The Trump Stock Market Rally Is About to End

Hands holding a piggy bank and a house model
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Stocks are up again. But one Sydney fund manager isn’t quite so bullish.

According to Bloomberg:

The S&P/ASX 200 Index’s 12 percent surge in just two months has sent the relative-strength indicator to the highest level since August, signalling the rally may have gone too far, too fast. That’s prompting Shaw’s Sydney-based Karl Goody to cash in on gains made since buying in mid-November so he can redeploy money after the pullback he expects in shares.

“I’m still pretty cautious,” said Goody, who helps oversee about $A10 billion as a private wealth manager at Shaw. “You’re going to see some profit taking over the next few days, even if it doesn’t become a more sizable sell-down.”

Reason to worry? Could be. Your editor’s crash alert remains on a high.

We can’t help but feel that the Donald Trump-driven stock market rally is one of the longest episodes of ‘buy the rumour, sell the fact’ in stock market history.

The US S&P 500 index is up nearly 9% since the November low. It’s trading at or around a record high. The market seems convinced that a Trump presidency will result in newfound riches for the American economy.

But what if it doesn’t? What happens on 20 January, on Trump’s first day in the White House? Will the economy magically sparkle?

We’re not convinced. The stock market has rallied in recent months in the expectation of radical things happening under Trump. But once he’s in office, get ready for the big sell-off to begin.

The way we see it, the biggest stock market boom from the Trump presidency has already happened before he takes office. From 20 January onwards, it will be all downhill from there.

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Controlling the housing market

In Tuesday’s Port Phillip Insider we made the point that, although Aussie governments have helped inflate house prices for 30 years, there’s no guarantee they will continue to do so.

The government has helped boost house prices because it’s in their interest.

If something happens which causes high house prices to no longer be in the government’s interest, the bubble will pop — or at the least, deflate gradually.

For the moment at least, that may not be likely. The inseparable link between house prices and the banking system is the single biggest reason why governments encourage housing bubbles.

If house prices collapse, the loans against those houses go sour. Folks are in negative equity. They can’t sell in order to pay off the loan. If they don’t have the income to cover the mortgage, due to an economic downturn, the banks won’t make back the money they’ve loaned.

If that happens on large enough a scale, it would be bad news for the banks. You would be looking at US, UK, and European-style banking bailouts.

And if you think it couldn’t happen in Australia, remember that if it wasn’t for the Commonwealth Bank of Australia’s [ASX:CBA] takeover of BankWest in 2008, Australia would likely have experienced a domestic banking collapse.

Back to our point, governments have only propped up the housing sector because it has been in their interest to do so.

But what happens when it’s no longer in their interest?

Our bet is that that time may soon arrive. And if we’re right, it will coincide with the wave of Baby Boomer retirees, as they shift from oversized three and four bedroom homes, to more manageable one and two bedroom homes.

As we pointed out, many Baby Boomers want to downsize so they can access the monetary value of their homes. Many who have minimal savings believe that their home is their ‘retirement fund’.

Trouble is, downsizing doesn’t provide the cash injection that most think it will. To stay in the same area, a one or two bedroom home may only be 10–20% cheaper than the large family home they’re selling.

Deduct the costs of buying and selling, and the cash injection they expected may turn out to be hardly worth the effort.

Our guess is that when enough Baby Boomers start grumbling about this fact, added with the number of younger folks who complain they can’t afford to buy an entry-level house, a future Australian government will have no qualms about taking a populist approach.

That is, they’ll introduce price controls on housing. Or rather, on specific types of housing. Sound unlikely? Don’t be so sure about that.

We were intrigued today by an interview in the Australian Financial Review with economist Steve Keen.

Keen believes Aussie house prices are in an extraordinary bubble. He believes that, sooner or later, there will be a house price crash.

However, Keen also believes there needs to be a complete reform of the banking and debt system, which will help make housing bubbles a thing of the past.

See what we said about the link between banks and housing.

To excerpt from the article:

So how do modern, monetary economies escape the spiral of ever higher debt? Keen believes there needs to be a reset of private debt levels via a “people’s quantitative easing” — effectively, a government bailout of households — to something more in the order of 50–100 per cent of GDP, from around 120 per cent now.

Under the plan, the banks would be instructed to use the government cash injections to pay down the account holders’ existing debt. If a person had no debt, then they would simply receive the cash.

He says the initial instalment should be larger than, say, the $1000 Rudd stimulus package, but not by much. “In anything like this, which hasn’t been tried before, I would want to do it in small doses,” Keen says.

What is then needed involves radical but simple regulatory reform of the banking sector.

“What I want to do is bring in a range of bank rules which would limit the amount of lending you can give against an asset to some multiple of the income-earning capacity of the asset.”

Keen gives the example of a property with an estimated or actual annual rental income of $50,000, in which case the loan limit could be $500,000. Now the bidder for a house ready and nominally capable to take on the most debt wins.

Under Keen’s prescription, both are limited to how much they can borrow, which means the bidder with the most savings is the one who wins.

We’re not sure the conclusion on that is true. The winner will be the bidder who is prepared to pay the most. It’s entirely possible that someone with greater borrowing capacity would choose not to use it.

In which case, the bidder with most savings withdraws, allowing the bidder with less savings to buy up to their maximum limit.

The point here is that this won’t be the first or last time that you’ll see commentary in the press about capping borrowing. And by natural extension, if the proposal is to cap borrowing, it must also cap house prices.

Whichever way you look at it, it will be an attempt at price controls. If that happens, the ‘golden age’ of Aussie house price rises will be over.

The debt binge will come to an end. The current banking system as you know it will come to an end.

The only matter is when. When will this all happen?

Ah, if only we knew.

Regards,

Kris Sayce,
For The Daily Reckoning

Kris Sayce
Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Daily Reckoning e-newsletter in 2005. He is currently the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service — Money Morning.
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