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A Surprising Rally

| November 14, 2016
MPCA Weekly Market Update

Stocks rallied as investors reassessed prospects for corporate earnings, economic growth, and inflation in the wake of the surprising victory of Donald Trump in the U.S. presidential election.Gains varied widely depending on how different sectors might fare under the new administration. Financials, industrials, and health care did well, while technology and “bond proxy” stocks such as utilities lost ground. Small-cap equities outperformed large-caps, although all the major indexes recorded solid gains. The blue chip Dow Jones Industrial Average reached a record high.

The week began with a strong rally on Monday that pushed the Standard & Poor's 500 Index 2.2% higher and ended a nine-day losing streak, the longest since 1980. The surge was attributed to rising expectations that Hillary Clinton would win Tuesday’s election as most polls had predicted. Stocks grinded higher on Tuesday as the nation voted and then rallied again Wednesday, advancing 1.1% despite the surprising Trump victory. While the post-election rally was contrary to market expectations for a sell-off if Trump won, perhaps it was simply the resolution of political uncertainty that allowed investors to dip their toes back into the investment waters. Trading volume was the highest since the Brexit vote in late June. 

Investors can certainly expect an uncertain investment environment in the coming months as market participants try to determine the details of how campaign promises will translate into legislative programs. In the short term, most are trying to determine how the incoming administration’s favored policies, such as increased fiscal stimulus, reduced regulations, and changed trade agreements, would affect the market. Financial stocks benefited from the possibility of rising interest rates and reduced regulation. Industrials rose on expectations of higher government spending, and pharmaceuticals and biotech companies rallied as the possibility of price controls faded.

Although market uncertainty is often supportive of safe-haven securities, investors sold U.S. Treasuries following the election as the possibility of bigger deficits and rising inflation under a Trump administration made the bonds less attractive (Note that bond prices and yields move in opposite directions). The yield on the benchmark 10-year Treasury note reached 2.15%, its highest level since January, and the 0.2-percentage-point rise in yield on the day after the election was the largest recorded in more than three years, according to The Wall Street Journal. Markets continue to price in a short-term rate hike when the Federal Reserve meets in December.

Many fixed income specialists expect to see more volatility in the bond market as a result of the election. On the positive side, if domestic rates continue higher, demand from overseas could limit upward rate movements because U.S. yields remain higher than yields in many other developed countries.

Economic news for the week was light but positive. The Labor Department reported that initial jobless claims dropped to 254,000, down by 11,000 from the previous week, although the less volatile four-week average ticked up to 259,750. The number has remained below 300,000 for 88 consecutive weeks, the longest streak since 1970, indicating continuing strength in the labor market. Meanwhile, as the holiday shopping season gets underway, the University of Michigan reported that consumer sentiment had improved after reaching a two-year low in October.

An overseas development highlighted investor concerns regarding the unintended consequences of protectionist trade policy featured during the contentious campaign season. This past week, Japan and India agreed to strengthen their economic, energy, and defense ties. After a meeting between Indian Prime Minister Narendra Modi and Japanese Prime Minister Shinzō Abe, the two countries agreed on exporting Japanese nuclear and high-speed rail technology to India and accelerated discussion about the sale of Japanese amphibious rescue aircraft to the Indian Navy. The meeting comes as the future of the Trans-Pacific Partnership (TPP) trade agreement is called into question. U.S. Senator Chuck Schumer (D-NY) told U.S. labor leaders that the deal at the center of President Obama’s pivot to strengthen ties with key Asian allies will not be ratified. Abe’s administration had positioned the TPP as a core element within its third pillar of Abenomics and has been pursuing its implementation over time.