Sturdy bull market

Long-term bull markets, especially those that have lasted for 35 years, aren’t to be killed off by the election of a potentially more erratic president, at least not in one go. They retain an inherent strength that has to play out over time and if anything slowly reverse course. They are like supertankers that can’t just be turned around in a heartbeat. The US Treasury market is exactly such a beast.

I know, I know… the bears can no longer wait. Particularly over the past 3 years now the pundits have prominently and repeatedly called for the end of the great bond bull run. And they have always been disappointed. But this time is finally and definitely different, or so they say. Donald Trump will spend like there is no tomorrow, drive growth and with it inflation. The Fed will be forced to bring rates up, and voila…

But how many times have we had a scenario like the one of the last 3 weeks, as in the world calling for the bull market to be over, in the past 35 years? In the mid-80s when Reaganomics first started to bite and pushed growth up, in the early 90s when we came out of a recession, at the turn of the century when the tech bubble burst, in 2009 at the height of the financial crisis when deficits ballooned, or in 2013 when Bernanke called the taper…?

In other words, massive corrections such as the one we have experienced post the Trump election are anything but new and should not be surprising. In fact, they are part of a super-bull run that have traditionally fuelled it even further. And the more the mainstream pundits jumped on the notion of but-this-time-it-must-be-over, the more they have been proven wrong, or should we say continuously embarrassed.

As long as they keep losing their own money and no their clients’ on such short trades, it will be fine. Unfortunately, they may well be stepping into the very same trap and fall victim to their own misinterpretations yet again. This is not to say that a Trump presidency does not have all the signs of an short-term boost by way of infrastructure spending and the potential creation of an inflationary blip.

The markets over the past 3 weeks have nicely reflected on all these expectations. Stocks, particularly Trump-themed ones, have been rising considerably, 10 year Treasury yields have shot up almost 100bp from their lows in July, the dollar surged against everything, and EM had to take a beating. That was all playing out in the run-up to Thanksgiving. But what will happen from here?

In conversations with people managing macro- and credit funds it was confirmed that many of them had been carrying forward decent performance numbers into the US election. The widely unexpected Trump win made them act quickly however. Risk was cut, rates hedged, and EM in particular liquidated at all cost causing quite a dislocation in some of the high yield paper.

There seems to be no one out there who want their portfolios to be exposed to undesired volatility so close to the year end. The hedges of the real money accounts are mostly in I gather, and the short-sellers out there are likely to be impatient when it comes to covering their positions. And you will have observed that the decisive moves before Thanksgiving aren’t the moves post Thanksgiving.

Has the Trump trade run out of steam? Well, for now I believe that is the case. Sobriety appears to be returning after the initial exuberance about anticipated miracles of the incoming administration. Reflation is a big word, and a much desired paradigm for that matter. But will it happen to an extent that justifies a continuation of the Trump trade? Well, people have certainly had their fair share of optimism.

The big question now is two-fold. The one leg of it is whether president Trump will be able to pull it off in the first place. His willingness to spend heaps of money is not enough. Congress will have to pass his proposals, and while he’s been grooming Democratic leaders in both House and Senate from an early stage, he will need to win his own party over and actually get it done. With America sporting a deficit of over 3% this will not be a walk in the park.

The other is whether whatever he can do is sufficient to have the entire economy catch on to it. The underlying momentum remains weak, and the structural macro shift may quickly eradicate any one-time effects that the new government may be able to pull off. Expectations are so high that any doubts creeping in on the miracle will have markets reverse course immediately.

Also, against this background and despite some better revised GDP numbers in Q3, a recession next year can still not be ruled out. Q4 is expected to come in much more moderate again. Remember, we don’t live in cycles any longer. Today’s changes are structural. Demographics have mostly taken over in the Western world, and a less global economy advocated by the next US president isn’t going to help either.

Imagine the Fed in a situation that requires fiscalflation to counter a potential recession. The December hike is a done deal and can for now be justified. Janet Yellen will probably not be re-nominated. There will be volatility by Trump appointing 2 new voting members. Further quick hikes and signalling a true sea change bear the risk of driving financing costs through the roof. And the Fed may have to back-paddle if the Trump kool-aid doesn’t work.

Until such time of further clarity Treasuries are likely to recover and eventually mean-revert, i.e. long yields should continue topping out and come under pressure again in coming weeks.