David Rosenberg: Investors are partying like it’s 2016-2018 again under Trump. That’s a mistake

Investors on Wednesday quickly went to the 2016 playbook, which was the last time the Trump-led GOP pulled off a clean sweep (the Republicans look set to do so again this time around, though the House race has not been formally called as of writing). The risk-on trade is in full swing – equities are ripping, led by tech and financials, and havens like gold and especially Treasuries are getting smoked. Oil is under downward pressure as is the U.S. dollar. Emerging markets, the Mexican peso and the Canadian dollar are big losers.
It may be just a bit too simplistic to assume that we are going to be in for a repeat of the 2016-2018 period, but that surely is the early expectation by the investment community. So far, just a day after the election, the old playbook is playing out to a tee. But will it last? The runway for markets seemed a lot more enticing back then.
First, equity market positioning, sentiment and valuations at the time were light years away from where they are currently. Investors were depressed, coming off Brexit and believing Hillary Clinton was going to win. Market Vane’s bullish sentiment was 60 then, and is at a nosebleed 70 currently. Today, investors had largely priced in a Trump victory early on and markets are frothy to say the least.
The forward P/E multiple was 17 times in November, 2016, versus 22 times currently. Every valuation metric from price-to-earnings, price-to-sales, price-to-book, the Buffett Indicator (market cap-to-GDP) and the CAPE multiple are completely off the charts today – which was not the case the first time Donald Trump won. And that’s not even taking into account an S&P 500 dividend yield over 2 per cent then and barely over 1 per cent today.
High-yield bond spreads were 500 basis points then and are 280 basis points now. Investment grade spreads were 140 basis points versus 85 basis points today. Like equities, a whole lot of good news and then some is embedded in the credit markets at current levels. Not the case back in 2016.
For bonds, the starting point for the 10-year T-note yield in November, 2016, was 1.8 per cent. One could have easily argued for a cyclical bear market in Treasuries at that yield level – but today’s 4.5 per cent yield offers coupon protection that did not exist eight years ago.
The stock market already had a tailwind in November, 2016, with or without the GOP sweep, as there was no competition from a 0-per-cent real risk-free rate (using the yield of the 10-year Treasury minus the impact of inflation). Today, that inflation-adjusted rate is north of 2 per cent. Big difference.
The Fed Funds rate was near the zero mark at 0.5 per cent back then – and it had only one way to go (to 2.5 per cent at the December, 2018, peak). At 5 per cent today, and coming off the cycle peak, there’s only one way to go on this score – lower. The only question is the magnitude.
With respect to the economy, 2016 was more mid-cycle in nature with an unemployment rate near 5 per cent versus the current late-cycle 4 per cent jobless rate. That is a huge difference. What it means for Donald Trump’s policy plank is that there are more acute capacity constraints today compared with the 2016 election win.
The deficit-to-GDP ratio of 3 per cent and federal debt-to-GDP ratio of 95 per cent were far less of a fiscal constraint on Mr. Trump’s fiscal ambitions then compared with today, where the deficit tops 6 per cent of GDP and the debt ratio is fast approaching 130 per cent. This is a fiscal straitjacket that the market bulls, yet again salivating over prospective tax relief, may not be factoring in.
And there is an added constraint on fiscal finances – back in 2016, debt-servicing costs were absorbing just over 10 per cent of the revenue pie. That interest expense ratio is double that today and even before Mr, Trump’s tax measures, that ratio is set to spiral to over 30 per cent within two or three years. This structural debt and deficit dilemma is not on anyone’s mind right now. But once the debt service ratio tops 30 per cent, what follows are failed Treasury auctions, a destabilizing decline in the dollar, and credit rating downgrades that will pose a threat to America’s reserve currency status.
Ask anyone who was in Canada back in the early 1990s as to what life is like once the government fails to prevent the debt service ratio from piercing the 30-per-cent threshold. Not a pretty picture. And something that the credit default swap market, unbeknownst to the equity market bulls, is beginning to sniff out.
David Rosenberg is founder of Rosenberg Research.
Also from Rosenberg Research:
A Donald Trump win means big trouble for the Canadian dollar
Don’t believe the academics. Trump’s policies won’t be all that inflationary at all
Love him or hate him, an economy under Trump should fare better than under Harris
These will be the stock market sector winners and losers after the U.S. election
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