EC Abrupt Rotation Underway In Response To Trump Victory

Proving to be a better magician than either David Blaine or Criss Angel, Donald Trump pulled a giant rabbit out his hat with his improbable victory to become President-elect of the United States. But even those few prescient souls who predicted a Trump victory couldn’t foresee the immediate market rally. Everyone thought that the market preferred (and had priced in) a Clinton victory. But they were wrong. Small caps in particular have been on a tear.

I said in my previous article on 10/31 that I expected the Russell 2000 small caps to resume their outperformance once the election results had a chance to shake out. Going forward, I expect a greater focus on positive fundamentals to permeate investors’ psyche, leading once again to healthier market breadth, diverse leadership, and higher prices. I expect Trump’s policies, along with a mostly cooperative Republican-controlled Congress, to be mildly inflationary and favorable for business investment and earnings growth, with certain market segments that had been targeted by the Democrats now set to strengthen. This already has become a positive for Sabrient’s fundamentals-based portfolios.

In this periodic update, I give my view of the current market environment, offer a technical analysis of the S&P 500 chart, review our weekly fundamentals-based SectorCast rankings of the ten U.S. business sectors, and then offer up some actionable ETF trading ideas. Overall, our sector rankings look neutral as adjustments to sell-side forward estimates based on the election are only starting to trickle into our model (even though investors haven’t waited around for them), but the sector rotation model now suggests a bullish stance.

Market overview:

Many commentators are comparing the election of Trump to the Brexit vote. Certainly from the standpoint of populist undercurrent and defying the polls, this is true. But one difference I see is that many who voted for Brexit in the heat of the moment seemed to regret their decision after the fact, while Trump supporters have no such regrets. On the other hand, many of those on the losing side are not going down quietly. From the massive protests in the streets to the continued uncivil discourse among ostensibly educated and open-minded individuals, it appears very much to me to be a reflection of our cable/social-media sound-bite culture.

Nevertheless, I think most people are willing to give the new president-elect a chance. Even President Obama commented after their meeting that Trump seems to be more a pragmatist than an ideologue, which is encouraging to him. After all, we still have our Constitution and its system of checks and balances. And who knows, his outsider status and almost childlike can-do attitude about fixing our many problems might actually bring about some positive changes long sought by struggling segments of our society, including our violent and decaying inner cities, out-of-work factory workers, new immigrants, debt-laden college grads, and the over-burdened middle class.

As for the market impact, after a brief bout of risk-off behavior and narrow market performance that inordinately hurt small caps in the weeks leading into election day, and despite expectations of a severe market selloff in the event of a Trump victory, stocks have come roaring back – led in a major way by small caps. The Russell 2000 is up +9.0% from the close on election day through Tuesday (5 days) – and is now at an all-time high. Meanwhile, the S&P 500 large cap index is up only +1.9%. Moreover, Russell 2000 is +15% YTD, and an impressive +37% since the lows on February 11 (versus +20% for the S&P 500). Small caps are suddenly the place to be. They are expected to be the primary beneficiaries of things like lower tax rates, lower health insurance premiums, deregulation, and a strong dollar.

Furthermore, there has been an overnight transformation in investor preferences. Rarely has such a sudden sector rotation occurred amid an already-bullish trend. Since Tuesday’s market close on election day, Financial is far-and-away the biggest winner, followed by Industrial, Healthcare, Basic Materials, and Consumer Discretionary. But its notable that 300 NYSE stocks hit 52-week highs on Monday, while another 300 hit 52-week lows. All boats are not being lifted, which I think is a good thing for stock pickers. Technology, which had been the clear leader during most of the second half of the year, and Utilities, which was the clear leader during the first half, have both taken a backseat for the moment as these other sectors play catch-up. Year to date, Energy at +16%, Industrial +15%, and Basic Materials +14% have become the market leaders. And if you look at performance since the market bottomed on February 11, we find Financial at +31%, Energy +30%, Materials +28%, Industrial +27%, and Technology +25%.

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Disclosure: Scott Martindale is ...

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