The 'Trump Trade' Reversal Could Now Be Here
Registration is now open... One of the most important trends in the world today... The Federal Reserve wakes up to inflation... A bond market 'massacre'... The 'Trump Trade' reversal could now be here... P.J. O'Rourke: Taking out the regulatory trash...
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It's one of the most important trends in the world today...
For the first time in years, price inflation and economic growth appear to be accelerating in the world's major economies at the same time. And the recent election of Donald Trump – who has promised the most dramatic policy changes in a generation – has only increased expectations of higher inflation here in the U.S.
But we're not alone in watching this trend...
Yesterday, the Federal Reserve released the minutes of its December policy meeting...
As we noted at the time, the Fed decided to raise rates for the second time in a decade.
This wasn't a surprise... But the minutes released Wednesday did show the Federal Reserve may be shifting its stance on inflation. As Bloomberg reported...
Federal Reserve officials focused on the impact of potential fiscal stimulus during their December policy meeting, with many starting to worry that the central bank might eventually be forced to quicken the pace of interest-rate increases to head off higher inflation.
Almost all the participants "indicated that the upside risks to their forecasts for economic growth had increased as a result of prospects for more expansionary fiscal policies in coming years," read the minutes of the Dec. 13-14 meeting of the Federal Open Market Committee, released Wednesday in Washington.
In other words, the Fed agrees that Trump's proposals to reduce taxes, cut regulation, and boost government spending – if successfully enacted – could cause inflation and economic growth to rise much faster than previously expected.
Of course, it's not yet clear if Trump will be successful.
Even with Republicans controlling both houses of Congress, it's not certain he'll be able to do all he has promised. And the U.S. experience with "stagflation" in the 1960s and 1970s shows higher inflation doesn't necessarily lead to a booming economy (or stock market).
But higher inflation could be devastating for the bond market...
This is because interest rates tend to rise with inflation, as investors demand higher yields to compensate for the loss of purchasing power. (Remember, bond prices fall as interest rates rise.) And right now, bond investors are more exposed to the risks of higher interest rates than at virtually any time in history.
If inflation begins to rise significantly, bonds will plummet.
But according to Paul Schmelzing, a PhD candidate at Harvard University and a visiting scholar at the Bank of England, inflation isn't the only concern for bond investors today. He says he has studied nearly 800 years of data, and he believes a bond market "massacre" is approaching. As Bloomberg reported...
Schmelzing, whose research focuses on the history of international financial systems, divided modern-day bond bear markets into three major types: inflation reversal of 1967-1971, the sharp reversal of 1994, and the value at risk shock in Japan in 2003.
The current bond market is facing the "perfect storm" of potential steepening of the bond yield curve, monetary policy tightening, and a multi-year period of sustained losses due to a "structural" return of inflation resembling that of 1967, he said. Last quarter was the worst for government bonds since 1987, according to data compiled by Bloomberg.
"By historical standards, this implies sustained double-digit losses on bond holdings, subpar growth in developed markets, and balance sheet risks for banking systems with a large home bias," Schmelzing said.
While bonds are likely headed much lower over the next several years, we believe a rally is likely in the near term...
Treasury bonds in particular became incredibly oversold late last year, and investors turned as bearish as they've ever been. As we noted in the November 22 Digest...
It appears virtually everyone believes rates can only go higher – and bonds can only go lower – from here. This represents a dramatic shift from just a few months ago, when most folks believed the opposite was true.
It makes us uneasy. When sentiment becomes this lopsided, it's often a sign a reversal is imminent... at least in the short term.
Of course, that's exactly what happened this summer. Government bonds in the U.S., Europe, and Japan had soared to record highs... Yields on vast swaths of this debt plunged into negative territory... And investors were piling into bonds like there was no tomorrow. Then bonds plunged...
As you can see in the following chart, Treasurys – as tracked by the iShares 20+ Year Treasury Bond Fund (TLT) – quietly bottomed in mid-December and have been moving higher ever since. TLT jumped another 1.3% to a new multiweek high today...
We could be seeing the first signs of a reversal in other "Trump Trade" assets, too...
Gold and silver also plunged following November's election. And by some measures, precious metals investors were even more bearish last month than they were in December 2015... just before the new bull market began.
Like bonds, both gold and silver bottomed in mid-December and have been moving higher since. Today, gold jumped nearly 1.5% to a new four-week high...
Meanwhile, the U.S. dollar – which has soared following Trump's victory – is now falling...
The dollar fell more than 1% today... This is a relatively large move for a major currency, and it marks the biggest decline since the dollar began rallying following November's election...
One last note...
Be sure to read below the mailbag for another can't-miss essay from Digest contributing editor P.J. O'Rourke. In his latest installment, he "takes out the regulatory trash"...
New 52-week highs (as of 1/4/17): Automatic Data Processing (ADP), American Financial (AFG), American Express (AXP), Boeing (BA), BP (BP), CommScope (COMM), WisdomTree SmallCap Dividend Fund (DES), WisdomTree Japan Hedged SmallCap Equity Fund (DXJS), BlackRock Floating Rate Income Strategies Fund (FRA), PureFunds ISE Mobile Payments Fund (IPAY), ProShares Ultra Telecommunications Fund (LTL), PNC Financial Warrants (PNC-WT), and W.R. Berkley (WRB).
