Tuesday, November 15, 2016

The Trump Trade Is Getting Out Of Hand: Buy Bonds

Markets have already run too far, too fast, and are increasingly vulnerable to any slip as a result.

By James Mackintosh
The Wall Street Journal 
November 15, 2016

It has taken markets just four days to price in four years of President Donald Trump. The verdict of investors isn’t just clear, but comes with a remarkable degree of certainty: more inflation, a little more growth, and no nasties such as a damaging trade war or a diplomatic disaster.

Such certainty ought to worry those thinking of buying in to the idea of a Trumpian reflation of the U.S. economy.

The boost from a market-friendly president-elect may run a while yet if Mr. Trump fills out his transition team with mainstream Republicans, to follow the weekend appointment as chief of staff of Reince Priebus . The danger is that markets already have run too far, too fast, and are increasingly vulnerable to any slip as a result.

Consider one of the most extreme moves—that of the 30-year Treasury. An investor who held on to her long bonds lost 6.6% in three days, the worst performance in data stretching back to 1989.

Don’t get me wrong, the direction of the move makes perfect sense. Mr. Trump’s transition team’s unfunded pledge to spend $550 billion on infrastructure would boost borrowing and, by creating jobs at a time of near-full employment, contribute to inflation. Add in big tax cuts for the rich, and it is easy to see why investors increasingly think three decades of falling bond yields may be over. Bonds are less attractive with the prospect of more borrowing and more spending, which means lower prices and higher yields.

But the key word is “prospect.” Consider just the infrastructure program. There is no word from Team Trump on how swiftly that money will be spent, but it will surely be spread over many years. A pre-election plan from two of his advisers suggested $1 trillion over 10 years, but with only $137 billion of government money in the form of tax breaks for private investors.

Looking on the bright side and assuming all that is new money, that would mean $100 billion of extra infrastructure spending each year, an increase of a bit less than 25% of what federal and state governments spend each year on transport and water infrastructure alone. Anyone who has driven around the U.S. knows the money is desperately needed, but $100 billion amounts to only 0.5% of GDP a year.

Investors who are less hopeful might assume that a lot of this spending would have happened anyway. Even without being cynical, a look at the American Recovery and Reinvestment Act of 2009 shows that spending infrastructure money quickly is hard: More than a year into President Barack Obama’s stimulus, less than one-third of the money allocated for transport infrastructure had been paid out. As Mr. Obama admitted to the New York Times in 2010, “there’s no such thing as shovel-ready projects.”

Staying positive, perhaps a president with a history of building towers, casinos and golf courses can quickly funnel money into the right roads in the right places. Maybe a real-estate mogul can get shovels into the ground more quickly than a civil-rights lawyer, but it won’t be instant.

All of this, of course, assumes Congress passes a new spending bill and tax cuts swiftly after Mr. Trump takes office on Jan. 20. And even then the markets seem to be assuming a lot.

Consider just some of the price shifts since the election. Shares in companies that should benefit from infrastructure spending have soared. U.S. Steel is up more than 30%, the price of copper leapt around 6% and the FTSE USA construction and materials sector had its biggest two-day jump since the Obama stimulus spending was getting under way in April 2009.

Markets could still get a lot farther ahead of themselves, as traders who missed out try to join in. Investors have made a bigger bet on inflation than growth; inflation-linked 10-year TIPS yields leapt Monday to 0.405%, but are up by much less than ordinary Treasury yields and still half what they were at the start of the year.

The rest of the Trump trade is already stretched, though. Moves based on hope are particularly vulnerable to any sign that they might be wrong, and the bigger the move, the more vulnerable they become. This has been a really big move in a very short time, and the risk is growing that comments by Mr. Trump will be taken badly by investors.

A 10-year Treasury yield of 2.224% may not be appealing to hold for the long term, but it is the highest this year and would provide a handy cushion when, and if, hopes of a Trump boom take a hit.

Article Link To The Wall Street Journal: