure spending, deregulation, trade and immigration restrictions.
Industrial, Healthcare, Technology and Financials equity ETFs saw inflows of between 3-7% of AUM over the past three days. Consumer Discretionary ETFs saw a big outflow instead followed by bond-like high-yielding defensive sectors such as Utilities, Consumer Staples and Telecoms. Commodity sector ETFs such as Energy and Materials ETFs saw modest inflows and Gold ETFs saw outflows instead.
EM equity ETFs saw outflows in both equity and bond space, as Trump policies such as trade and immigration restrictions are expected to have more negative impact on EM.
Figure 2 shows that HY ETFs also saw strong inflows, which in terms of AUM surpassed those for overall US equity ETFs.
Figure 3, which depicts the weekly change in the short interest for the biggest ETF in each major asset class, saw a big divergence between US HY ETFs which saw the biggest decline and EM bond ETFs which saw the biggest increase in the short interest over the past week.
What is perhaps most puzzling from Figure 2 and Figure 3 is the lack of negativity on HG bond ETFs which encompass a lot of long duration bond funds. Even if we split the universe of these HG bond ETFs into those that have short duration vs. those with longer duration, we observe little differentiation in flows. Figure 4 shows both short and longer duration ETFs saw strong inflows on Tuesday and Wednesday. On Thursday, there were some outflows but merely reversing the previous day’s inflow. And Thursday’s outflows were similar for both short duration and longer duration ETFs.
Outflows from longer duration bond funds acted as an amplification force during the later phases of the bond market selloffs of May/June 2013 and April/May 2015. There is similar risk in the current episode, i.e. there is a high chance that selling of longer duration bond funds by retail investors will amplify the rise in bond yields over the coming weeks, which in turn will pressure the “Fed Model” rationale for high stock prices. Actually scratch that: now that yields and stock prices are soaring at the same time, we don’t expect any expert to refer to the Fed Model for a long, long time.
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In short: far from causing a market crash, or a drop anywhere between 2 and 10%, or more, as absolutely all Wall Street experts predicted, the Trump victory unleashed a massive risk-on, inflation and debt fueled rally, which has swept in a near record of equity ETF inflows, just as we explained on the morning of Wednesday, October 9, when futures were still down 3%. However, before readers rush to buy stocks, we urge everyone to read Deutsche Bank’s warning from yesterday, in which FX strategist Alan Ruskin warned that the sharp turn taken by commodities, after U.S. bond market “took down” EM assets Thursday, will add to EM pain, and that there are si ns that higher bond yields, “knock” of stronger USD are having a “domino impact,” taking down weakest risky assets first before moving on to next weakest. In other words, enjoy the Trump rally while it lasts.