In the mailbag, one subscriber took our advice on American Express (sort of). Send your questions, comments, and complaints to feedback@stansberryresearch.com. As always, we can't provide individualized advice, but we read every e-mail.
"You asked if we bought it? You damn right I did. Well, kinda sorta... I bought two Jan. 18, 2019 $75 Calls. I'm up 240.73% exactly at the end of today's close. I know you'd suggest I sell half my position now, but I think I'll let TradeStops handle that. Thanks guys." – Paid-up subscriber Matt E.
Regards,
Justin Brill
Baltimore, Maryland
January 5, 2017
Taking out the Regulatory Trash
A lot of government regulation is about to be swept away.
President-elect Trump has promised a regulatory cleanup. Republicans in the House and Senate tell us they're ready to wield the broom. And a Supreme Court with a soon-to-be conservative majority will make sure to put the lid on the trash can.
Or so we hope...
Government regulation is hard to get rid of. The Code of Federal Regulations (CFR) is the list of all the rules, directives, standards, edicts, and commands put into force by all the federal departments, agencies, sub-agencies, and commissions.
The CFR has grown from 71,224 pages in 1975 to 178,277 pages in 2015. The number of pages dipped slightly after Republicans took control of Congress in 1995 and plateaued a bit during the first part of the Reagan administration. But if the CFR were a blue-chip investment and its page length were its value... you'd be a happy trust-fund baby.
One problem with eliminating government regulations is that nobody seems to know how many government regulatory agencies even exist.
The Administrative Conference of the United States, a federal agency tasked with keeping track of federal agencies, says there are 115.
The Freedom of Information Act website maintained by the Justice Department lists 252.
The Federal Register Index records 257.
The count in The United States Government Manual is 316.
And testimony at a 2015 Senate Judiciary Committee hearing claimed there are "over 430."
If you're going to take out the garbage, it helps to know where the garbage is. Government bureaucracy seems to have been having a wild party and dumping its regulatory cigarette butts, Solo cups, and empty beer cans in the chandelier.
But there's another problem with eliminating government regulation, a problem that's more fundamental.
Politicians – left, right, and middle-of-the-road – don't understand that government regulation is a just-plain-bad idea.
The purpose of government is to protect persons and property. This requires about two laws – laws that have existed since time immemorial. They're right there in the Ten Commandments, No. 5 and No. 7: "Thou shalt not kill" and "Thou shalt not steal." And for the sake of sanctity of contract, let's throw in No. 8: "Thou shalt not bear false witness."
That's the law. And that's all we need. Regulation is a lot of screwing around with the details.
A regulator is somebody who tells you you're not allowed to kill and you're also not allowed to kill during months with an "R" in them. A regulator isn't satisfied with stealing being forbidden. He makes a list of what you're forbidden to steal – including, but not limited to, everything from aardvarks to zymometers. The law says you can't lie. The regulator says, if your socks match your tie, you can't lie, either.
Of course, if government regulations were nothing but silly, we could have a laugh, ignore them, and get back to business. But a skillful regulator does more than make pointless elaborations on the law. A skillful regulator takes the law and beats, bends, twists, and hammers it into an instrument of bureaucratic power.
A skillful regulator kidnaps the law and transports it from the realm of legislation to the realm of bureaucracy, where there is little or no lawmaker oversight. A skillful regulator moves the law beyond the reach of the law. Government regulatory agencies become a law unto themselves.
And at work inside the 115... or 252... or 257... or 316... or 430 government regulatory agencies are some very skillful regulators.
Congress and the president have to do more than get rid of a few government regulations. They have to get rid of the whole concept of government regulation.
We have plenty of laws against doing harm. But what if we decided to regulate doing harm? What if, for example, we passed "The Federal Harm Prevention Act"?
Imagine if we created a U.S. "Bureau of Harmlessness" to issue federal guidelines to eliminate all harm of any kind.
Actually, this is such a good example that I'm sure the Obama administration and its friends in Congress would have passed just such an act, if they'd thought of it first.
It's constitutional – at least under a liberal, Ruth Bader Ginsburg-type interpretation of Article I, Section 8 of the U.S. Constitution (the so-called "General Welfare Clause"): "The Congress shall have power to... provide for the... general welfare of the United States."
And what could be more conducive to the general welfare of the United States than a complete lack of hurt, pain, suffering, injury, adversity, abuse, detriment, and damage?
Now, let us contemplate what this new government-regulatory agency would be like.
First, its size. The Bureau of Harmlessness (BOH) would need to be large. How many experts would it take to determine what is harmful and what is not? All of them. And each of us is an expert on the subject of what we consider to be harmful to ourselves. The BOH would have 324,328,265 employees.
Second, its scope. The bureau would require exceptionally broad enforcement powers for its wide-ranging mandate. Just bringing wind, rain, and snow under federal control would present huge statutory problems and demand an extensive legal staff. (Fortunately, climate-change activists have shown us the way forward in achieving bureaucratic regulation of the weather.)
Finally, its effect on your daily life. Carbon dioxide has been proven to be harmful to the environment: "Exhale and Go to Jail."
Regards,
P.J. O'Rourke