The remaking of U.S. politics also is likely to upend the nation’s mortgage market. There are two reasons why: interest rates and regulation.
Changes in these areas could affect the course of the housing recovery, the availability of credit to borrowers and the extent to which lenders are willing to take on new risk. It may also affect the current structure of the mortgage market, in which banks mostly have focused on plain-vanilla and jumbo loans while nonbank lenders have targeted riskier borrowers, sometimes with more exotic mortgage products.
Interest rates are the most immediate concern. Donald Trump’s victory has led to a surge in bond yields and, in turn, mortgage rates. In the two days following the election, the average rate on 30-year fixed-rate conforming mortgages spiked a quarter of a percentage point to 3.87%, according to MortgageNewsDaily.com.
Mortgage rates are still incredibly low by historical standards; the average over the past 45 years is 8.26%, according to data from Freddie Mac. But the quick rise in the 10-year Treasury yield has lenders worried mortgages could become more expensive far sooner than they had anticipated.
Depending on how far that runs, higher rates could arrest further gains in home prices. While prices have shot up in many U.S. housing markets over the past couple of years, superlow mortgage rates have kept higher prices within reach of many borrowers.
“The ultimate problem is the impact of rising rates on home values,” said Stu Feldstein, president at SMR Research Corp., a mortgage-research firm. “We’re back into a bubble condition in part because of low rates that have enabled people to buy houses much more expensive than their incomes could afford.”
He said his firm expects that by the end of 2017 rising rates will have contributed to home values declining in about one-third of the U.S.
The speed and size of any increase in rates will depend in part on Mr. Trump’s fiscal policies and whether markets believe that could lead inflation higher. “We have a new narrative,” said Chris Whalen, senior managing director at Kroll Bond Rating Agency Inc., noting that markets, not just central-bank actions, will play a role in the direction of mortgage rates. “We’re back to a situation where what investors think matters again and that’s very important for mortgages.”
The second point lenders are considering is whether a more bank-friendly regulatory environment is on the way. In part, that will depend on how the administration approaches any rollback of the Dodd-Frank regulatory overhaul law.
In an interview with The Wall Street Journal on Friday, Mr. Trump said of Dodd-Frank: “We have to get rid of it or make it smaller.”
The law resulted in a number of safeguards for mortgages, including requirements for lenders to make sure borrowers can afford mortgages they sign up for. Risky mortgages including those with balloon payments and with little verification of applicants’ income or assets largely became much harder to find. A looser lending environment would result in conflicting developments: More borrowers would get approved, while raising the risk of more foreclosures to come. Analysts say most lenders would be unlikely to return to practices and products that burned them during the housing crash.
Bryan Sullivan, chief financial officer at nonbank lender LoanDepot Inc., said the “hangover” from the crisis persists, making lenders wary.
But the new regulations also made lenders more risk averse. Banks have increasingly targeted only the most creditworthy borrowers or those taking out jumbo loans—mortgages that exceed $417,000 in most parts of the country.
Along with regulatory risk, banks have faced greater legal peril over mortgages in recent years. The biggest banks, in particular, have paid tens of billions of dollars in settlements and fines related to soured mortgages.
So the appointment of a new attorney general, and the approach of the Justice Department toward lending transgressions, will have a big impact on how lenders assess legal risk. Big banks, for example, have largely abandoned making loans that are insured by the Federal Housing Administration for fear of being penalized when risky mortgages go bad.
“A more reasonable attorney general…would be a great outcome,” said David Stevens, president and chief executive of the Mortgage Bankers Association.
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That’s the view of economists at Goldman Sachs Group Inc., who argue that while some of President-elect Donald Trump’s proposals could boost U.S. economic growth in the near future, his other policies would offset those positive impacts over the long-run.
Trump’s surprise victory in the presidential elections has spurred a rally in stocks and upped market-based expectations of inflation as the President-elect is expected to enact a host of tax cuts and boost infrastructure and defense spending that he says will jump start growth by 3.5 percent per year, on average. Still, the prospect of tighter trade and lower immigration under Trump’s presidency could raise the thorny prospect of “stagflation,” a scenario in which prices rise alongside unemployment while the economy slows.
“The positive fiscal impulse from his tax reform and infrastructure proposals could provide a near-term boost to growth and, depending on the specifics, could have positive longer-run supply side effects,” the Goldman team, led by economists Alec Phillips and Sven Jari Stehn, write. “However, other proposals could lead to new restrictions on foreign trade and immigration, which could have negative implications for growth, particularly over the longer term.”
Faced with lingering uncertainty over Trump’s policy proposals, the Goldman economists run through three different scenarios for the U.S. economy. The first is a “full” enactment of Trump’s campaign promises with everything from increased fiscal spending to trade restrictions included. The second is a “benign scenario” in which only Trump’s fiscal proposals are enacted. Lastly, there’s an “adverse scenario” in which trade and immigration are curbed while the Federal Reserve grows more hawkish.
