What investors need to learn from the T-Word

As investors what can we learn from the now endless second guessing by investment commentators of what will happen to investments now a celebrity apprentice host is running the White House? Financial assets such as equities were moving up, then down, then up, then sideways, then up again. Bonds have experienced a gargantuan sell-off. (Bond markets are always much smarter and better predictor of the future than equities markets).

Some sectors have shot up in hopeful anticipation that his policies will actually happen and they will also benefit; others the reverse. Yes volatility is here to stay for a while. Markets hate uncertainty, and always within a market their will be winners as well as losers. Never before has careful stock and sector selection been so crucial.

There’s little point trying to make sense of this. Trump was a dark horse, making entire professions, from the media to pollsters, the investment community and the parties themselves look foolish. And now all those that got their predictions wrong will spend the next few months telling us what Trump’s election means for the future. Mmmmh.

Take outs to always remember

Democrats’ lost. Why? Most suggest the blame lies with sexists, racists and anti-immigrants. This seems a bit superficial. What reason is there to believe there are more of these characters around now than when Obama was re-elected four years ago? This chart might offer a more considered explanation.

People that are feeling economically left behind (middle classes in the West) are at the same time, finding themselves in a short space of time herded together into a global market of intense disparities of wealth, cultures and power creating humiliating new hierarchies. Digital communications have increased people’s capacity for envious and resentful comparison. The result is a hatred and irritability of everybody against everybody else.

Inequality of wealth distribution for the last few decades of growth: Middle America is doing fine in absolute terms but in relative terms it is not. The richest in society has taken most of the gains from the latest engines of economic growth – technology and globalisation. The response by voters has been that it’s better to wreck the joint (and see what happens) than more of the same……….and it may be a better explanation for swinging voters going with Trump (than any inherent racism or sexism, although there was some of that, too). It was not just uneducated white working class people supporting Trump- far from it.

This declining income trend repeated across the developed world, is a reversal of what many X-Gener’s and Baby Boomers have experienced in their youth. The post-war boom, which led to a massive and prosperous middle class, is now beginning to look like an outlier – not the norm.

Many renowned economists are observing that recent technological advances haven’t boosted labour productivity in the way of earlier inventions like electricity, manufacturing and plumbing. Certainly statistical evidence supports this. Wealth is being created but is very concentrated in less than 10% of the population. The ‘trickle down effect’ that served us all well post war has not happened this time around. Blaming people in other countries is just populist politics and angry people without their brain engaged.

To quote Peter Thiel, Silicon Valley venture capitalist and a member of Trump’s inner circle, “we wanted flying cars but instead we got 140 characters”. You might like to retweet that!

The result in the working class (as one example) is one of financial hurt and resentment. US government data has 38 per cent of all American workers earning less than $US 20,000 in 2015. The official poverty threshold in the USA for a family of five is $US 28,410!

Note: In Australia wage growth was only 1.9 per cent over the past year, half what it was four years ago and the lowest on record. Most of this is in lower skilled and public sector roles. Australia is not immune, and there is no new government policy or economic event on the horizon to stem this trend. China won’t help us much in this regard but could well damage our prosperity very quickly.

Middle class rules! It is the middle class with the disposable incomes that drive most of a country’s growth, mainly because the rich tend to accumulate assets with their excess cash while the poor and middle classes spend it. And you can’t spend what you don’t have – the poor. This is why Trumps tax cuts to the rich won’t help at all, just sustain the current trend.

Trump implied he had the way up! To Make America Great Again sounds a lot like “Make me great again.” People saw him more likely to advance their place in society (via their incomes) more than the usual establishment. Its possible Trump’s appeal was in the implicit promise, sincere or otherwise, to restore rising prosperity on a relative level. Clear headed investors need to dislocate the economics from the politics.

These declining figures and trends may be an expression of something bigger, a reversion to the long term investment return average that should cause all investors to reconsider their take on what makes for an acceptable return.

