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David Rosenberg: U.S. stock market isn’t really that hot after all

David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave

Deborah Baic/The Globe and Mail

When I was on CNBC on Monday afternoon, the discussion was over this stellar stock market performance of the past month, otherwise known as the "Trump Rally."

Let's examine it a little closer, if you don't mind.

No doubt there have been stellar performances among the two sectors that stand to benefit most from the "D" word (deregulation): financials and energy. These were the two sectors that were on the long list for a long time in the event of a Trump victory.

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Both have lived up to their billing, having advanced 14.1 per cent, and 7.0 per cent, respectively, since the election. These two sectors, representing just over 20 per cent of the S&P 500 market cap, have accounted for all the gains since then. The other 80 per cent of the stock market is flat as a pancake.

Now, I have no problem with financials and energy, and there likely is more upside too. The former was one of the few sectors heading into the election that was undervalued and the banks will get an added boost as well from expanded net-interest margins; the OPEC deal, if it holds together, is an added plus for the energy group.

But the other sector that has been getting heady has been the industrials – soaring on high hopes of some big infrastructure package.

The deregulation file is something that Donald Trump can do on his own and there is also support in Congress – especially with regards to Dodd-Frank and the Volcker Rule – but there is little appetite actually for a boondoggle spending program.

Besides, there always is infrastructure spending going on – the highway spending bill passed two years ago and the remnants of the American Recovery and Reinvestment Act of 2009. It's just that infrastructure is a nice motherhood issue and it gets investors excited – but frankly, the up-move in industrials premised on infrastructure looks really overdone to me. And when you look at the stock market excluding financials, energy and industrials, well guess what? It is actually down fractionally since Nov. 8.

Go figure.

It is not a stellar market at all. Just a stellar performance by a couple of sectors.

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And this is not a Trump Rally, by the way. The market likely would have rallied on a win by Hillary Clinton, too. Practically every new president back to Truman seven decades ago enjoys what is otherwise known as a Honeymoon Rally – the median stock-market advance the month after an election is nearly 1 per cent.

Okay, so the president-elect is now at 3 per cent, again skewed by two or three sectors. Big deal. Ronald Reagan, who was the original "Make America Great Again" advocate (as opposed to a copycat), saw the equity market soar 6 per cent in his first month in office.

Guess what? The market peaked less than four weeks into his term and for the next two years we had an economic downturn and a 25-per-cent slide in the stock market. The combination of rising bond yields, Fed tightening and a stronger dollar took care of that honeymoon.

After all, we all know what happens when the honeymoon is over. The hard work begins.

That slump we just saw in October export volumes and widening in the trade deficit is surely just an early sign of what is to come.

Before The Donald does anything on his first hundred days, something tells me the lagged impact of the tightening in financial conditions associated with the recent bounce in interest rates and appreciation of the U.S. dollar is going to come back and bite the economy in the tush, as was the case heading into 2016.

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As for the Treasury market, I get it. We were massively overbought at the July lows in yield, and the reversal in what was a negative term premium and a pickup in real rates that has accompanied a more loose fiscal policy outlook makes sense.

But there are 30 basis points of the run-up in yields since the election that do not make sense, and that is the increase in inflation expectations. There is no link at all between fiscal policy and inflation – look at Japan as a classic example.

For all the talk of a U.S. unemployment rate of 4.6 per cent, that statistic is missing the nearly 12 million people either working part-time but want a full-time job and those not officially in the labour force but would take a job if offered one.

These folks serve up competition for jobs from the sidelines and help explain why wage growth is still rather modest.

So, the broad unemployment rate that includes marginally attached workers and those employed part-time for economic reasons is still elevated at 9.3 per cent and I don't believe we get to full employment until we break well below 8 per cent.

Meanwhile, the U.S. dollar is firming and that will cause import deflation and the Fed, let's face it, is tightening monetary policy.

So with all that in mind, I see 2 per cent on the 10-year U.S. Treasury note yield (the yield is now about 2.4 per cent) before we ever see 3 per cent again. My two cents.

David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.

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About the Author
David Rosenberg

David Rosenberg is chief economist and strategist for Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave. More

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