Trump’s full policy package would boost annualized GDP growth by about 0.2 percentage points in the second-half of next year, though that would slow relative to Goldman’s baseline forecast after that — by as much as 0.5 percentage points in 2018 to 2019 as the Fed hikes rates to counter core inflation rising to 2.3 percent, the economists said. The benign scenario, meanwhile, would boost economic growth by as much as half a percentage point between 2017 and 2019 and deliver only marginally higher inflation.
Stagflation comes about via the adverse scenario as real GDP growth is 0.8 percentage points lower in 2018 and 2019 while inflation peaks at 2.3 percent in early 2019 and unemployment jumps to 5.3 percent. Under that scenario, the Fed would initially hike rates aggressively to fight inflation but would stop in 2019 as it tries to combat faltering economic growth and job losses.
Goldman isn’t the first bank to warn about the possibility of stagflation. HSBC Holdings Plc Chief U.S. Economist Kevin Logan wrote last week that: “If Trump does follow through on the full extent of his proposals, our economics team believes there could be a short-term boost to GDP growth from tax cuts and increased defense spending, but stagflation could quickly set in if import prices rise and the immigrant labor force contracts.”
Of course, the Goldman economists don’t expect all of Trump’s campaign promises to be fully enacted. Instead the economists forecast some scaled-down fiscal boosts, slowing immigration and more trade restrictions.
Under that scenario, tax cuts boost annualized GDP growth by 0.1 percentage points higher Goldman’s baseline forecast in the second half of next year but growth slows thereafter. From 2018 onward, U.S. GDP growth would be about 0.1 to 0.2 percentage points slower, Goldman says.
“The risks around our base case appear asymmetric,” Goldman warns. “A larger fiscal package could boost growth moderately more in the near term, but a more adverse policy mix would likely lead to a significant slowdown, higher inflation and tighter policy in subsequent years.
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The wave of selling that has swept across government-bond markets since Donald Trump’s election last week resumed Monday as investors continued to weigh the prospects of increased fiscal stimulus and a quicker pace of interest-rate rises.
The yield on the benchmark 10-year Treasury note reached a high of 2.238% Monday, up from 2.118% on Thursday’s close after U.S. government bond markets were closed Friday. Treasury yields, which rise as prices fall, are hovering around their highest level since early January after recording their largest one-week gain in over three years following Mr. Trump’s victory.
Selling has spread across other developed-nation bond markets as Treasury yields have climbed. The yield on the 10-year Germany government bond was up 0.3% on Monday as European markets opened, on track to close at its highest level since January. U.K. government bond yields have retraced to levels last seen in the month before the Brexit vote, which triggered a sharp rally in these securities.
Developed-market government bond yields in Asia also jumped.
“The election of Trump and his promises of fiscal stimulus have opened the floodgates, with a rush to sell bonds,” strategists at Societe Generale wrote in a note to clients Monday.
“We see no let-up just yet,” they said. They recommended investors keep a light exposure to interest-rate risk in their portfolios.
While much of Mr. Trump’s policy agenda remains unclear, the president-elect has promised infrastructure spending and tax cuts.
U.S. President Barack Obama, right, with U.S. President-elect Donald Trump during a news conference in the Oval Office of the White House last Thursday. Photo: Bloomberg
Many analysts say that would boost bond supply, economic growth and inflation, potentially hurting fixed-income assets. Investors are particularly concerned that an increase in signs of inflation and growth could push the Federal Reserve to raise interest rates at a faster clip than previously expected.
The Wall Street Journal’s latest monthly survey of economists shows Mr. Trump’s policies are expected to usher in a period of higher economic growth, inflation and interest rates.
On average, economists forecast the economy could expand 2.2% in 2017 and 2.3% in 2018 as a fiscal stimulus takes effect, up from about 1.5% over the past 12 months. Inflation, meanwhile, is seen at 2.2% next year and 2.4% in 2018.
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The rout in the Treasury market continues overnight unabated. The Long Bond traded at 3 percent overnight and that level has not stopped the hemorrhage as we are a tad cheaper as I compose this electronic missive. The aforementioned Long Bond is the best performer on the curve in overnight trading as 5s 30s has flattened to 133.8 from 140.3 in late trading on Thursday. Similarly, 10s 30s has flattened to 76.3 from 81.8. The belly of the curve has been clubbed as if it was a baby seal.The 2s 5s 10s spread is now + 9.4 basis points after closing at + 4.9. For some perspective I should note that on election evening at 930PM that spread was -9.5. The 2s 5s spread in that time frame has widened to 66.9 from 45.1.
One dealer cites several factors for the overnight bloodletting in fixed income but at the top of his list is selling by convexity types who are experiencing duration extensions which need hedging. Convexity types are always the last ones to the party so if they are indeed selling then we are probably close to the end of this particular sell off.
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Japan’s economy grew more than forecast in the three months through September, as a rebound in exports compensated for continued weak spending at home by people and companies.
