Have you noticed the move in the 10-year Treasury since the election? While we forecasted that the yield curve would steepen, we did not expect the 10-year rate to breach 2.30% so fast. In fact, we are revising upward our earlier forecast that the 10-year rate would reach 2.5% in the first half of 2017.
Have you also noticed the move in the dollar since the election? It has risen to a 13-year high! While we have been steadfast dollar bulls, we did not see a move of this proportion coming so fast.
Have you noticed the global stock markets since election? The U.S market has hit new highs; the European and Japanese stock markets have all risen dramatically while the Emerging Markets are taking it on the chin.
What does all of this mean? Reflation is in the air!
Let's look at the other data points this past week supporting this view:
- Trump and his team are already working on plans for major tax reductions, repatriation of foreign cash, huge increases in infrastructure spending, reductions in regulations including Dodd-Frank and ObamaCare, changes in trade agreements and immigration policies. He will hit the ground running after inauguration. Many Democrats appear to be coming on board, too.
- Japanese and European bond yields turned positive. Both the ECB and BOJ reiterated that they would continue with aggressive monetary ease, buying all bonds to suppress the yields from what they otherwise would be supporting a lower currency and economic growth.
- There is almost total certainty that the Fed will hike rates in December, which is now considered a positive as it supports the view that reflation and a stronger economy are on the horizon. Yellen's Congressional testimony confirmed that the Fed would stay behind the curve letting the economy get hot.
- Industrial commodity prices moved up dramatically while oil prices languished due to continued doubts that OPEC will cut production. Remember the low oil prices boost economic growth as it increases consumers' disposable income and corporate profitability.
- Stock leaderships has shifted to beneficiaries of economic growth with rising prices and sold the old winners. Paix et Prospérité anticipated these shifts, positioned our portfolios accordingly and continue to significantly outperform the averages. Financials have appreciated rapidly to over 22% of our portfolios from 18% just four weeks ago. Have you also noticed the huge move in the transport index?
- German Chancellor Merkel is on the defensive as the populist movement gains momentum throughout Europe boosted by a Trump victory. We expect many European countries to ease fiscally boosting the near term deficits despite resistance from Germany. Watch the upcoming elections in Italy and France. We believe that forecasters of European growth are looking through the rear view mirror rather than the front windshield and will be raising their 2017 and 2018 economic forecasts.
- Recent economic statistics in the U.S have been surprisingly strong boosting fourth quarter growth estimates near 3%.
- There is a growing sense of optimism building in the United States that better days are ahead led by a Trump administration. We expect the same mind shifts to occur overseas. Can you imagine this positive impact on global growth?
- The huge shift out of bonds, risk off, into equities, risk on, is in its early stages as we mentioned last week. Stocks are still under owned as an asset class and bonds over owned. Stay the course -buying beneficiaries of reflation and don't trade out of your positions.
Let's wrap this up.
The Trump victory has surprisingly been a breath of fresh air for business, individuals and the financial markets. The pundits, along with investors, were looking in the rear view mirror rather than through the front windshield and totally missed the rise in populism with all its implications. The masses were left behind by the fiscally conservative government policies of the last few years including excessive regulations.
The pendulum has now begun to swing the other way as monetary policy has done all it can do to stimulate growth. The baton is finally being picked up by governments to adopt policies for growth including less regulations. Monetary stimulation for years was offset by mandated increases in the capital ratios of banks with one offsetting the other.
Therefore, there has been little, if any, growth at all over the last few years. That is changing. You will have both monetary and government policies finally going in the same direction, which will lead to more growth, more jobs, more inflation, higher interest rates and much higher profitability.
It's time to look at stock valuation. It is clear that the 10-year bond will break 2.5% next year. It is equally clear that if Trump lowers corporate taxes from 35% to 20% that base S&P earnings would be boosted 10%. If you assume that the 10-year bond hits 3% and S&P earnings hit a run rate of $138 per share by year end 2017 then the market could sell at 2346 up from 2182 today, up another 7.6% plus dividends.
We buy stocks, not the market, that significantly outperform the averages. Invest in those companies that will benefit from reflation and an accelerating economy with rising volume, prices, operating margins and much higher earnings and cash flow far above the average stock. Sell/short the old winners that will sustain earnings growth but well beneath that of the S&P. Own stocks that will have earnings growth in excess of the decline in market multiple which will occur as interest rates slowly rise. Clearly these are the reflation beneficiaries including cyclicals, industrials, industrial commodities, financials, transportation and technology.
I want to close with a final comment that the trend is your friend. George Soros' success was due to correctly identifying a trend, increasing his winning exposure as events supported that trend and not trading out of his positions until near the end of the move. He was quick to reduce and even totally reverse his exposure too if events no longer supported his position. I watched and learned so much from him for which I will be ever grateful. Paix et Prosperite successfully utilizes many of the same tools as the Quantum Fund.
So remember to review all the facts; step back, pause and consider mindset shifts; look through the front windshield when considering asset allocation and risk controls; do independent research on each investable idea and…Invest Accordingly!