It is undoubtedly the cleanest trade out there in the world today. Of all the momentous changes in the prospects for asset classes as a result of the presidential election, bonds absolutely top the list. And not just US bonds, but German, Japanese, British, and every other kind of bond out there in the world as well are exiting a 30-year bull market and entering a 20-year bear market.
Fixed income instruments are totally toast for the next four and possibly eight years. Indeed, the list of reasons is so long that I'll have to list them one by one.
1) The hallmark of Trump's economic policy revealed so far is to lift the economy out of the mire by launching a massive round of deficit spending. Independent analysis predicts that the US national debt could rise by as much as $10 trillion over the next decade. That's what a massive tax cutting, spending rises gets you. Call it Reagan 2.0.
Even if the Federal Reserve does nothing, this unprecedented issuance of new government paper will crowd out private borrowers and drag interest rates upward, to the detriment of bond prices and borrowers everywhere.
2) The bond market was already in trouble well before the election. Prices peaked in July, and have been steadily eroding since. Every bond position I have strapped on since then has been from the short side.
This was because the world was assigning a growing probability of a Fed interest rate hike at their December 14th meeting. You could see this in the way bank shares traded which started moving off of multiyear bottoms during the same time period.
All the election did was pour gasoline on a small fire that was just starting to build.
3) After hiding in a deep cave for the past nine years, inflation is about to make a dramatic comeback. It was already starting to edge up with recent economic reports. The October Nonfarm Payroll Report showed us that hourly earnings leapt by 2.9% YOY, while the headline U-6 structural unemployment plunged to only 9.5%.
And here is the problem. If you initiate a huge new jobs program with weekly jobless claims already at a 43-year low, wages will take off like a scalded chimp. Oh, and by the way, wages are the largest component in any inflation calculation.
4) Years of zero, or subzero, interest rate policies from central banks around the world have created a substantial malinvestment bubble in all fixed income assets. As a result, the relative valuations have reached ludicrous levels.
The S&P 500 (NYSEARCA:SPY) is now trading at 18.5 times earnings, and possibly 17 times 2017 earnings. US Treasury bonds (NYSEARCA:TLT) at a 2.20% yield are trading at an amazing 45 times earnings. Yes, the liquidity and risks are better for bonds, but they are not THAT much better.
This sets up the mother of all asset reallocations, out of the worst yielding financial instruments in the world into the best.
5) After spending 50 years in the financial markets, I can describe to you a problem that I have noticed from the very start. Institutional investors keep their foot firmly on the gas pedal while only looking in the rear view mirror.
Call it the herd instinct, safety in numbers, or lack of imagination, but portfolio managers, by definition, ALWAYS overweight the wrong asset classes at market tops, and underweight the right ones at market bottoms.
Making matters worse is the fact that these institutions move with the speed of molasses in the dead of a High Sierra winter. Some entertain changes in sector and asset weightings only once a quarter while others do it annually.
Yes, this means they can minimize tax bills. But it also assures that they are perpetually behind the curve. When the memo gets out and real changes DO occur, they unfold over years, if not decades.
Every institution in the world is now overweight bonds and underweight stocks. Guess what happens next?
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.