Key Points
Gross domestic product expanded by an annualized 2.2 percent, according to data released by the Cabinet Office on Monday (median estimate of economists +0.8 percent).
Private consumption rose 0.1 percent (estimate 0 percent).
Business spending was unchanged (estimate +0.2 percent).
Net exports, or shipments less imports, added 0.5 percentage point to GDP.
The GDP deflator fell 0.1 percent from a year earlier.
The surprisingly strong expansion, the biggest since early 2015, will likely provide some relief to Japanese Prime Minister Shinzo Abe as he faces the possible economic fallout from Donald Trump’s U.S. election victory. Trump has said he strongly opposed a trade pact at the center of Abe’s economic reform policies, and if his campaign rhetoric on trade becomes policy, Japanese companies could take a hit in one of their biggest markets.
Economists say another key question is whether demand among Japanese consumers can improve. Exports have compensated for weak domestic demand, with the value of shipments abroad growing in August and September, when adjusted for price changes, but stagnant wages have left most Japanese consumers reluctant to spend.
Economist Takeaways
“It would be a mistake to think Japan’s economy is gaining momentum given today’s GDP data,” said Norio Miyagawa, senior economist at Mizuho Securities Co. in Tokyo. “The worst is over but it’s not accelerating. I don’t think exports can continue to be a strong driver like today’s report suggested. If Trump boosts spending and raises U.S. growth, that would be a plus for Japan but there isn’t much momentum in the rest of global economy.”
Japan’s economy will continue to recover in the fourth quarter thanks to improving external demand lifting exports, but “domestic demand, such as private consumption and capital spending, isn’t that strong,” said Yoshiki Shinke, an economist at Dai-ichi Life Research Institute in Tokyo.
Combined with a recent weakening of the yen, the latest GDP figures reduce pressure on the Bank of Japan to introduce more monetary stimulus, Marcel Thieliant, senior Japan economist at Capital Economics, wrote in a note.
The Details
Private inventories subtracted 0.1 percentage point from GDP in the third quarter.
Measured quarter on quarter, GDP grew 0.5 percent (estimate +0.2 percent).
Government consumption rose 0.4% from the previous quarter, adding 0.1 percentage point to quarterly growth.
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Central bankers lowered interest rates to near zero or below to try to revive their gasping economies. In the process, though, they have put in jeopardy the pensions of more than 100 million government workers and retirees around the globe.
In Costa Mesa, Calif., Mayor Stephen Mensinger is worried retirement payments will soon eat up all the city’s cash. In Amsterdam, language teacher Frans van Leeuwen is angry his pension now will be less than what his father received, despite 30 years of contributions. In Tokyo, ex-government worker Tadakazu Kobayashi no longer has enough income from pension checks to buy new clothes.
Managers handling trillions of dollars in government-run pension funds never expected rates to stay this low for so long. Now, the world is starved for the safe, profitable bonds that pension funds have long needed to survive. That has pulled down investment returns and made it difficult for funds to meet mounting obligations to workers and retirees who are drawing government pensions.
“Unless ordinary people have money in their pockets, they don’t spend,” the 70-year-old Mr. Kobayashi said during a recent protest of benefit cuts in downtown Tokyo. “Higher interest rates would mean there’d be more money at our disposal, even if slightly.”
The low rates exacerbate cash problems already bedeviling the world’s pension funds. Decades of underfunding, benefit overpromises, government austerity measures and two recessions have left many retirement systems with deep funding holes. A wave of retirees world-wide is leaving fewer active workers left to contribute. The 60-and-older demographic is expected to roughly double between now and 2050, according to the United Nations.
Government-bond yields have risen since Donald Trump was elected U.S. president, though few investors expect a prolonged climb. Regardless, the ultralow bond yields of recent years have already hindered the most straightforward way for retirement funds to recover—through investment gains.
Pension officials and government leaders are left with vexing choices. As investors, they have to stash away more than they did before or pile into riskier bets in hedge funds, private equity or commodities. Countries, states and cities must decide whether to reduce benefits for existing workers, cut back public services or raise taxes to pay for the bulging obligations.
Corien Wortmann-Kool, chairwoman of the Netherlands-based Stichting Pensioenfonds ABP, Europe’s largest pension fund, says low interest rates have put the whole system under pressure. Photo: Cats & Withoos
“Interest rates have never been so low,” said Corien Wortmann-Kool, chairwoman of the Netherlands-based Stichting Pensioenfonds ABP, Europe’s largest pension fund. It manages assets worth €381 billion, or $414 billion. “That has put the whole system under pressure.” Only about 40% of ABP’s 2.8 million members are active employees paying into the fund.
Pension funds around the world pay benefits through a combination of investment gains and contributions from employers and workers. To ensure enough is saved, plans adopt long-term annual return assumptions to project how much of their costs will be paid from earnings. They range from as low as a government bond yield in much of Europe and Asia to 8% or more in the U.S.
