Investors are doing what investors always do, “Buy on the rumor and sell on the news.” Months before Donald Trump is president and living in the smallest home he has ever owned, investors are aggressively rebalancing their portfolios. Stocks of banks and brokerage companies rallying into the double digits since the election included JP Morgan, Wells Fargo, and Schwab. On the sell side are stocks of gun manufacturers as the fear of losing gun rights have abated. No doubt there will be more stock portfolio rebalancing as rumors circulate on changes in many other industries that include medical, biotech, transportation, energy, building, and lending.
However, it’s the conservative investor that should be the most worried. As analysts predict more pro-growth legislation out of a Trump presidency, the Federal Reserve’s almost decade-long concern of disinflation has switched their attention to the risk of rising inflation above their benchmarks. Traders perceived last December’s rate increase by the Federal Reserve as short lived due to a stagnant economy and low inflationary trends. However, traders appear convinced that President Trump and Congress will pass pro-business policies that will prompt economic growth and produce inflationary pressures on prices (a stark reversal of predictions only a week ago). Overnight analysts became convinced the Federal Reserve will not only raise the discount rate in December but maybe several more times in 2017. A steady rise in rates will most certainly end the nearly 30-year bond rally (bond prices correlate opposite to interest rates). Below is a chart of Barclays Aggregate Bond ETF (AGG) and National Municipal Bond ETF (MUN) for the past month.
As illustrated, since election day bond prices in the past week have erased almost 50% of this year’s gains. The precipitous decline is probably overdone, and a modest bounce back may be experienced. However, since 2010 bond traders have been forecasting not if, but when bonds will begin a multi-decade decline in prices as rising inflation prompts regular Federal Reserve interest rates hikes (Ben Bernanke raised the discount rate 16 times in the late 1990’s).
To know where you are going you need to know where you have been. In 1958, the economy was in a similar bull market comparable to the 1982 – 2000 bull run. The end of WWII (1945) was the year the 10-Year Treasury Yields bottomed below 3%. However, all bull markets eventually end. In 1960 John F. Kennedy won the presidential election on a pro-growth platform, and as his administration tried to stimulate the economy, the Federal Reserve was raising rates to keep inflation within their benchmark range. Then began a long, unfortunate series of events that resulted in unprecedented volatility 20 years. President Kennedy is assassinated (1963), President Nixon removes the US currency off the gold standard (1972), OPEC Oil Embargo (1973), President Nixon impeached, President Carter, and Iran hostage crisis (1978) just to name a few. The DJIA that peaked at an all-time high of 1,000 in 1966 began a series of 50% market crashes and then rallying back 100% six times from 1966 to 1982 (see DJIA chart).
The Federal Reserve is trying to navigate through cycles of hyperinflation by implementing aggressive rate increases that pushed the 10-Year Treasury yield from 3% to 15.84% in 1981 and the Prime Lending rate to 21.5% (1980).
Now 58 years removed from 1958, the US economy is in different circumstances but similar to 1958 in that we may be at the threshold of another long-term interest rate rally. What can we learn from this past era and what should investors be considering for their portfolios?
Don’t let me lose you here, and if I do please ask questions below and I will help clarify for you.
JP Morgan provided us the below chart illustrating the rise and fall of the 10-Year Treasury and compared the returns of Corporate Bonds vs. S&P 500 from 1958 to 2012. During the cycle of rising rates (1958 – 1982), the annualized average total return of corporate bonds (dividends plus appreciation) was 3% and well below the average annual inflation rate of 5%. Meanwhile, the S&P 500 experienced an average annualized total return of 8.6%.
WHAT DOES THIS MEAN TO ME?
It amazes me that on election night millions of Americans crash the Canadian immigration site seeking enrollment applications, LOL!. The DJIA futures market plunged over 800 points as traders sold off on fears (ie., speculation) that a Trump presidency would cause massive civil unrest and economic collapse. Twelve hours later seemingly all concerns had vanished, and the DJIA opened nearly even. Investors continue their buying and rallied stock prices through Thanksgiving based on, you guessed it, *speculation* that economic conditions will be improving in 2017 along with corporate profits.
Whether Trump’s policies produce more economic growth or not, it is clear the Federal Reserve wants to raise rates. Last December the committee raised the Discount Rate 0.25% and stated their goal of four more rate increases in 2017 (none so far). If interest rates begin to rise steadily, then we should anticipate bond prices to decline, and the S&P 500 to outperform. Investors looking for income should consider instruments that rise with inflation and interest rates such as Treasury Inflated Protect Securities (TIPS) and floating rate funds. From 1973 to 1982 energy stocks provided competitive dividend yield, and the stocks rallied with the rise of oil prices. History is a terrific starting point in formulating a future strategy, and we will dive into more details from this era as events continue to develop from Washington!
What are your thoughts about the Trump presidency from an economic perspective? Are you a buyer or seller? Are you hopeful or fearful? Let us know, we would love to hear from you!