Avoiding politics in finance has become impossible. Analysts usually need to ignore the noise of presidential elections, which often have little impact on the fundamentals of most companies in most sectors. There are, of course, exceptions; both Clinton and Trump made comments during their campaigns that had broad implications for healthcare, financials, and other sectors. And with a Clinton victory baked into stock prices before Trump’s surprise win, there was plenty of volatility in many sectors to come as a result of the surprise upset.
But it hasn’t been all bad. It hasn’t been bad at all, actually. The S&P 500 had its best week in 2 years, and there were only three days for the market to react to Trump. One of the biggest moves has come in the financial sector. The Financial Select Sector SPDR Fund (XLF) rose 11% in a single week—an astronomical gain for a sector ETF. It’s one of the biggest one-week moves in the fund’s history and, as far as I can tell, the biggest one-week move to the upside ever for the fund.
The underlying companies in the ETF are of course driving its gains, and looking at individual firms is also telling. Wells Fargo (WFC) rose 16%. J.P. Morgan Chase (JPM), Citigroup (C), Bank of America (BAC), and Goldman Sachs (GS) also had huge gains—all but C are up over 13% for the week, and C rose nearly 10%.
The possibility that Trump will repeal Dodd-Frank is part of the reason why financial firms are surging, but it isn’t the main reason.
To really understand what’s happening, we need to look at Treasuries. The iShares 20+ Year Treasury ETF (TLT) fell 7% last week. The 10-year Treasury rate soared to over 2% from 1.9% at the beginning of the month—now its highest since November 2015. This is partly in anticipation of the Federal Reserve’s December meeting, which is widely expected to cause the Federal Funds rate to rise slightly. But it’s also in anticipation of a longer-term trend that is expected in a Trump presidency: higher inflation.
The dynamic is complicated, partly because Trump’s own economic plans are unclear. He’s changed his plans, been vague of many details, and made outlandish claims that are difficult for economists to model. But some economists are wading through this morass and have come to the conclusion that, yes, Trump will cause inflation to go up. Whether that is good or bad is another issue.
It’s interesting that Trump is broadly expected to cause inflation to rise. The Fed has been working on getting inflation up for years and has failed to do so. Partly this is because fiscal policy has been contractionary, so expansionary monetary policy has offset the deflationary impact of Congressional gridlock. That gridlock is expected to end, or at least fall back a little, with a Republican majority in the House and the Senate and a Republican president at the helm. This should mean more fiscal action, which in turn should offset the deflationary impact of gridlock over the last few years as Congress has blocked many fiscal plans from the Democrats and Obama.
The specifics of Trump’s economic plans as they are understood will also boost growth in the short term. That’s the conclusion of Goldman Sachs economists, who see a fiscal boost from Trump’s tax reform and infrastructure spending plans in the short term. That short-term boost doesn’t mean Trump is good for America. GS’s economists also say his stances on restricting trade and immigration will be negative for growth over the longer term.
But here’s the key: no matter whether the policies are good or bad for growth on any time horizon, the economists conclude “core inflation and the funds rate are likely to be higher for the next few years in almost all scenarios.” In a bizarre sense, the Fed and Trump will be working together to boost inflation despite Trump’s past criticisms of the Fed. With monetary policy and fiscal policy acting in uniform to increase prices, inflation and the Fed funds rate are destined to go upward.
So why is this good for banks? Remember how banks work: they lend at low short-term interest rates and borrow at higher rates. The spread between what they can borrow money for and the rate they can lend at is their profit margin. If inflation and the Fed funds rate are higher, it will push interest rates up for everything: mortgages, auto loans, and so on. This will increase banks’ ability to make a profit even if the spread between Treasuries and other interest rates remains constant. Why? Because higher interest rates mean they can take on more risk and lend to a larger group of people, expanding their business.
It’s no wonder, then, that financial firms have done so well after a Trump victory. Will it continue? That’s uncertain. But financial firms will likely begin to trade more in-line with expectations for the Fed than anything else as we get closer to December, and then investors will look carefully for any hint of changes to regulation and economic policies that will impact banks in the future.
In other words, analysts will need to be a bit more macro in their thinking, especially when it comes to the financial sector. But analysts in other sectors need to look at the new regime as well and start thinking how policies and ideological stances from a new White House will impact those industries.