When to quit the Trump trade

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For no obvious reason the beyond being seriously overbought, the Trump trade pulled back overnight with DXY down:

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Commodity currencies fell as well:

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Gold was firm:

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Brent unchanged:

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Base metals fell:

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And big miners:

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EM stocks pulled back:

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And HY:

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Treasuries were bought:

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And European spreads widened:

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Stocks finally pulled back:

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Data was pretty good in the US with a solid housing report, tearaway Philly Fed and consumers loading up on debt:

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BofAML today takes a look at how long to stay long the Trump trade:

Year to date market price-action is pro-risk, pro-cyclical…stocks +4.8%, bonds +0.2%, commodities flat, dollar -0.9% (Table 2)…Japan outperforming US, high yield outperforming investment grade…only surprise has been weak US dollar and strong EM & industrial metals…asset performance in sync with rising GDP, CPI, EPS expectations.

Big tactical trough in markets last February occurred on 2nd day of Yellen’s HumphreyHawkins testimony; big trough caused by bearish Positioning, Profit recession & big easing of FX & credit policies; 12 months later, we remain long risk until Positioning turns dangerously bullish…our Bull & Bear Indicator (currently 6.3 – Chart 1) rises above 8…FMS cash levels drop toward 4%…GWIM private client equity allocations rise above 63% (currently 59%)…and fatigue in rally leadership (oil, HY, banks, small cap) signal hubristic Positioning; until then we say stay long the “Icarus Trade” with targets of SPX 2500, oil $70/b, GT30 3.5%, DXY 110.

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Market top likely will coincide with “peak macro” data (trough last Feb coincided with negative global profit growth)…US ISM index (this remains single best indicator of profit cycle) above 58 would be first sign that investors should “fade the euphoria” as best of global EPS growth revisions would likely have already occurred (note EPS currently conspicuously robust at 12.6% for 2017 – Chart 2).

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And due to new policy populism & economic nationalism, it’s wise to track the end of “secular stagnation”…key catalysts for higher rates are signs from wages, housing, small businesses, credit availability (all depressed in recent years by deflation, debt, disruption) that secular stagnation ending…our Make America Great Again indicator (“MAGA” – Chart 3) off to a good start in recent months; we regard housing in particular as absolutely key to bond markets. Path of least resistance for yields is higher until rates rise to a level that hurts housing.

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Lastly on the rally…bullish Positioning & Profit expectations have been most dangerous when they coincided with hawkish Policy. Right now, policy is dovish given US fiscal stimulus hopes & easy global central banks. In H2, as fiscal optimism peaks & central banks taper, expect bear flattening of the yield curve (Chart 4), spread widening, and a higher MOVE index. Francisco Blanch recommends hedging against H2 policy risks using gold/or and equity volatility (especially EM Asia). Note a March Fed hike (not the BofAML view) would clearly curb some enthusiasm.

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Fiscal stimulus is likely to remain thematic. The noise on US tax reform and the new coercive capitalism of policy makers should not detract from view that fiscal policy will be eased and a chunk of that easing will be done via infrastructure spending: G6 government spending on public infrastructure is currently lowest since 1948 (just 3.5% of GDP – Chart 5). We project combined fiscal stimulus in US/Canada/Japan/UK/Europe/ China could be close to $1 trillion in 2017.

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We are long “inflation assets”. Investors faded the QE theme too early, the fiscal stimulus theme too early, and should resist temptation to fade inflation; after all…just 7 months ago global rates were at 5,000 year lows…there is still $9.5tn of negatively yielding debt in the world (Chart 6)…the valuation of deflation assets remains amazingly high versus inflation assets (e.g. combined market cap of deflationary Google & Apple greater than combined market cap of inflationary EZ/Japan financials)…real assets relative to financial assets are the lowest since 1926…

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China is a good “inflation” trade: H-shares are one of the best-performing markets this year (9%); China Monetary Conditions, a lead indicator of Chinese nominal activity, have improved significantly from Jun’15 lows, China’s PPI has surged from -6% in Dec’15 to 7% today, and capital outflow likely to ease in coming months as policy makers stabilize the CNY (Chart 7), and capital seems very likely to find a home in the Chinese equity market (rather than real estate or commodities).

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Ultimately what will kill the bull are higher interest rates. 5.0% on the 10-year Treasury yield has historically been the level above which rising bond yields = falling stock prices. The 2013 “taper tantrum” shows the “hurt” level is likely much lower today (Chart 8). A hawkish Fed and ECB tapering in 2017 are the most likely catalysts for higher market volatility. And note another sharp 50-75bps rise in yields in H1 would make the current Treasury drawdown the worst since Volcker/oil ’80-’81 shocks and raise the risk of a “financial event”.

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MB is obviously a little less enamored of global reflation than it is US reflation but the timing here looks reasonable provided The Donald does not stumble too badly on fiscal. We retain allocations of:

  • buy the dips in the S&P500 and USD;
  • sell the rallies in AUD and commosities;
  • buy the dips in Aussie bonds;
  • buy the dips in gold for portfolio insurance;
  • sell property!
About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.