Stocks paused from their post-election rally last week as the Dow Jones Industrial Average gained a paltry 18.28 points or 0.1% to end the week at 19170.42. The S&P 500 fell -1% to 2191.96 while the Nasdaq Composite Index fell -2.65% to 52255.65. Further gains or losses may be less dependent on news from Trump Tower and more responsive to Italian voters’ rejection of constitutional reform on Sunday, December 4. The “no” vote in Italy bodes poorly for Italian banks, which are insolvent and in need of government support, and potentially a movement toward exiting the European Union. Despite a wider-than-expected margin of defeat (“no” votes were nearly 60% of the total), markets in Europe and the US by rallying. I have to confess that while I expected the “no” vote I did not expect markets to greet the result by rallying and am scratching my head at the response.
Italian voters are the latest to embrace populism and reject the elites governing their country. Following the Brexit vote and Donald Trump’s victory, Italians rejected much-needed constitutional reforms that could improve governance and chances for economic reform because they were focused on rejecting the heavy hand of the European Union and the straitjacket of the single currency that is suffocating their economy. This is what happened in the UK and points to the likelihood that the European Union is doomed in the long-term. For the moment, however, the immediate threat from this vote is to the insolvent Italian banking system that desperately needs to restructure. In the coming days, markets may come to see the vote with dark rather than rose-colored glasses as I do.
The US Dollar Index faded a bit last week but still closed at 100.66, near its 52-week high. On a broad basis, US stocks are now engaged in a battle between expectations of higher growth and earnings due to Trump’s pro-growth and lower tax agenda and the costs of higher interest rates and a more expensive dollar. The market is expensive with the S&P 500 Market Cap/GDP Ratio at 125%, near a historic high, and the Shiller Cyclically-Adjusted Price Earnings Ratio at 27.02 versus its historical mean of 16.71. While these valuation metrics aren’t deterring investors yet, they indicate that the market is very vulnerable to disappointments – and disappointments can come from many economic and geopolitical fronts. With higher rates and European instability on the horizon, investors should proceed with caution. That may not happen until year-end performance chasing is over, but I would expect the rally to peter out in January.
Truth be told, stocks aren’t a reliable indicator of anything right now.
The real “brains” of the market (and the real profit opportunities) lie elsewhere.
Here’s what you should be watching instead.
To continue reading click here.