Take me back to Kansas: Future growth in real GDP per capita is highly likely to be slower than in any extended period since the late 19th century; and growth in real consumption per capita for the bottom 99 percent of the income distribution will be even slower. Why?

Growing inequality is one reason, with a few others brewing into the “perfect storm” with real GDP growth much less than we have come to expect – both in the USA and the rest of the West. The natural slowing of population growth (especially in working age people across the entire West and the East); higher education and medical costs; flattening worker productivity; and a huge debt overhang that has ballooned to gargantuan of never seen before proportions, mean that rising high returns that were a hall mark of the last 30 years, sustainably or even for an extended period is unlikely.

For investors, this is a picture of an unfamiliar future world. In the long run, average asset price growth cannot outstrip real GDP growth by much. For example, in China debt is growing at double that of GDP as most of the credit is not being spent to grow the economy via productive businesses- but in asset bubbles such as property speculation and advance building of surplus infrastructure. Unless each of these problems is addressed, we may have to get used to returns lower than we have come to expect.

By the way no government or opposition is talking about these things so it would be a brave person to bet that things will transpire to take us all ‘back to Kansas’.

Bonds –end of a 30 year rally? The bond market reaction to Trump’s victory has been astounding. Even before the election 10-year bonds were heading higher, which is why bond proxies like AREITs and infrastructure stocks have been hammered (priced on their income generation and also seen as ‘safe’ investments that until now were paying higher than government bonds). Bond rates have increased after the election, prompting calls that the days of ‘lower for longer’ were over.

The sell-off is occurring though, easily exceeding $1 Trillion USD so far. It’s one reason why equity markets are currently hitting new highs. The 30 year old Bond rally seems over, but let’s wait and see.

"On average Bond markets and the people that analyse them, are far smarter than their equity market counterparts. Bond markets are the primary driver of most investments performance."

Will all his domestic policies actually happen…. and with the effect everyone is hoping for? Certainly touted new US policies are likely to support the 30 year bond rally ending (IF they happen) but that’s not totally assured for now. Best to wait and see a bit longer yet. The US futures market predicts there’s a 92 per cent chance of a rate rise by the Fed in December, with Yellen making noises in support of this.

Remember that Trump’s aims (he has no policies yet) are for super big fiscal spending in things like infrastructure (but the devil in the detail means most spending won’t go to essential things like bridge repairs and other essential repairs and upgrades). Also conventional Republicans have always been much less disposed to pump priming and spending on infrastructure and they still have huge clout on Capitol Hill. With inflation in Europe rising and the UK considering fiscal stimulus, the rise in bond yields might be simple relief at the receding threat of deflation.

What about trade? Just as important to Americans (and us) is if his anti-trade rhetoric to gain votes will also actually happen in the veracity everyone assumes? These two factors are perhaps the biggest issues that has an impact on investors; so watch these carefully (what he does not what he says of course!)

Mortgage rates: Should we panic about mortgage rates just yet? During the Republican 1990s, US Treasuries yielded an average of 6.7 per cent a year. In the following decade the figure had fallen to 4.5 per cent. With yields still less than 2 per cent in most countries, a rapid return to rates of prior decades seems a bit of a stretch for the next few years. There’s no need to panic about those mortgage rates just yet. Modest increases? Sure in the next year most likely, along with the same in bank deposits.

The biggest lesson to have learnt…….. All of which is to suggest that much of the energy, intelligence and words devoted to predicting future economic performance, interest rates and stock prices are wasted. As the US election shows, we’re kidding ourselves if we think we have a handle on what the future holds, although that doesn’t stop careers being built on ex-post rationalisations of it.

Your protection against future adverse events is best achieved through buying good businesses at attractive prices – especially those that are proven to generate ever growing streams of income throughout all market gyrations, not in trying to predict what those events might be.

In the end they always come up as what we might say as…… ‘Trumps!’

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