The problem is that investment-grade bonds that once churned out 7.5% a year are now barely yielding anything. Global pensions on average have roughly 30% of their money in bonds.
Low rates helped pull down assets of the world’s 300 largest pension funds by $530 billion in 2015, the first decline since the financial crisis, according to a recent Pensions & Investments and Willis Towers Watson report. Funding gaps for the two biggest funds in Europe and the U.S. have ballooned by $300 billion since 2008, according to a Wall Street Journal analysis.
Few parts of Europe are feeling the pension pain more acutely than the Netherlands, home to 17 million people and part of the eurozone, which introduced negative rates in 2014. Unlike countries such as France and Italy, where pensions are an annual budget item, the Netherlands has several large plans that stockpile assets and invest them. The goal is for profits to grow faster than retiree obligations, allowing the pension to become financially self-sufficient and shrink as an expense to lawmakers.
ABP currently holds 90.7 cents for every euro of obligations, a ratio that would be welcome in other corners of the world. But Dutch regulators demand pension assets exceed liabilities, meaning more cash is required than actually needed.
This spring, ABP officials had to provide government regulators a rescue plan after years of worsening finances. ABP’s members, representing one in six people in the Netherlands, haven’t seen their pension checks increase in a decade. ABP officials have warned payments may be cut 1% next year.
“People are angry, not because pensions are low, but because we failed to deliver what we promised them,” said Gerard Riemen, managing director of the Pensioenfederatie, a federation of 260 Dutch pension funds managing a total of one trillion euros.
Benefit cuts have become such a divisive issue that one party, 50PLUS, plans for parliamentary-election campaigns early next year that demand the end of “pension robbery.”
“Giving certainty has become expensive,” said Ms. Wortmann-Kool, ABP’s chairwoman.
That is tough to swallow for Mr. van Leeuwen, the Amsterdam language teacher. Sitting on a bench near one of the city’s historic canals, he fumed over how he had paid the ABP every month for decades for a pension he now believes will be less than he expected.
Japan is wrestling with the same question of generational inequality. Roughly one-quarter of its 127 million residents are now old enough to collect a pension. More than one-third will be by 2035.
The demographic shift means contributions from active workers aren’t sufficient to cover obligations to retirees. The government has tried to alleviate that pressure. It decided to gradually increase the minimum age to collect a pension to 65, to require greater contributions from workers and employers and to reduce payouts to retirees.
A typical Japanese couple who are both 65 would collect today a monthly pension of ¥218,000 ($2,048). If they live to their early 90s, those payouts, adjusted for inflation, would drop 12% to ¥192,000.
The Japanese government has turned to its $1.3 trillion Government Pension Investment Fund for cash injections six of the past seven years. That fund, the largest of its kind in the world, manages reserves for Japan’s public-pension system and seeks to earn returns that outpace inflation. The more it earns, the more it can shore up the government’s pension system.
In February, Japanese central bankers adopted negative interest rates for the first time on some excess reserves held at the central bank so commercial banks would boost lending. The pension-investment fund raised a political ruckus in August when it said it lost about ¥5.2 trillion ($49 billion) in the space of three months, the result of a foray into volatile global assets as it tried to escape low rates at home.
The government-mandated target is a 1.7% return above wage growth. “We’d like to strive to accomplish that goal,” said Shinichiro Mori, a deputy director-general of the fund’s investment-strategy department.
The fund posted a loss of 3.8% for the year ended in March because of the yen’s surge and global economic uncertainty. It was its worst performance since the 2008 global financial crisis. Mr. Mori said performance “should be evaluated from a long-term perspective,” citing returns of ¥40 trillion ($376 billion) since 2001.
Mr. Kobayashi, the former Tokyo government worker, said the government’s effort to boost returns by making riskier investments was supposed to “increase benefits for everyone, even if only slightly. It didn’t turn out that way…And they are inflicting the loss on us.”
Mr. Kobayashi joined roughly 2,300 people who marched in downtown Tokyo in October to protest government plans to cut pension benefits further.
Japanese senior citizens protested cuts to pension benefits, then marched through downtown Tokyo in October. Photo: Kosaku Narioka/The Wall Street Journal
In the U.S., the country’s largest public-pension plan is struggling with the same bleak outlook. The California Public Employees’ Retirement System, which handles benefits for 1.8 million members, recently posted a 0.6% return for its 2016 fiscal year, its worst annual result since the financial crisis. Its investment consultant recently estimated that annual returns will be closer to 6% over the next decade, shy of its 7.5% annual target.
Calpers investment chief Ted Eliopoulos’s strategy for the era of lower returns is to reduce costs and the complexity in the fund’s $300 billion portfolio. He and the board decided to pull out of hedge funds, shop major chunks of Calpers’ real-estate and forestry portfolios and halve the number of external money managers by 2020.
“Calpers isn’t taking a passive approach to the anticipated lower return rates,” fund spokeswoman Megan White said. “We continue to reassess our strategies to improve performance.”
