There are two major themes in the market today: 1) buy stocks and 2) buy gold and bonds. Typically they don’t happen simultaneously and that should be cause for concern. The stock market has continued to move higher since Election Day, which has come to be known as the Trump rally. The stock market moves higher because the market thinks it will move higher. Expectations for the future often guide decisions made today and certainly there is a degree of ‘animal spirits’ in the market today. How else to explain a constantly climbing stock market with such divisiveness and uncertainty around legislation post-election? The concept of ‘animal spirits’ were first proposed by John Maynard Keynes as a way to describe the state of mind held by consumers and businesses. Certainly the stock market has moved higher purely on confidence in the future of the US economy. Why is half the market suddenly so confident in the fundamentals and the potential untapped growth?
Last week also saw a more hawkish Janet Yellen during her Humphrey Hawkins testimony when she commented that the case for future rate increases exists regardless of any upcoming legislation. Can that be? Not only were her comments surprising but I would have expected the 10yr to be trading at 2.60% for such a hawkish tone, but to see yields drop just a day after her testimonyhas me concerned there is an undercurrent of disbelief in this optimism around economic growth. Not necessarily disbelief the Fed won’t raise rates three times this year; although the market is only pricing in two raises. There is growing concern that this stock market rally of hope and optimism is just that and is about to meet reality. Today the 10yr trades at 2.39%, a surprising low level given the fact that China is selling US Treasuries at an unprecedented rate. Don’t despair, a US 10yr Treasury bond at 2.43% is a great investment if your alternatives are the UK’s 1.20%, France’s 1.03%, Germany’s 0.27% or Japan’s 0.07%.
What all of this means is that there is risk the market moves in both directions, but the magnitude of those risks are not equal. The biggest risk is headline risk. Tomorrow a new tax deal with full Republican support could send bond yields rising rapidly. Or perhaps an infrastructure deal could increase future inflation expectations and the Fed is forced to raise rates ahead of schedule. If rates move higher they could move very quickly. However if optimism and hope begin to fade, rates could move the other direction. The new administration is still in their first 100 days so the market doesn’t expect all of the answers tomorrow; they want to see the entire picture, the game plan. Therefore if rates fall it could do so very slowly. With headline risk and the possibility the market could move much higher you must have patience and proceed with caution. Patience does have an expiration date and failure to act on a tax overhaul or lack of support around other promised legislation could be troublesome and create a wave of despair over time.
So the question is when will new legislation make its way to the headlines and how much support will that legislation receive versus the opposition it certainly will be met with. The US economy is challenged by a growing national debt, the debt ceiling, a health care program in desperate need of attention, sticky wage growth, underemployment, GDP now lower than the national debt, etc. The positives or arguments for higher interest rates are low unemployment, decent GDP, rising inflation and a positive current outlook with the X factor being new legislation.