Prophets

The Pain Trade Is Alive and Well

The notion of the theoretical “return to normalcy” in rates will die a sudden death.

Markets move against conventional wisdom.

Photographer: Justin Sullivan/Getty Images

Federal Reserve policy makers talk of interest-rate hikes. They blather about cutting back on their $4.5 trillion portfolio of bonds. Yet, instead of backing up, as predicted by almost everyone, yields decline, the curve flattens, and the “Pain Trade” continues.

The Fed’s dot-plots are watched with a laser focus. Everyone knows that at some point President Donald Trump is going to appoint four new members to the Fed, maybe more. My belief is that they will be business people, and the days of the Ivy-Leagued economists running the Fed will end. Pragmatism is coming, which for the bond market means “lower rates for longer and lingering.” The notion of the theoretical “return to normalcy” in rates will die a sudden death.

There is too much at risk to suggest otherwise. Central banks are too heavily invested in America’s bond markets. Insurance companies are being forced to participate, like it or not. Municipal bond yields have very little spread to Treasuries and, in many cases, corporates have better yields even after taxes. Demand is driving this bus!

When it comes to equities, the big run is mostly behind us. I am not calling for reversal, but stagnation. Trump’s agenda, for all practical purposes, is caught in a deadlock. It is not the “old normal” of Democrats versus the Republicans, but something far more derisive and something far more significant.

All of the so-called establishment, the people that have lived off the status quo such as the lawyers, the lobbyists, the accountants, the old-line news media, the political hacks, etc., are pushing back against the arrogant outsider who wants to revamp the entire system in Washington.

Consequently, many of the hopes and dreams and campaign promises made by Trump are caught in no-man’s land. The timeline supposed by many after Trump’s election is not the timeline that we are getting. Not even close!

Reality has reared its ugly head, once again, and promises may not be kept because it is becoming increasingly clear that they may not be delivered. This is not, by the way, because Trump does not want to make good on his word, but because in my opinion the bureaucrats and Congress won’t let him make good. Checkmate.

Whether you consider health care, or tax cuts, or tax reform, or less regulations, or a whole array of other proposals made by Trump, the ones requiring congressional approval are sinking into the swamp’s mud hole. The drain is not working and this should be acknowledged by market participants if they wish to make appropriate investment decisions. I have proposed “cash flow investing” as a better alternative than going for the gusto with “appreciation.”

Europe is no haven. Forget all of the drivel you hear about Greece’s primary surplus. It is just noise. Yesterday the Business News Network calculated that Greece's debt stands at 197 percent of gross domestic product. Without significant debt relief, this is “game over” territory. That was true when the European Central Bank calculated Greece's debt at 183 percent of to GDP, and it is even truer now.

Greece has a debt payment of $7.8 billion due in July, and three nations -- Germany, the Netherlands and Sweden-- are refusing to proceed with a bailout unless the International Monetary Fund is involved. Yet, with America’s representatives on the IMF now reporting to the Trump administration, you can hear the wailing from Berlin to Brussels. An “endgame” of some sort is rapidly approaching.

There, there are a number of places that I am avoiding. It is not that I know the outcome, rather it is that I can identify the risk. Here is a mistake that many institutions and people alike make. They are far too focused on trying to determine the “outcome” when they should be focused upon diagnosing the risk.

In this category I include oil, Fannie Mae, Freddie Mac, Grexit, Brexit, Italian banks and the forthcoming Italian elections. All are far too risky to be played by investors, though speculators may discover Heaven, or Hell, in any of them. I prefer safer roads, as being admonished by Dante is not on my “to do list.”

I am still being led by the tried and true. Preservation of capital remains uppermost in my mind, especially when uncertainty and longer timelines are a significant part of the mix. What can’t be known, well, can’t be known, but the ability to identify the singular risks and then to handicap all the risks, considered together, is a skill set that is an imperative for investors.

Bloomberg Prophets Professionals offering actionable insights on markets, the economy and monetary policy. Contributors may have a stake in the areas they write about.

    To contact the author of this story:
    Mark Grant at mjgrant@bloomberg.net

    To contact the editor responsible for this story:
    Robert Burgess at bburgess@bloomberg.net

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