Yet the Sacramento-based plan still has just 68% of the money needed to meet future retirement obligations. That means cash-strapped cities and counties that make annual payments to Calpers could be forced to pay more.
That is a concern even for cities such as affluent Costa Mesa in Orange County, which has a strong tax base from rising home prices and a bustling, upscale shopping center.
The city has outsourced government services such as park maintenance, street sweeping and the jail, as a way to absorb higher payments to Calpers. Pension payments currently consume about $20 million of the $100 million annual budget, but are expected to rise to $40 million in five years.
The Downtown Recreation Center in the city of Costa Mesa, which has outsourced government services such as park maintenance to absorb higher payments to California’s public-pension plan. Photo: Andrew Cullen for The Wall Street Journal
The outsourcing and other moves eliminated one-quarter of the city’s workers. The cost of benefits for those remaining will surge to 81 cents of every salary dollar by 2023, from 37 cents in 2013, according to city officials.
The mayor, Mr. Mensinger, is hopeful for a state solution involving new taxes or a benefits overhaul, either from lawmakers in Sacramento or from a California ballot initiative for 2018 that would cap the amount cities pay toward pension benefits for new workers.
Weaker cities across California could face bankruptcy without help, said former San Jose Mayor Chuck Reed, who oversaw a pension overhaul there in 2012 and is backing the 2018 initiative that would shift onto workers any extra cost above the capped levels. “Something is broken,” he said. “The plans are all based on assumptions that have been overly optimistic.”
Costa Mesa resident James Nance, 52, worries the city’s pension burden will affect daily life. “We could use more police,” said the self-employed spa repairman. “I’d like to know the city is safe and well protected, but I know there have been tremendous cutbacks.”
Costa Mesa ended the latest fiscal year with an $11 million surplus, its largest ever. But that will soon disappear, Mr. Mensinger said, as pension costs swallow up $2 of every $5 spent by the city.
“We have this gigantic overhead cliff called pensions.”
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An early bear market may be best for an incoming president
Bull market in the S&P 500 is the second-longest of all-time
The election’s over, but for equity investors it’s the same old bull market, one the new president might prefer die a quick death.
Donald Trump inherits a 2,826-day-old rally in U.S. stocks that has defied history, overcoming anemic economic growth and a 15-month earnings recession that pushed valuations to a seven-year high. Squeezing out even a couple more years would be a feat of unprecedented longevity, with August 2018 looming as the month the advance will exceed all that came before.
Maybe it’ll keep going forever — it’s already 32 months longer than the average advance since the 1930s. But if it doesn’t, a new president’s best hope often is that equity pain hits fast. Just ask Barack Obama and George W. Bush. Lucky timing on market cycles has been a blessing for three straight presidents, helping them enjoy powerful advances by their second term.
“Any incumbent president wants to get a bear market over early,” said Jim McDonald, the chief investment strategist at Chicago-based Northern Trust Corp., which oversees $875 billion. “Not that they can always control that, but there’s a strong relationship between the performance of the stock market in the year of the election and whether the incumbent party gets elected.”
Linking stocks to past patterns may seem simplistic, but it represents a big chunk of the bull case for stocks, considering the market’s historical habit of going up often seems like the lone force propelling it nowadays. Besides motionless earnings, investors are coping with the start of a Federal Reserve tightening cycle and the weakest economic recovery since World War II.
Stocks Stamina
Fatigue was on few minds last week as the S&P 500 powered to its biggest gain in two years, first on Hillary Clinton’s improving odds, then on speculation Trump’s fiscal policies will reinvigorate profits. Banks and health-care stocks had their best stretches since 2009 amid expectations of looser regulatory scrutiny, while small-cap shares have gained six straight days.
At the same time, early stock market verdicts on a new administration are notoriously unreliable, and in the end there’s little to suggest a president can do much to affect the market either way. A study by Leuthold Weeden Capital Management LLC found that equity returns are almost identical under Republicans and Democrats since 1928.
Predictions that time alone is enough to halt a rally have crashed and burned for three straight years. Among arguments for continuation, stocks just seem to have more stamina nowadays, with two of the three longest advances coming in the past 30 years. The last five are, on average, 800 days longer than the five before them.
Optimists also say the length of this advance is misleading because even though sentiment has been plenty resilient, it’s never reached the euphoria that marked tops like the one just before Bush’s first term. Yes, valuations are high, but the best year for this bull market would’ve been average during the late 1990s advance, and even that rally didn’t end until the economy started to contract.
Earnings Momentum
“There hasn’t been enough growth to create excesses that would traditionally lead you into the next recession,” Hank Smith, who helps manage more than $6 billion as chief investment officer at Haverford Trust Co. in Radnor, Pennsylvania, said by phone. “The odds of a recession are low, and part of the reason, in a perverse way, is that we’ve had such a weak economic expansion.”
Earnings recently turned higher, a sign of momentum that has historically proven hard to reverse. Among the nine instances since 1936 when companies emerged from an extended streak of profit declines, stocks posted gains in all but two. The S&P 500 rose an average 12 percent over the following year.
