Bernie & the Trump
Why the Supporters of Bernie Sanders and Donald Trump are Foretelling the End of the 35 Year Bull Market in Bonds
The current presidential race shows populist sentiment within the country. In the Republican Party, it is represented by Donald Trump, while Bernie Sanders is the progressive vessel for Democratic Party voters.
Their respective followers are fed up that the gains in income and wealth during the past 30 years have gone primarily to the top. Sanders feels the problem is inherent in the power of Wall Street and the big banks, while Trump focuses on illegal immigration and China’s manipulation of its currency.
My guess is that it is an all-of-the-above deal, plus a change in culture in which corporate America rewarded financial engineering, such as stock buybacks, over long-term investments in plants, equipment, research, etc., all leading to capital gaining power over labor.
For capitalism to work well, it requires a balance of power. If labor gets too much, you end up with runaway inflation, such as we experienced in the 1970s. When capital gets too much, you end up with deflation, income inequality, and financial bubbles.
The current political process, while messy, could be forcing our economy to start generating a distribution of income that reflects the will of the majority of voters. How we get there is anyone’s guess.
At the time I am writing this, the U.S stock market, as represented by the Standard & Poor 500 Index, is already down 9% for 2016. Moreover, the price for a barrel of oil hovers around $29, while the bond market, as represented by the Barclay Aggregate Bond Index, is up .95%.
I do not think the carnage in the stock and oil markets is over. Collapsing oil prices, along with a world drowning in debt (some of which will never be repaid), tells me that deflation—a risk that we rubbed up against during the 2007-2008 financial crisis, that is characterized by falling prices—remains.
If we get a bout of deflation, then bonds—primarily bonds issued by governments of big countries such as the United States, Japan and Germany—will do well. Stocks, however, will fare poorly. Plus, even after January’s 9% drop, the U.S. stock market remains pricey, according to three valuation indicators: CAPE, Tobin’s Q, and Market Cap to GDP.
If I am correct about deflation, it will be helpful today if a portfolio owns a high percentage of safe bonds. But at some point, deflation will end, and investors should be planning today on how much of their safe bonds they would be comfortable reallocating into stocks and more aggressive bonds—because, while a change in the distribution of income should help our democracy and economy, it will bring back concerns about inflation. As more people share in the gains, their purchasing power also goes up, which could cause prices of goods and services to go higher. If that happens, a portfolio loaded with bonds could become a problem, as safe bonds won’t feel so safe in a world of rising interest rates.
So if you have a portfolio heavy in bonds, take 20 minutes to find out how much risk (stocks) you might be comfortable owning in the future. Find out now, because if you wait and the stock market falls further, your results might be too heavily influenced by the recent turmoil in the markets.
Two on-line questionnaires I am familiar with—Riskalyze (www.riskalyze.com) and Finametrica (www.riskprofiling.com/US)—will provide you a report you can use to evaluate against your current portfolio.
The political process portends a point at which the gains in income stop going to a small percentage of people. When that happens, it will signal the end of the 35-year bull market in bonds. Why not start preparing your portfolio for that today?
These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.