Text size

“We are in a big, fat, ugly bubble.” So said Republican presidential candidate Donald J. Trump about the stock market in his first debate in late September against Democratic challenger Hillary Clinton.

Since Election Day, what’s being called the Trump Rally has sent the major U.S. stock indexes to records and has added approximately $1.5 trillion, or 6%, to the value of listed equities, according to Wilshire Associates. That includes a 1.25% gain Wednesday worth about $325 billion with the Dow Jones Industrial Average, the Standard & Poor’s 500 and the Russell 2000 small-stock index all setting records.

“The only thing that looks good is the stock market,” Trump also said in that debate back then. “But if you raise interest rates even a little bit, that’s going to come crashing down.”

The Federal Open Market Committee meets next week and a 25-basis-point (one-quarter percentage point) increase in its federal funds rate target is the one prediction that can be safely made in this year of stunning surprises. The fed funds futures market puts a 93% chance of such a hike, to a 0.5-0.75% range.

The greater threat to the stock market was the specter of rising intermediate- and long-term interest rates, which are set by the bond market. Since Election Day, the benchmark 10-year Treasury note yield is up almost exactly 50 basis points, at 2.35%. That’s also a hair less than a full 100-basis-point jump from the lows touched after the surprise vote in late June by the United Kingdom to leave the European Union.

So, if anything, the “big, fat, ugly bubble” in the stock market has gotten bigger, fatter and uglier. And that is notwithstanding a surge in bond yields, which failed to bring the stock market “crashing down.”

Clearly, the stock and bond markets anticipate greater growth in profits and the economy in general as the result of the tax cuts, increased federal spending and easing of growth-hindering regulations. That, in turn, would mean less reliance on monetary policy to sustain growth.

We’ll see if those expectations play out—or remain flummoxed as so many other predictions this year.

So far, at least the markets appear to be downplaying the potential threat from protectionist actions such as punitive tariffs. For now, Trump can claim the public relations win in persuading Carrier from moving a factory to Mexico from Indiana, with the help of incentives from Indiana, where Vice President-elect Mike Pence still is governor.

Meanwhile, Trump again tweeted his administration will declare China a “currency manipulator” as part of his campaign to narrow the U.S. trade deficit. The latest data also show, once again that, notwithstanding the president-elect’s assertions, China currency manipulations have been to support the yuan in order to slow its decline—and not to drive it lower.

China this week reported a massive $60 billion plunge in its currency reserves for November, which followed a $46 billion drop in October. From its peak in mid-2015, China’s currency reserves have shrunk by a nice, round $1 trillion, to just over $3 trillion.

That’s still a massive cache of reserves. But that Beijing has had to spend so much of it shows the massive waves of capital outflows, which are far in excess of China’s current-account surplus.

Starting with the steep fall in August 2015, the yuan has declined from approximately 6.20 to the dollar, to 6.90 at its weakest point last week, and to around 6.88 currently. That move should be seen in the context of an appreciating dollar. While the Chinese currency has dropped more than 10% against the greenback, the U.S. Dollar Index has appreciated by over 5% during that time.

The fact remains the yuan is overvalued and the Chinese public knows it. Beijing has to resort to controls, such as a $50,000 per year limit on purchases of foreign currencies. Much of the capital flight also comes from businesses that had borrowed in dollars in the expectation of a stable yuan exchange rate. The weakening of the Chinese currency increases the burden of dollar debts, so they buy up greenbacks to pay back the loans. There are reports some companies are encountering difficulties in obtaining the foreign exchange for debt repayment or other purposes.

Trump’s badmouthing of the stock market during the campaign was understandable. There isn’t any argument here that easy monetary policy and low interest rates have inflated the value of equities and other assets, from real estate to collectible automobiles to art.

But Trump’s continued threats to label China as a currency manipulator could have more serious consequences. Whether he makes good on them is another matter.

Naming Iowa Gov. Terry Branstad as ambassador to China shows the president-elect’s sensitivity to U.S.-China trade, however. Not only is the Iowa governor said to be a friend of Chinese President Xi Jinping, his state’s main business, agriculture, also is key in U.S. trade with China.

As with another president, investors may do better to watch what they do, not so much what they say (or tweet).

Email:randall.forsyth@barrons.com

Follow Barron’s on Twitter

Like Barron’s on Facebook