And the start of a new administration is often a bullish time for equities. Since the 1928 presidential race, the S&P 500 has rallied an average of 5.1 percent in the first full year after an election, Bloomberg data show. That includes gains of at least 23 percent in 2009 and 2013, following the two most recent votes.
Bush Comparison
“There are no alarm bells going off right now, but something will eventually come along and jolt the economy in a negative way,” said Tom Anderson, chief investment officer for Boston Private Wealth, which oversees $7 billion. “Bull markets don’t just die solely from old age. There’s always some sort of contributing factor.”
A relevant comparison for the incoming president could be 2000, when George W. Bush entered office following a decade-long rally that by Inauguration Day was giving strong evidence of its own mortality. Stocks fell more than 40 percent in the first 22 months of Bush’s first term, failing to find a bottom until a year after the Sept. 11 terror attacks.
For Bush, that actually was good timing. By Election Day 2004, the S&P 500 had posted gains in 15 of the preceding 19 months, rising 10 percent in the year before the Republican was returned to office. For Obama, the index was up 13 percent in the 12 months before he won a second term in 2012.
Of course, the reason market cycles are important is their sensitivity to the economy. When a rally ends, history suggests an economic recession will follow within a year. The five-year bull market that began in 2002 saw the U.S. economy fall into an 18-month recession in December 2007 amid the worst financial crisis since the 1930s.
Wobbly Economy
The economy is already showing signs of wobbling. Citigroup Inc.’s U.S. Economic Surprise Index is back in negative territory and has been since the last week of October after hitting an almost two-year high in July. While the latest payroll data showed an increase from the prior month, it still missed economist forecasts. Further, workers have been in short supply for 13 straight months, according to the Institute for Supply Management survey of service-industry companies, which make up almost 90 percent of the economy.
“The market will anticipate a recession and head down well before an official recession is called,” Crit Thomas, global market strategist at Touchstone Advisors of Cincinnati, which oversees $15 billion, said by phone.
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President-elect Donald Trump announced Republican National Committee Chairman Reince Priebus as his chief of staff, a selection that suggests that the Republican is interested in a more conventional approach to governing after his insurgent campaign.
Mr. Trump on Sunday also named Steve Bannon, who was in consideration for the White House’s top personnel position, as chief strategist and senior counsel.
“Steve and Reince are highly qualified leaders who worked well together on our campaign and led us to a historic victory,” Mr. Trump said in a statement. “Now I will have them both with me in the White House as we work to make America great again.”
A trained attorney, the 44-year-old Mr., Priebus has spent most of his career in politics. After an unsuccessful run for Wisconsin state senate in 2004, he became youngest person elected state party chairman in 2007. He has been the national party’s longest-serving chairman, a post he was elected to in 2010, and is a close ally of House Speaker Paul Ryan, a fellow Wisconsin Republican
.
Known for his fundraising prowess and a Midwestern modesty that belies his ambition, Mr. Priebus used the party’s national apparatus to provide much of the nuts-and-bolts infrastructure that helped the Trump campaign win the election last week. The RNC staff provided thousands of field operatives and a data operation that helped turn out the Trump vote in key states.
In the process, Mr. Priebus became a part of the Trump inner circle. He was among a small group inside a glass-encased Trump Tower conference room with Mr. Trump when they were informed the Washington Post was preparing to publish an 11-year-old video in which the nominee made lewd comments about forcing himself on women.
As the rest of Mr. Trump’s team strategized the response, Mr. Priebus was largely sidelined by an avalanche of calls and emails from top Republicans urging him to pull the party’s funding from the Trump campaign.
Reince Priebus
Born:
March 18, 1972
Education:
University of Wisconsin-Whitewater, B.A.; University of Miami, J.D.
Political career:
2004: Lost Wisconsin state senate race
2007-11: Chairman, Wisconsin Republican Party
2011-present: Chairman, Republican National Committee. Oversaw the post-2012 review of Republican party weaknesses and the subsequent buildup of the organization across the country. Asserted greater party control over scheduling and oversight in the 2016 presidential debates.
Personal background:
Born in New Jersey, raised in Wisconsin
Married, two children
Has close ties with House Speaker Paul Ryan of Wisconsin
Trump ties:
Relationship developed during the campaign, providing a bridge to GOP establishment
Traveled to New York in September 2015 to urge Mr. Trump not to run as an independent and to sign a pledge to support whoever was nominated
Opened doors to party donors after Mr. Trump’s nomination, gave him access to party get-out-the-vote machinery, helped with debate preparation and made numerous campaign appearances with him
Mr. Trump highlighted Mr. Priebus’s role during his victory speech the night of the election, calling his adviser an “amazing guy.”
“Reince is a superstar,” Mr. Trump said. “He is the hardest working guy.”
banker and ex-Navy surface warfare officer who served as chief executive officer of the Trump campaign, is best known for his role in leading Breitbart News, a rabble-rousing political news website that has become a must-read for antiestablishment conservatives.
