Equity benchmark shows strength while bonds sell off in sharp divergence
The US stock market is diverging between old and new, with the industry-heavy, history-laden Dow Jones Industrial Average jumping to a record high even as the younger, technology-oriented Nasdaq index sagged lower in the wake of this week’s presidential election.
President-elect Donald Trump’s pledge to cut taxes and deliver a package of infrastructure spending has raised investors’ hopes of faster economic growth and higher corporate profits, but there was a clear discrepancy between the most popular US equity indices on Thursday.
The Dow Jones Industrial Average climbed 0.9 per cent to a record 18,769.5 by midday in New York, powered by blue-chip financial stocks such as Goldman Sachsand JPMorgan, venerable tech company IBM and Home Depot.
However, the S&P 500 gave up its early morning gains and was trading flat by the afternoon, while the Nasdaq Composite slumped 1.2 per cent, its biggest one-day drop in a month.
The decline was led by companies like Amazon, whose founder and Washington Post-owner Jeff Bezos has clashed with the incoming president, Netflix and Google. Amazon fell nearly 5 per cent on Thursday to a four-month low.
Nonetheless, gains for stocks in the wake of Tuesday’s US presidential election upset have defied expectations that a victory for Mr Trump would trigger panicked selling because of the geopolitical uncertainty his administration would usher in.
Instead, bonds and equities have broken in opposite direction with investors anticipating increased government spending will help corporate bottom lines, but raise national debt and inflation, which is leading to a wide-ranging sell-off in bonds.
“The market will power higher,” said Susan Bao, a portfolio manager at JPMorgan Asset Management. “Business confidence is the cheapest form of stimulus.”
The yield on the benchmark 10-year note rose as high as 2.11 per cent, its highest level since early January and up sharply from a low of 1.71 per cent that it hit in the immediate aftermath of the election result. Yields climb as bond prices fall.
The shift between bonds and equities could represent a turning point in financial markets. For the first time in nearly a decade, markets are not being helped by central bank policy, with the Federal Reserve moving gradually from accommodation to tighteningover the past year.
“The market is starting to discount what is likely to be an aggressive fiscal stimulus package comprised of personal and corporate tax cuts as well as infrastructure spending,” said Alan Gayle, director of asset allocation at RidgeWorth Investments. “The exact degree and shape of it are still unknown but ultimately we should see a boost to growth in 2017.”
Any new Trump administration spending plan would have to be financed by borrowing and could potentially fuel inflation at a time the gradual pick-up in US economic activity has led analysts to believe it may already be stirring.
“Ever since the financial crisis, the central bank has effectively controlled the entire yield curve for every economy throughout the world — first it was zero-interest rate policy, then quantitative easing,” said Nicholas Colas, chief market strategist at Convergex. “We are contemplating fiscal stimulus at the top of the economic cycle and that is definitely gasoline on the fire of inflation.”
Reassuring words about an orderly transfer from Mr Trump and outgoing President Barack Obama, coupled with signs of support for Mr Trump from Republican party stalwarts who had been at odds with their candidate during the campaign, provided the trigger for change in sentiment from a shock result to nascent optimism.
Bob Michele, global head of fixed income at JPMorgan Asset Management, added that if increased government spending successfully spurred inflation and growth, the Federal Reserve’s path to normalisation “becomes a lot steeper than the relative shallow one priced in”.
“It’s game, set, match for central banks with big fiscal spending on the horizon,” he said. “Why do they need to inject liquidity and engineer negative rates? It seems unnecessary going forward.”
Investors stressed while fiscal stimulus was probably low-hanging fruit for the new administration, other policies such as healthcare and immigration reform as well as the sweeping changes to trade policy that Mr Trump ran on would be trickier to pursue and less straightforward for markets to interpret.
“I do not see this period of volatility going away because we are still in the early stages of how growth is going to get going … I think this is going to make for choppy markets,” said Kathleen Gaffney, multi-sector portfolio manager at Eaton Vance.
Pharmaceuticals and banks have been the big gainers, alongside industrials and energy companies, while real estate and utility companies — sectors that pay attractive dividends and are closely linked to moves in Treasury markets — have been out of favour.
Financials are being bolstered as lenders benefit from a steeper yield curve and expectations that Mr Trump comes with less regulatory oversight than Hillary Clinton.
The prospect of heightened scrutiny had also weighed on the healthcare and biotech sectors amid expectations of a win by Mrs Clinton in the run-up to the election.
Utilities and real estate investment trusts, two areas which have drawn buyers this year for their high yields, are under pressure. So-called bond proxies become less attractive as yields on bonds rise.
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