Donald Trump’s honeymoon with the markets is over

Unless investors find something positive to focus on, recent optimism about the new US president could swing to fear.

Alongside the risk of hard-line policies from Trump, there’s a significant degree of complacency built into global markets. Picture: AFP/ Nicholas Kamm.

Donald Trump’s honeymoon with the markets is over.

It doesn’t mean the Australian share market can’t still reach 6000 points this year, but until investors see something positive to focus on — like a firm commitment to major US fiscal stimulus, or stronger-than-expected earnings reports and capital management from Australian corporates — the recent optimism about the new US president could swing to fear.

Mr Trump’s executive orders to build a wall against Mexico and halt immigration from seven predominantly Muslim countries were in line with his pre-election stance, and for two months the markets didn’t worry about the implications of his hard-line positions on borders and trade.

However market sentiment took a turn for the worse after the hastily-implemented travel bans over the weekend drew criticism from world leaders.

Markets could stay jittery before the statement from the Federal Reserve’s meeting, due early Thursday Australian time. Any hawkish comments could see markets build in a March rate hike from the Fed.

While by no means unprecedented, the sacking of US attorney general Sally Yates over her refusal to uphold Trump’s executive order on immigration served to highlight Trump’s hard-line stance, causing a further negative reaction from global financial markets in Asian trading.

Australia’s S&P/ASX 200 closed down 0.7 per cent at 5620.9 after falling as much as 1 per cent intraday as money flowed from equities to safe havens like previous metals and bonds.

In much the same way that the US share market was basically clinging to technical support levels despite a slight break back under 20,000 on the Dow Jones index, Australia’s S&P/ASX 200 remained above key support from the August 2016 peak at 5611, equivalent to 5555 on the SPI 200 futures.

But the 10-point fall in S&P/ASX 200 in the closing match and strong volume on Tuesday suggested there was some heavy institutional selling going on. Moreover the intraday dip coincided with a fairly broadbased “risk-off” reaction from global markets to the sacking of the attorney general.

S&P 500 futures fell about 0.3 per cent, which was a decent fall for Asia and enough to signal a further slide in the cash market. At the same time, global benchmark 10-year US Treasury bond yields fell 3 basis points to 2.45 per cent and spot gold rose as much as 0.6 per cent to $US1203.15 an ounce.

One of the biggest concerns — apart from the risk of hard-line policies from Trump and the chance of a March rate hike from the Fed — is the high degree of complacency that’s currently built into global markets.

Not only is the S&P 500 trading on a forward PE ratio near 17 times versus a 10-year average near 14 — the complacency gauged by the low level of the “VIX” index of volatility on S&P 500 futures is fairly extreme.

To be sure, the S&P 500 hit a rather crazy forward PE of about 28 times during the TMT boom and earnings for US companies would suddenly lift if Trump were to implement corporate tax cuts.

However, even after jumping 12 per cent on Trump’s new immigration policy, the VIX was still pretty close to the lows it hit in 2006 and 1993. The hedge fund community has been running a record 134,224 contracts net short position on the VIX, and while a jump in the VIX doesn’t necessarily mean the US share market is about to collapse, it can be a fairly strong contrarian indicator.

Bloomberg reported that a “mystery buyer” had bought $US33m of VIX call options with deep out-of-the-money strikes in the 19 to 24 per cent area year to date.

Whether it’s hedging or speculation, buying VIX calls or S&P 500 puts makes sense with the S&P 500 at record highs, Trump’s honeymoon with markets on the rocks and the 35-year rally in bonds over.

Bell Potter’s Richard Coppleson said the S&P 500 rose 9 per cent from Ronald Regan’s election in November 1980 to his inauguration in January 1981, before falling 30 per cent through August 1982.

Of course Trump is strongly pro-growth and business, but Mr Coppleson now warns that the S&P 500 could fall 10 per cent over the next three months.

Of course much will depend on Trump’s announcements. Positive news on tax or infrastructure could delay a US share market correction until the seasonally weak May to September period. Then again if he plays hardball with China on trade or the South China Sea, a pullback could come sooner.