The 62-year-old Mr. Bannon would bring a different style. He wears his sandy blond hair long and his khaki pants baggy. He pushed Mr. Trump to focus on white working class voters despite Republican Party leaders aiming to expand the appeal of the party to minority voters. He was also instrumental in assembling a surprise news conference just hours before the second presidential debate that featured Mr. Trump and several women who had accused his rival’s husband, former President Bill Clinton, of sexual misconduct.
At the news conference, Mr. Bannon, wearing glasses and pushing his hands into his jacket pockets, flashed a mischievous smile as stunned reporters—who had been told they would be witnessing debate preparations—surveyed the room.
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Strategists raised equities to overweight from underweight
Fixed income securities cut amid growing inflation risk
Citigroup Inc. views the 72-hour-old rotation into stocks following Donald Trump’s presidential victory as the start of something big.
Strategists led by Jeremy Hale raised the firm’s recommendation on global equities to overweight from underweight, meaning investors should hold more stocks relative to their benchmarks. They cut fixed income, saying government bonds and the credit market will underperform in the next 12 months.
The shift came during the S&P 500 Index’s best week in two years as more than $1 trillion was wiped off the value of bonds around the world. While acknowledging the risk that fixed income volatility spills into equities, Citigroup said Trump’s plans to ramp up fiscal spending will benefit corporate earnings and make bonds less attractive.
“Fiscal easing could be exactly what the U.S. and global economy needs right now, thus lifting real growth expectations but also inflation expectations,” the strategists wrote in a note to clients. “The prospect of stronger nominal growth should bode well for earnings, though we highlight how higher bond yields and rich US equity valuations as a starting point, constrain our optimism.”
The capitalization of a global bond-market index slid by $450 billion Thursday, a fourth day of declines that pushed the week’s total above $1 trillion for only the second time in two decades, Bank of America Merrill Lynch data show. Global stocks gained $1.3 trillion in the same period while the S&P 500 advanced 3.4 percent. Yields on U.S. 30-year bonds, which are more sensitive than shorter maturities to the outlook for inflation, jumped the most this week since January 2009.
While stocks will benefit more from Trump’s policy, investors should avoid emerging markets, Citigroup said, reversing its stance to favor developed countries. The MSCI Emerging Markets Index has slumped 5.5 percent for the biggest three-day decline since August 2015.
“Valuations remain attractive in most emerging market assets, equities included, but economic fragilities remain and the improving second derivative of growth may falter if local currency weakens,” the strategists wrote. “We can’t help but feel a stronger U.S. dollar could dramatically hamper investor flows and, as a corollary, credit and economic growth.”
In the U.S., stocks are poised to decouple from bonds for the first time after they moved in the same direction in the previous eight months. The two assets had shown a closer relationship this year as investors focused on the monetary policy by the Federal Reserve, whose quantitative easing have helped fuel broad market gains.
As a caution against a repeat of synchronized selling across markets, as happened in early September, or the risk of heightened volatility should higher rates be perceived as bad for all assets, Citigroup suggested investors to increase cash holdings.
“The markets have largely been Fed focused throughout 2016, ” said Alan Gayle, a senior strategist at RidgeWorth Investments in Richmond, Virginia. “We’re going to see a shift away from monetary policy orientation toward fiscal policy possibilities.”
Citigroup didn’t specify the percentage of money investors should earmark to each asset.
In Bloomberg survey conducted at the end of October, Wall Street strategists advised investors allocating about one-third of their investment in bonds, 48 percent in stocks and the rest in cash and commodities.
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Tailwinds during his tenure now risk buffeting next president
Nation’s interest costs, already highest since 2011, to rise
Barack Obama will go down in history as having sold more Treasuries and at lower interest rates than any U.S. president. He’s also leaving a debt burden that threatens to hamstring his successor.
Obama’s administration benefited from some unprecedented advantages that helped it grapple with the longest recession since the 1930s. The Federal Reserve kept rates at historically low levels, partly by becoming the single biggest holder of Treasuries. The U.S. could also rely on insatiable demand from international investors, led by China deploying its hoard of reserves. Global buyers added $3 trillion of Treasuries, doubling ownership to a record.
Now those tailwinds are turning around. The Fed is telegraphing more hikes at a time when interest costs on the nation’s bonds are already the highest in five years. The government’s marketable debt has more than doubled under Obama’s stewardship, to a record of almost $14 trillion. And the deficit is expanding again, after narrowing for four straight years, just as overseas holdings of Treasuries are shrinking at the fastest pace since 2013.
“We’ve really got ourselves into a pickle here,” said Edward Yardeni, president of Yardeni Research Inc. in New York, who’s been following the bond market since the 1970s. “All these years we’ve been kicking the can down the road, and suddenly we’re seeing a brick wall.”
