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December 30, 2016

Why the Trump Rally?

At around 1AM EST on election night the Dow Jones futures were down 900 points, due entirely from the Trump election victory that so few really thought was possible.

But then something really strange happened…… the market closed up sharply the following day on November 9th and since then has continued to rally an astonishing 1600 points since that Wednesday following the election. So in effect the Dow Jones average has rallied some 2500 points since that 1AM plunge in the futures. But why?

It’s the same reason the market has rallied so much since 2009 — a telegraphed debt explosion. Instead of tanking as expected on the uncertainty all agree comes with a Trump presidency, the market chose to repeat the same pattern since the March 2009 spike, when debt explosion is clearly telegraphed. For most of the rally since 2009, it was QE and interest rates at zero by the Federal Reserve that sparked the Dow Jones, S&P and Nasdaq to new all-time highs. But this recent and remarkable rally it was the perception of government fiscal stimulus that carried the day. Sprinkle in the favorable seasonality, and nearly all fund managers offsides chasing performance into year end — and you get a massive 2500 point rally in just a few weeks.

Dare to argue with this notion that debt explosion, not profits, goose the market? Then just look at a chart of the S&P since 2009 overlaid with a chart of the expansion of the Federal Reserve’s balance sheet. Charts don’t lie, and these two correlate almost perfectly until 2015 when QE combined with negative interest rates from Europe, Japan and China hit full throttle to more than overcome stall speed from our monetary policy.

This also explains how the S&P managed to make new highs this year, despite having five consecutive quarters of declining profits and an economy that can’t exceed 2% growth for the past eight years. The end result is a market trading at a very high historic PE multiple that far exceeds growth in profits and revenues. And let’s remember that profit growth is even more pathetic when you account for the trillions in stock buybacks from companies in the S&P 500 over the past several years. As I mentioned in my last post, those stock buybacks have exceeded all profits in the S&P 500 since 2009.

When looking at the largess of the currently stretched PE multiples, just look at the Russell 2000 index. I tried to find on the Internet a table that measured this PE multiple, but each search resulted in Not Available. Why? Because the true number would leave you speechless. Fortunately, our good friends at recently posted a well-organized piece measuring this index and it was calculated at an eye-popping 273 times earnings, a level so high it’s actually hard to comprehend.

The reason it is so sky-high is that many of the companies in this index are losing money, not making profits. Another reason for this PE escalation is that so many fund managers have become too lazy to engage in single stock analysis and instead just buy the entire basket of 2000 stocks through index funds. Since 2009 the Russell 2000 has far outperformed the S&P 500 despite being comprised of the smallest and riskiest stocks. So the Russell 200 now trades at 273 times earnings while the much safer large profit blue chips trade around a 20 PE multiple. Of course it should be the other way around, but irrational exuberance can last for extended periods, much like the internetstocks at the turn of the century. But we all know how it ends.

I am very disappointed that the debt explosion in recent years nor the Federal Reserve were ever mentioned in the long and grueling Presidential campaign over the past two years. Voters vented their frustration over immigration, Obamacare, and other issues but not a peep about our country’s ballooning debt levels. It reminds me very much of the conditions brewing in 2007 just before the housing crisis took hold. Back then the laughable and ridiculous NINJA loans were known to most and thus hid in plain sight and amazingly investors and even the largest and most savvy Wall Street firms seemed dumbfounded when it crashed so suddenly. Weren’t home prices to rise forever?

Expect the same to occur in the coming years when the Kondratieff Winter really takes hold. Just like the housing crisis, it seems absurd just before it seems self evident and it also now hides in plain sight. History does repeat and people do forget its lessons. Since 2009 this evolving Kondratieff Winter has lived up to it’s billing on economic growth with sub 2% growth since 2008 despite tens of trillions in fiscal deficits and monetary stimulus.

No one would have believed this in 2008. But unlike all the past K-Winters, the stock and bond markets have rallied as a direct result of the outsized interference of global monetary policy since the financial crisis. I expect this condition to reverse soon as interest rates and inflation continue to rise as they have in 2016 and finally damage stock and bond prices. No telling when — it will happen when it happens.

When looking at the big picture of global stocks and bonds consider this: Bloomberg reported today that the value of all US stocks rose 9% in 2017 to $25.3 trillion. This amount, the highest ever, is still less than the total debt of the US with the current deficit over $20 trillion and the Fed’s balance sheet well over $5 trillion. This would mark the first time ever that total federal debt exceeded stocks. This is because their debt levels are far exceeding stocks gains and this deficit will continue for many, many years and it is likely stocks will not exceed debt in our lifetimes.

The election of 2016 echoed the wave of populism now sweeping the globe as voters everywhere are expressing their outrage over globalism that has lead to many job cuts as corporations export labor where it is cheapest. Very sadly there has not been a single politician anywhere on Earth who dares to defend globalism when they see jobs lost in their district or state.

But they should. There are so many benefits of globalism that are not being touted. By lowering the cost of capital globalism leads to lower prices for everyone on many goods (see Walmart) and creates scale to our benefit. It also decreases poverty in many nations by creating new middle classes in countries like China and India totaling in the billions of people that can now buy our products (see Apple Computer) and contribute to global GDP growth. Such growth has also contributed to the vast increase in corporation profits since the early 1990’s, which has contributed to increased wealth fro stocks for so many Americans not withstanding the monetary largess we mentioned.

Americans in all states should encourage globalism because it allocates labor in a far more efficient way and allows capital to chase its highest utility. Kondratieff Wave theory has much to say on this matter. As the winter season changes into Spring, a vast array of new technologies takes hold to create a whole new paradigm through the “creative destruction” process championed by Joseph Schumpeter. (See more in our tab on the homepage.) And who cares if all the horse and buggy jobs are gone?

It is inherent in long wave economic cycles that new and more efficient paradigms are created, especially at the beginning of the Spring cycle phase. Debt is purged and new technologies lift all boats higher. As I have said in previous posts we are now having the first ever overlap where the Spring and Winter cycle phases are underway at the same time. The historic debt levels associated with Winter phase and the transforming technologies of Spring that include the internet cloud, oil and natural gas fracking, smartphones, nanotechnology, etc. now coexist as strange bedfellows. The challenge for our leaders now is to articulate this to the voters and propose legislation to fund job training in these new industries that have displaced workers fired from old paradigm industries.

But our politicians seem ignorant of these benefits and instead choose to take the path of least resistance- blaming corporations for lost jobs. I sure hope we don’t see any more interference with free markets from President elect Trump as he did with Carrier as there is already too much interference in the capital markets.The voting public at large cannot be expected to understand all of these complex dynamics of long wave cycles so I hope our politicians will brush up a bit on this. Oh, one more plus-the jobs coming from these new industries will also pay much more in wages than the old jobs too.

The Federal Reserve policies of ZIRP and trillions of QE stimulus are the root cause of inefficiency on a mass scale because under their policies capital cannot chase its highest utility. The ECB and the Bank of Japan’s monetary policies are far worse however. With such low macro economic growth companies have been reticent to reinvest their profits to expand their business so instead they buy back their stock. Thus the Federal Reserve actually destroys job creation in the private sector while robbing tens of millions of savers with tens of billions in interest just to blow the largest asset bubble in world history just a bit higher.

We are, sadly, left with trillions more in debt, and voters should voice their anger over that.

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