The Way The Fear Blows
You can see our quick review video about where the markets ended up finding support here.
The New “New”
What’s all this slamming dividend payers, rampant chatter about huge internal sector shifts, cries over a dollar getting too strong and bashing Trumponomics as the trigger for the bond bear market?
If all of these are the new fears, what happened to no growth being the fear?
Old Experts are New Experts?
Note how the economic perspective has changed dynamically in the last 10 days.
Prior to election day, a Trump win was a sure bet for a minimum 10% drop in the markets with even more certainty of a recession setting in soon thereafter.
Mrs Clinton was deemed the safe market bet. Sectors lined up for her run into power.
And then: Boom! America spoke. Experts ran back to the drawing board and found a different solution to shout about from the rooftops; inflation fears, trade wars, rising rates and an industrial turnaround.
Nothing new to see here; they just re-painted the old platform.
By example, retail sales, defined as lagging, terrible and a sure sign the Holiday Season would be weak were wrong by about half. They not only beat expectations by a mile for the latest month of data but the sales mark for the previous month was also revised higher by almost double to match year-over-year increases.
And the excuse for doing so was more jobs, better wages, higher salaries and pent-up demand.
A Step Back First
For the sake of clarity we need to understand that interest rates have not been low solely because of slow growth. We’ve had massive fiscal shackles put on a growing economy. Fear is what was keeping rates low.
Add up record high taxes, reams of regulation and massive economic upheaval from Obamacare and you get an economy on fumes; not because of lack of capacity but for lack of desire to build more.
Money tends not go into areas where it is unfairly treated.
High tax rates have once again taught Washington DC a lesson: Tax something too much and there becomes a point where you get much less of it.
The New World of Bonds
Should we be terrified of rising interest rates? Nope.
In fact, the signs that fear is finally thawing and capital is moving from the presumed safety of bonds actually suggests capital is ready to risk again.
And that’s a good thing.
(Just remember: First inning, first batter, long game.)
In the past week bond yields are up sharply, which is great news for the economy and the stock market.
That’s because we suspect it is due to the same types of reasons that markets awoke in the early 1980s.
The roaring energy building from the Barbell Economy and demographic shift underway has finally received a tailwind to offset the headwinds in place for the last eight years.
Bonds are falling because they are beginning to realize that Trump means business, with the notable exception of an ill-advised desire to reduce the U.S. trade deficit by increasing tariffs on imports – this would only punish U.S. consumers.
Trump's economic policies are a welcome breath of fresh air for an economy that has for too long been suffering from crushing tax and regulatory burdens.
And even on the fear of trade wars, it’s highly likely that Trump’s team of economic policy advisors will walk him through a path which will prevent him from making the mistake of starting a trade war.
Also, higher real yields tell us that the market is sensing growth and can improve going forward.
Meanwhile the dollar has risen to the top of its two-year trade range, and that tells us that the U.S. economy is likely to be the most attractive of the developed economies in the years ahead - just as these notes have suggested would happen for, well, years.
Let's Stay Focused
While confidence is in the early stages of finally rising again, and the demand for money and safe assets is beginning to decline, let's make sure we do not get ahead of ourselves.
There is much work to do before things really improve on the surface – you can’t erase eight years of poor fiscal policy and debt accumulation in the first week of a new administration, one that’s still two months away.
Perma-Bears Will Fret
Expect the new wave of things we’ll be told to worry about to include US Fed tightening interest rates and its impact on any budding economic boom and tipping us instead into another recession.
And we’ll hear that the bond market is flashing a big warning - a shot over the bow of Armageddon – version XXXVII: Trump wants to spend too much, and the bond market vigilantes will thwart his bad idea.
We’ll soon begin to learn that the market has not been rising just because of easy money. Stocks would already be down big if it was. The higher interest rates tend to be symptomatic of stronger growth.
Higher rates won't lead to an exploding deficit because the stronger growth that pushes interest rates higher will also work to reduce the deficit by boosting tax revenues. Interest rates have been low because the market has had a very pessimistic view of the future growth potential of the U.S. economy.
Tax Cuts Will Help
President-elect Trump's tax cuts won't explode the federal deficit - they will help boost growth and generate higher revenues. Besides, after all the fretting, the deficit currently stands at a non-threatening 3% of GDP.
Let's remember that today's 35% corporate tax rate has failed miserably to generate revenues because corporations have refused to repatriate more than $3 trillion in offshore profits.
Collecting 35% of nothing is a poor result, yes?
On the other hand, Trump's plan to charge corporations only 10% on their offshore profits is likely to generate even more income to pay for the infrastructure programs too many fear will be inflationary.
Besides, we are forgetting that Gen Y is a major deflationary force (they are experts at it); another good thing and a great offset in the economic growth ahead.
Art Laffer said years ago: "If you tax something less, you can expect to get more of it."
Let's summarize: Bond yields are rising because the market is becoming less concerned about slow growth and more confident that growth will pick up.
The same thing is happening in Japan and in the Eurozone.
Many have overlooked or completely missed that industrial commodity prices are up over 20% in the past year.
Let's embrace this thought through all the mess:
- Global growth fundamentals are improving.
- What scares us today will embolden us and the market tomorrow.
I have said this always:
- bull markets are much tougher to ride than bear markets
- secular bull markets are even worse
- young secular bulls markets play the most head games of all
Fantastic. Pray for corrections.
The Bottom Line?
We're still in the early stages of what could be an ugly market for bonds for a bit, but we're also still in the early stages of Trump's policymaking and transformation process.
I have no doubt that we will need to keep a flexible view and remain focused on the long-term benefits of the Barbell Economy at work.
We should expect to see disappointments and positive surprises along the pathway of repair.
With the generational power shift cycle repeating it’s helpful to keep in mind that Reagan's first year was quite a bumpy ride in several spots as well.
In his first year everyone wanted his head on a platter. The fight against the outsider then was blistering and intense.
Be confident we have been through worse before and built out of it just fine.
We should not fear the shift required ahead as change engulfs and improves the economic demand headed our way, but instead see it as a long-term benefit.