The deteriorating backdrop for the world’s biggest bond market risks spoiling the plans of Tuesday’s winner, whether it’s Hillary Clinton or Donald Trump. Both have promised measures to foster growth and create jobs. The prospect of the three-decade bull market in bonds approaching a turning point has implications for everything the candidates want to tackle, from infrastructure spending to national security to tax cuts.
Investor Scorecard
In some ways, Obama lucked out. The Fed bought $1.7 trillion of Treasuries from 2009 to 2014, soaking up the equivalent of a quarter of the increase in debt outstanding. While its securities purchases helped support the bond market, the era of extraordinarily low rates also crimped returns for fixed-income investors. Treasuries have earned about 3 percent annually on average since 2009, the skimpiest since at least the Reagan administration, according to Bank of America Corp. data.
Benchmark 10-year yields have averaged about 2.5 percent during Obama’s terms, compared with about 4.4 percent under his predecessor, George W. Bush. Yields fell even as the economy recovered from the financial crisis and added jobs for six straight years. Stocks fared better than Treasuries: the S&P 500 Index generated a 15 percent annualized return under Obama, compared with an average of about 10 percent from 1980 through 2008.
America’s economic expansion hasn’t kept the debt burden from consuming an ever-greater share of the nation’s financial resources, promising to complicate the next president’s decisions. Though the deficit shrank as crisis-era spending ended, debt levels have still increased to pay for rising entitlement outlays. In fiscal 2016, the Treasury shelled out $433 billion in interest payments on the obligations, an amount that will swell as rates rise, as the Congressional Budget Office projects.
A measure known as net interest cost, which balances what the government receives in interest payments against what it pays on debt, will nearly triple by 2026, to $712 billion, the CBO forecasts. The expense would more than double as a share of the economy, to 2.6 percent.
Even without new fiscal spending, the U.S. is set to sink deeper into the red as revenue fails to match the growing expenses of Social Security, Medicare and interest costs, the CBO predicts.
“The Treasury has kind of gotten a free lunch over the last several years,” said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC in New York, and a former researcher at the Richmond Fed. “Deficits had been artificially suppressed by the nature of monetary policy. Now you have structural issues with spending on entitlements, and a policy impetus that seems to be moving toward fiscal stimulus.”
Burgeoning Burden
While there’s no guarantee that either major candidate will be able to get their proposals through Congress, economists predict the potential shift toward looser fiscal policy will expand the debt burden.
Proposals from Democratic nominee Clinton include a $275 billion infrastructure plan that she intends to pay for through corporate tax-law changes. She’s also suggested tax increases for the wealthy. The plans would inflate the debt by $200 billion over a decade, according to analysis from the non-partisan Committee for a Responsible Federal Budget.
Trump, the Republican candidate, has made pledges including cutting taxes and spending as much as $500 billion on infrastructure. The proposals would boost the debt by $5.3 trillion, the Committee for a Responsible Federal Budget estimates.
With the debt load projected to soar, Obama’s successor can still count on domestic buyers, who have stepped up even as foreign central banks reduced their stake in Treasuries for an unprecedented three consecutive quarters. U.S. commercial banks, for example, boosted holdings of federal and agency borrowings to a record $2.43 trillion last month.
Stimulus Continues
“One good thing for the new team that comes into the Treasury Department is that even as financing needs increase, the market clearly has the capacity for the additional supply,” said Amar Reganti, a fixed-income strategist in the asset-allocation group at GMO LLC in Boston and a former deputy director of the Treasury’s Office of Debt Management. “So, yields shouldn’t become unhinged.”
The next president can also depend on some of the monetary stimulus that prevailed during the Obama era to persist. The Fed isn’t about to shrink its $4.45 trillion balance sheet anytime soon. And while policy makers’ median projection is for two rate increases in 2017 after a hike next month, swaps traders see just about one move in that span, for the shallowest tightening cycle ever.
Wild Card
That all may change, though, if inflation accelerates.
Fed officials said this month month that the pace of price gains has increased, and a steepening in the Treasury yield curve since August suggests bond traders agree inflation is picking up. If the economy starts running hot even before new fiscal spending, the combination may spur inflation to rise more quickly, undermining the value of bonds’ fixed payments.
An Atlanta Fed index estimated on Friday that the economy is expanding at a 3.1 percent annual rate this quarter, signaling the U.S. may be on track for its strongest back-to-back quarters since 2014.
The scenario of quicker growth and inflation may push Wall Street to ramp up expectations for Fed hikes and anticipate higher yields for years to come.
The consensus is for benchmark 10-year Treasury yields to rise to 2.13 percent at the end of 2017, from 1.82 percent as of 7:04 a.m. in London on Monday, according to the median forecast of economists surveyed by Bloomberg.
“There’s been so much borrowing going on that’s been enabled by extremely low interest rates, one shudders to think what would happen if rates actually ever did go back to normal,” Yardeni said. “The impact on the interest expense would be significant, and could really bring deficit concerns back to the fore.”