The Twilight Zone

”There is a fifth dimension beyond that which is known to man. It is a dimension as vast as space and as timeless as infinity. It is the middle ground between light and shadow, and it lies between the pit of man's fears and the summit of his knowledge. You're moving into a land of both shadow and substance, of things and ideas. That's the signpost up ahead—your next stop, the Twilight Zone!“


So went the opening narration of Rod Serling’s ‘60s TV series and classic anthology of science-fiction, The Twilight Zone”. Could there be a better way to describe the transition to a Trump presidency?


The twilight zone is technically defined as an area of ambiguity between two distinct states or conditions. This ambiguity expressed itself in the cacophony of perspectives with respect to the expected stock market direction following the election this week. Sell. Definitely Sell. Everything. Wait … No, buy. Now! This short episode epitomizes the violence of the financial markets cycles in the post Lehman Brothers world discussed in “System Reset” in September. From being a potential cataclysm for the markets in the weeks preceding the election and up to Wednesday early morning, the Trump win suddenly appeared to be a great value driver for the stock market. How come?


In my view, investors have been behaving like a bunch of neophiliacs—literally addicted to novelty. Such is the state of despair when it comes to value creation that almost any change is assumed to be a good thing. To illustrate the point, consider the universally positive share price reaction driven by announced changes in corporates’ strategy, portfolio or leadership teams, almost independently from substance. With the Trump election, market participants got a gargantuan spoon of the “change drug”, leading to a state of euphoria. What followed was a massive, collective rationalization exercise: Of course a Trump presidency is good for the markets—how could it be otherwise since it brings change? Fiscal policy, including lower taxes and higher infrastructure spending, should boost growth and inflation the short to mid-term. And the more controversial issues related to trade and immigration may be discounted since they are not well defined yet.


The notion of change associated with Donald Trump has been amplified by the fact that his win was unexpected. Even though many would now say that they saw it coming, the truth is that his election is a shocker for the world. Some may actually even welcome it as the psychological shock required to move from the current global macro impasse to a different, more dynamic economic regime.


So for now the equity markets have succumbed to the seductive power of a significant and unexpected change. As a result, our Diversified Industrials sector—still in the middle of a weak reporting season—had a great week with a 4-6% stock performance since Wednesday. It outperformed the broader stock market given its cyclical nature. The sector did particularly well in the US (top of the performance range) driven by the expectation of lower corporate tax rates and higher infrastructure investments, including in power and energy (with the exception of renewables) through the proposed American Energy and Infrastructure Act. A revamping of the US manufacturing footprint could also become a new theme if jobs are effectively brought back to the US, which would benefit the automation players. Given the “risk on” sentiment, the high quality cyclicals have naturally underperformed the sector due to their defensive characteristics.


What remains totally uncertain is whether the change brought by the 45th POTUS will bring anything good from an economic perspective. But that is for another day.

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