The Trump Trade

I just had to start a post with Trump in the headline. Seems like everyone is doing it these days. In my business at least this obsession is warranted because he’s having such a profound effect on investor sentiment. And this has implications for retirees as well as all other investors.

I’m not sure that we can put much faith in anything old orange face says. But everyone seems very excited about his promise to create a pro-business environment and spend billions on infrastructure. For now at least, this seems to portend a stronger economy and higher interest rates. And the US central bank seems to agree, hinting they could raise rates perhaps three times in 2017. This has crushed bond investors over the past four months.

So why does this matter? Firstly, many investors (especially retirees) favour defensive or balanced funds that have concentrated investments in bonds. This recent piece by Pension Partners is a good reminder that bonds – and defensive funds that hold a lot of bonds – are likely to disappoint in coming years. As the author notes, low bond returns are essentially guaranteed by the math of low yields. Also, and this is the important point, there are really only three options open to investors who want decent returns:

(1) Take more risk with higher yielding bonds.

(2) Take more risk with a higher weighting to stocks.

(3) Save more, spend less, retire later.

The second implication is for managers such as myself. While Clinton seemed assured of victory, the prevailing narrative was “lower for longer”; ie. a slow economy would lead to lower bond yields and a sluggish stock market. The smart money seemed to be in defensive sectors, such as gold, bonds, utilities and real estate trusts. But all that changed once the Donald got elected. Trump’s victory was a catalyst for a rotation out of defensive sectors back into financials, construction, health care and other more aggressive sectors that had been languishing.

This rotation has favoured value (mean reversion) investors who had bought out of favour stocks and have seen these investments suddenly come become fashionable. It has hurt momentum investors (such as me) who had profited earlier in the year by investing in utilities, REITs, gold stocks, lithium stocks, graphene and coal stocks. These sectors, like bonds, have been killed over the past four months. This has created a certain amount of anguish as my investing style has languished behind the market. It simply takes time to transition from under-performing sectors to outperforming sectors. Thankfully, the Trump Trade is likely to last well into 2017 and beyond, creating many opportunities for the momentum style to get back on top.

I will have much to say about the relative merits of value vs momentum investing in subsequent posts. But I’ve already broken my promise to keep these things short.

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