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The Market Corner November 2016

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The Market Corner: The Month in Review

 

By: Filippo Lecchini, PhillipCapital

 

Infrastructure spending

 

With the elections gone the market is now fully focused on the guessing game: what is the President elect going to do? Who is going to be on the cabinet? Will he do what he promised? And so on and so forth.

 

One sector certainly has lofty expectations for the new Presidency. The metals stocks have been rallying very hard since the November 8th close, all north of 20%. US Steel is up 46% since the Elections.

 

The general assumption is that a big infrastructure bill might be on the way and all the materials producers like the steel companies will greatly benefit from it. That seems logical but also worth thinking about in terms of indirect effects: iron ore for example, used in the production of steel, is rallying as well benefiting not only the producers but also the shippers, the refiners, etc.

 

As we look at these movements there are two aspects to take into consideration: one is the fundamental component; if the Government spends the money these companies will benefit. One is more technical and specific to the market action we observed; stocks are forward looking instruments so the price incorporates expectations under uncertainty.

 

At some point the technical and the fundamental aspects will have to reconcile and come together. We will know then if the market had anticipated correctly whatever comes next.

 

…and finally rates.

 

The FED Fund Futures are implying 100% probability of a hike in December. This conversation has spanned now several years but what is extraordinary is the idea of a 100% probability. No uncertainty at all?

 

It is hard to believe that such an outcome would be set in stone the way some media make it sound and I wonder what would happen if the FED actually took no action once again. Presumably the equities market would like that, since it had been rallying under the assumption of a hike. But maybe not, since normalization of monetary policy seems like a good idea 8 years after the financial crisis.

 

For those who are interested here is an opportunity to learn how those probabilities are calculated, in this short and entertaining paper:

 

http://www.economics-finance.org/jefe/fin/KeaslerGoffpaper.pdf

 

100% probability might not be accurate after all (does anything in life happen with 100% probability?), but this hike still appears to be very likely.

 

Looking ahead:

 

The Opec Countries meet in Vienna on Nov 30th and the speculations of a production cut are raging.

 

The Federal Reserve meets on December 13th with a decision expected on Dec 14th.

 

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