By: Guy Adami, Director, Advisor Advocacy
Published December 14, 2016
Now that a month has passed since the November elections, I thought it would be a good time to examine what has been happening in the stock markets. In the days leading up to the election, I was asked how I thought the market would react under different outcomes. I thought that these were the likely scenarios:
- Hillary Clinton wins in a popular vote and Electoral College landslide. Market trades higher, as participants view it as a continuation of Obama’s eight-year run.
- Hillary wins in a similar fashion, and the Democrats seize control of both the House and the Senate. Under that scenario I thought both healthcare and banks would be sold in a meaningful way as more, not less regulation would be in the cards.
- Hillary is elected president, but Trump wins the popular vote. Candidly, I thought this is what would happen, as I didn’t see a path to victory for Trump under the Electoral College system, but I did see him squeaking out a win with the popular vote. Under this scenario, I thought the market would sell off as Trump would rail against the “rigged system,” which could possibly lead to civil unrest.
What I didn’t see happening was exactly what wound up happening: a one-sided Trump victory in terms of the Electoral College, but a significant Clinton victory in the popular vote (albeit almost all of that from the state of California). I thought a Trump victory would be negative – if not catastrophic – for the stock markets for a number of reasons, not least of which is his quasi-protectionist trade platform.
For a few hours it looked as though that market view was spot on. At 2:30 a.m. on Wednesday, November 9, S&P futures were down over 100 points, gold was exploding to the upside and 10-year yields were trading around 1.72%. By the open some seven hours later everything had reversed, and the rest, as they say, is history. So what now?
Today we see the S&P 500 trading at all-time highs, as are the transports as measured by the $IYT and the Russell 2000 as measured by the $IWM. As impressive as that is, the most impressive move since the election has been that of the banks. Goldman Sachs has traded from $180 to $240. J.P. Morgan has traded from $70 to $85. Bank of America has traded from $17 to $23.
Book Value vs. Trade Value
Although I don’t necessarily agree with the move higher, I think I understand what is taking place. Market participants are convinced that the shackles of Dodd Frank and other onerous regulation will finally be taken off. Eight years of sideways stock action will be replaced by a sharp move higher as the entire sector gets repriced – not necessarily on a price to earnings valuation, but repriced in terms of where these companies trade relative to book value.
At different times over the last eight years, many of these banks have traded at a discount to book value. In 2007, I believe Goldman Sachs traded close to 2.5 times price to book. Now I am not suggesting valuations could or should reach that level, but somewhere between where things are now and 2.00 times price to book seems reasonable.
When Goldman reported their 3rd quarter earnings on October 17, it was stated that their tangible book value was $168.91. If we were to say that 1.8 times tangible book could be reached under all the mandates this Trump administration wants to quickly achieve, then we are theoretically looking at a $304.00 stock. You can do similar math with $C, $BAC, $JPM, $MS and, to a certain extent, $WFC. Now again, I’m not certain I agree with this logic, but I think this is exactly what the market is looking at.
Of course, a Trump victory didn’t magically make all the ills of the world go away. China is having a difficult time with their currency, and their debt to GDP stands at an alarming 248%. Italy is dealing with a banking crisis in large part due to their own making and exasperated by their recent referendum result. Bond yields globally have spiked in a meaningful way, which seems great on the surface, but has huge implications for sovereign debt service. Here at home the S&P 500 is trading north of 25 times GAAP earnings, which seems to be a bit frothy. That being said, nobody seems to care. Bad news isn’t bad news until it is. So for now at least, to borrow a line from a 1992 classic movie, “Party on, Garth.”