By: Guy Adami, Director, Advisor Advocacy
Published January 25, 2017
Since the 104-point sell-off in the S&P on the night and early morning of the presidential election, the market has rallied some 12.5%, culminating with an all-time high print of $2,282.10 on January 6. In the wee hours of the morning of Election Day, I was on CNBC. The market was at the low of the session, and I was asked my thoughts. My answer was pretty straightforward: Although I thought the market would bounce from the violent sell-off, I thought a Trump victory would potentially be devastating for the equity markets, both here and overseas. I thought there would be a huge flight to quality in the form of our bond market, and I thought gold would trade up in a meaningful way.
In retrospect, I could not have been more wrong. The market did bounce, but it never stopped. The yield in the 10-year bond traded down to 1.72% that night before reversing higher. Within a month, 10-year yields were up by a staggering 80 basis points. The bounce in gold was short-lived as well, as the US$ exploded higher. It’s as if all the headwinds and global market risk had been forgotten overnight.
In my opinion, the market risks we were facing before the Trump victory have not gone away. Politics aside, in many ways those risks have only been exacerbated. As my friend and colleague Thomas Byrne has both written and said, “Trump is a Republican in name only.” Although the potential for tax reform, easing of regulations that are strangling businesses both small and large, repatriation of dollars domiciled overseas and fiscal stimulus are all extraordinarily positive, his protectionist rhetoric and penchant for speaking extemporaneously without regard to the consequences could create a scenario where the VIX at $12.00 will seem like a gift.
For an example of what I mean about President Trump, let us examine his recent comments about the greenback. On January 16, in an interview published by The Wall Street Journal, Trump said that the US$ has gotten too strong, especially considering that the Chinese yuan is – and I quote – “dropping like a rock.” Quoting Mr. Trump again: “Our companies can’t compete with them now because our currency is too strong and it’s killing us.”
The Strong Dollar Policy and Trade
Now for a couple of decades the battle cry for both Democratic and Republican administrations has been the unfettered belief in the “strong dollar policy.” For citizens, a strong dollar policy makes a lot of sense, as one’s buying power increases as the strength of the US$ increases. Of course, astute politicians and economists know that a weaker currency is paramount for a country with trade deficits, such as the ones we have here in the United States. One of the points President Trump made over and over again during his campaign was how horrible our trade deals were with other nations. Earlier this month, I read a great piece from Douglas Borthwick, one of my go-to analysts for foreign exchange:
With a removal of the Strong USD Policy, the US Dollar will weaken against its global counterparts. This will give the FED the ability to normalize US interest rates, as they can use the weaker USD and the resulting inflation as an excuse for raising rates. The FED will then be used by the Administration as a brake on US Dollar weakness. The weaker USD will also force other countries struggling to get their economies moving to rewrite trade agreements in a way that is more advantageous to the US. In other words, we will see a normalization of US Interest rates, and better negotiated trade deals. Both a win for the new Administration.
I will say this: although it is true that a weaker US$ will go a long way in helping our deficit problems, there are many unintended negative consequences, not the least of which is the invisible tax it puts on all of us as our buying power diminishes. Simply stated, although a weaker US$ policy seems to be logical on the surface, there are no easy ways out of the hole we have dug ourselves into. It should go without saying that it is highly unusual for an incoming president or sitting president to make any comments about our currency, let alone be as vocal as Mr. Trump has been. Although politics have always played somewhat of a role in our markets, never have they been as front and center as they are now.
In terms of the markets, what has stood out to me – and to just about everyone else, for that matter – is the strength of the financials since Election Day. Before we take a look at earnings, let’s examine exactly what has taken place. Since the close on November 8, look at the following moves:
- Bank of America closed at $17.00; it is currently trading $22.50, up some 32%
- Goldman Sachs closed at $181.92; it is currently trading $232.00, up some 27.5%
- J.P. Morgan closed at $70.03; it is currently trading $83.50, up some 19.2%
- Morgan Stanley closed at $34.10; it is currently trading $42.25, up some 23.9%
Will the Stock Market Trend Continue?
These are staggering moves over a short period of time in a space that had all been left for dead. The bull case is playing out in the form of decreased regulation, rising interest rates on the back of an improving economy, favorable tax policy, an industry-friendly government and renewed animal spirits. In the past week, we have had earnings from the aforementioned J.P Morgan, Goldman Sachs, Bank of America and Morgan Stanley. Even the most ardent bear would have to agree that earnings have been solid. So the question for traders and investors alike is simply: “Is the move over, or is there more room to run?”
Here is what I have been saying and the answer I will give to that question. If you are of the belief that the shackles have been taken off the banks and we are returning to the high-flying days of 10 years ago, it comes down to the right multiple to attach to book value. Obviously, when things were at their nadir for the space, most of these banks traded at a discount to book value (in some cases, a pretty significant discount). Compare that to the lofty multiple that some of these banks enjoyed prior to the financial crisis, and you have established the range.
Now, I am not suggesting we will or that we should go back to 2.50 to 3.00 times book value, but I am willing to submit there is further room to the upside. I am a fan of tangible book value, as I believe it provides the most accurate assessment of a company. Using a scenario where banks trade up to 1.8 times tangible book, let us again look at the four banks we highlighted:
- Tangible book value for Bank of America as stated in their 4th quarter earnings released on January 13 is $16.95. Currently, BAC is trading at 1.32 tangible book. At 1.80 times tangible book, we are looking at a $30.50 stock.
- Tangible book value for Goldman Sachs as stated in their 4th quarter release on January 18 is $172.60. Currently, GS is trading at 1.34 times tangible book. At 1.80 times tangible book, we are looking at a $310.50 stock.
- Tangible book value for J.P Morgan as stated in their 4th quarter release on January 13 is $51.44. Currently, JPM is trading at 1.62 times tangible book. At 1.80 times tangible book, we are looking at a $92.60 stock.
- Tangible book value for Morgan Stanley as stated in their 4th quarter release on January 17 is $31.98. Currently, MS is trading at 1.32 times tangible book. At 1.80 times tangible book, we are looking at a $57.50 stock.
For all of these names, using the same multiplier of 1.80, the stock prices would be much higher if we were to use book value. That said, the gap between tangible book value and book value is alarming, but that will be the subject of another call. At any rate, using my logic, it is easy to create a scenario where banks have more room on the upside. Of course, just to confuse you a bit more, let me throw in this caveat. On October 31, 2007, Goldman Sachs made an all-time high of $250.70. Six days ago, Goldman Sachs made a 52-week high of $247.77. If the weakness of the last couple of days in Goldman persists, you will begin to here chatter about a major double top. As you technicians know, that is not bullish.
In closing, there are two things that I continue to keep a keen eye on: the Russell 2000 Index as measured by the IWM and the Transports as measured by the IYT. I remain of the belief that as long as the IWM remains above $130.00 and the IYT remains above $160.00, the bull market in the S&P will remain intact. If we were to close below one or both of those for a few days, I would need to reexamine my bull thesis.