November 2016 Monthly Market Review
Donald Trump’s unexpected victory in the U.S. Presidential election had a significant, immediate, and broad impact across the capital markets. It is unclear precisely how policies will change under Trump’s leadership and whether he will be able to fully implement the plans he discussed during the campaign. However, at this stage, the market appears to have interpreted the impact of his platform as positive for economic growth— through tax cuts, higher consumer spending, and increased government spending. U.S. inflation expectations, as measured by TIPS breakeven rates, moved modestly higher on the expectation that these policies are likely to lead to greater demand for domestic goods and increased commodity consumption as infrastructure spending rises. In this environment, U.S. equities, the U.S. dollar (USD), commodities, and natural resource stocks rallied during the month, while emerging markets and fixed income and other interest rate-sensitive assets declined.
Nominal U.S. Treasury yields rose on the belief that many of Trump’s policies could be inflationary and lead to an increased fiscal burden. These views led to the market pushing interest rates higher along the yield curve. The 10-year U.S. Treasury yield increased nearly 20 bps the day after the election and rose 56 bps for the full month. An analysis of 50 years of monthly 10-year Treasury yield data dating back to 1966 revealed there have been only 29 months with a larger basis point increase than that experienced in November (less than 5% of historical monthly observations). Given the low level of interest rates, the 56 bps rise represented a significant change in percentage terms. Since 1966, there has been only one month with a larger percentage increase than the 31% jump during November. The 30-year Treasury also rose sharply (+46 bps), representing the second largest percentage increase in the history of the data series, which started in 1977. In both cases, the only month with a larger increase was January 2009, which also coincided with an election/inauguration cycle. Year-to-date (YTD), the 10-year and 30-year have each retraced declines experienced earlier in the year.
In this environment, the Bloomberg Barclays Long U.S. Treasury Index fell 7.4% for the month in total return terms, and is only up 1.9% YTD. Other areas of fixed income were not immune to the impact of the rise in yields; the Bloomberg Barclays Aggregate Index fell 2.4% in total return terms. Also, developed market yield curves across the globe were under pressure as the U.S. market repriced. The Bloomberg Barclays Global Treasury Index fell 5.0%, but only declined 1.6% in local terms as currency negatively impacted unhedged returns for U.S.-based investors.
While fixed income struggled, broad U.S. equities rose as the Russell 3000 Index gained 4.5%. However, November was a highly volatile month that saw high stock dispersion across market cap, style, and industries, particularly following the election. Implied S&P 500 correlations, which were elevated in the days leading up to the election, subsequently declined to intra-month levels last experienced in 2008. In the hours following Trump’s victory, S&P 500 futures hit their down 5% pre-market trading limit on November 9th. However, by market open, investors had digested the news and the market rallied to finish the day in positive territory. While large/mid cap stocks (as measured by the Russell 1000 Index) appreciated 3.9% for the month, small cap stocks (as measured by the Russell 2000 Index) generated their best month since October 2011, gaining 11.2%. Investor preference for small caps in part reflected Trump’s victory as these companies are typically more domestic-oriented than their larger cap counterparts.
From a U.S. equity sector perspective, the surging financials sector (+13.9%) was the most noteworthy. Outsized gains were primarily fueled by the resurgence of banks, which stand to benefit from the steepening of the yield curve and an administration seeking to amend Dodd-Frank regulations. Bank of America (+28%) was the top performer, while JPMorgan Chase (+16%), Wells Fargo (+15%), and Citigroup (+15%) each posted mid-teens gains. This group of stocks, along with Berkshire Hathaway (+9%), represented the top five contributors to the Russell 3000 Index during the month. Other notable areas of market strength included industrials (+8.9%) and materials (+6.9%), which surged post-election on expectations of significant infrastructure spending. Energy (+8.4%) also had a strong month, which is described in more detail on the following page. While it remained the worst performing sector on the year, health care (+1.9%) posted a modest gain in November—though there was notable dispersion across industries. As a group, biotech was a notable post-election gainer as Hillary Clinton had pledged to fight high drug prices. Conversely, the potential repeal and replacement of Obamacare caused headwinds for medical equipment stocks and other companies likely to be hurt by significant policy reform. Technology (−0.3%) was a laggard, in part fueled by concerns that potential changes to immigration laws or implementation of protectionist trade policies could hurt companies in the sector. Facebook (−10%) was the top detractor from Russell 3000 Index results; key constituents Apple (−3%) and Alphabet (−4%) also lost ground.
While U.S. equities experienced broad gains, the election brought a halt to the 2016 emerging markets equity (EME) rally. EME entered November up 16.3% YTD, which was well ahead of both U.S. and developed international equities. However, EME fell 7.0% in the week following the election, as sentiment shifted sharply on concerns over the President-elect’s campaign stance on trade policy and immigration, as well as the prospect of policy rate hikes and USD strength. Emerging markets currencies were particularly battered in the aftermath of the election. The currencies of Mexico, which relies heavily on U.S. trade, and Turkey approached record lows versus the USD in November, closing the month down −8.1% and −9.7%, respectively. The Brazilian real (−6.4%) and South African rand (−3.9%) also fell meaningfully post-election. India’s rupee (−2.4%) hit a record low relative to the USD as well; however, that weakness were primarily attributable to Prime Minister Narendra Modi’s ban of the country’s large bank notes. Unsurprisingly, in USD terms, Turkey (−15.0%), Mexico (−12.8%), Brazil (−11.2%), South Africa (−8.0%), and India (−7.5%) were among the worst EME performers. On the whole, EME fell 4.6% after a reprieve from post-election losses.
Within marketable real assets, the energy complex posted strong returns as crude oil (WTI) advanced 5.5%, natural gas rallied 15.4% (as measured by the Henry Hub Natural Gas Spot Price Index), and energy company stocks climbed 8.4% (as measured by the S&P Energy Index). Oil surged 10% on the final trading day of the month and energy company stocks advanced 5.1% on news that the Organization of the Petroleum Exporting Countries (OPEC) reached a deal to reduce its crude production by 1.2 million barrels per day for an initial six months, while non-OPEC producers reportedly agreed to cut an additional 600,000 barrels per day over the same period. Global crude supply is approximately 98 million barrels per day, so the agreement is expected to trim current supply by approximately 1.8%. The deal is the first in eight years and the cuts were on the high end of expectations, which largely anticipated an approximately 750,000 barrel decline. Many did not expect a deal to transpire because of the difficulty involved in determining which countries would be willing to cut production and by how much. Ultimately, Saudi Arabia agreed to cut the most (500,000 per day), while Iran, which is attempting to grow production to pre-sanction levels, was exempted from cuts. After initially resisting and not participating in any cut since 2001, Russia agreed to account for half of the cut by non-OPEC producers (600,000 per day).
The agreement is expected to help expedite the rebalancing of the global crude market. Even without the deal, many had expected the market would rebalance in the middle of 2017—despite historically high production from Saudi Arabia, Russia, and other major producers. The deal is also expected to heighten the floor for oil prices, potentially in the high-$40 to low-$50 range. Enforcement of production quotas will likely be a challenge as, in the past, some producers have cheated after agreeing to cuts. Further, as oil prices have stabilized above $40 per barrel in the last six-plus months, certain low-cost U.S. shale producers have added production. This agreement and related higher expected oil prices may induce a further ramp-up in shale production, potentially offsetting the impact of some of the cuts.