The Fixed Income Playbook for Trumpanomics
Donald Trump roiled markets with a surprise victory over Hillary Clinton bringing the White House back under Republican control. Even more importantly, he has been given a mandate to pursue his economic policies as Republicans retained control over both the Senate and House of Representatives. Initial flight-to-quality trades lasted only of a couple hours (mostly coming in illiquid after-markets) and have rapidly reversed. Equities are rallying, gold is selling off, treasuries are getting bludgeoned, and industrial metals have continued to move higher. The market is adjusting to the replacement of U.S. government sterility and gridlock with the unified Republican mandate of growth. Investors should take notice and adjust their portfolio accordingly – this market action will have follow through.
While the details of Trumpanomics have been amorphous, there are a few pro-growth initiatives that are likely to gain traction: lower corporate and individual taxes, a repatriation holiday, and increased infrastructure spending. If passed, these policies are incredibly pro-growth, and inflationary risks could become a real problem—no pun intended. As monetary stimulus passes the torch to Keynesian fiscal spending, economists can expect fiscal deficits and national debt to increase more than current projections. Infrastructure spending estimates range from $500 Billion to $1 Trillion over the next decade. Holbrook expects this spending to be front-end loaded, and could contribute up to 1% to Real GDP growth in 2017. Those calling for recession next year might want to throw that thesis out the window. Inflation and higher rates, however, will be an escalating concern.
Inflation and rising rates pose a menacing threat to fixed income portfolios since benchmark durations are at an all-time high. Such an environment will likely produce outperformance for active management. Lowering effective duration in investor portfolios will be critical as rates recalibrate higher. Investment Grade portfolios will benefit from increasing exposure to TIPS relative to treasuries. Floating rate (or fixed-to-float) corporates or ABS help limit interest rate sensitivity. For income generation, investors should look to high yield corporates that have near-term call dates or close maturities (within 5 years)—the higher the coupon, the better the rate increase absorption. Generally, investors should consider taking more credit-risk versus interest-rate risk. Tax-exempt investors can find value in the muni-market but should opt for shorter-dated maturities when available.
This article is distributed for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the author which are subject to change without notice. Forward looking statements, estimates, and other information contained herein are based upon proprietary and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.