I am firmly of the view that the ONLY certain outcome of the US Presidential election is a sustained increase in cross asset class volatility.
Firstly, let me say we are far from convinced that the fact US equity markets didn’t “collapse” in the wake of Trump’s victory is a green light to buy risk assets. Far from it, it may well be giving us a chance to lower our weightings from risk assets into what could prove a “sugar hit” that fades with time.
It would appear very few funds were positioned for a Trump victory. Even those few who were, would have been surprised by the market response. We are of the view you are watching a forced positioning unwind and it is premature to assume what you have seen is a sustainable market reaction.
We are also of the view that knee jerk reactions will NOT add overall value to the portfolio. This requires patience and conviction with the risk of losing money arguably higher than the risk of making money in the short term.
The AIM Global High Conviction Fund exited all our US technology equity holdings a week before the US election. We felt it was prudent to move onto the sidelines and we have remained on the sidelines as an aggressive internal rotation has occurred in US equities. The technology stocks we liquidated are all lower, some significantly, than the prices we sold them, which we feel vindicates our portfolio/risk reduction decision pre the election.
Our only high conviction reaction to the US election was to increase our short position in US 30-year Treasuries. We are of the view that Treasuries are a lose/lose and that short position in US Treasuries has broadly protected our long investments in structural growth equities around the world as bond yields have spike to reflect increased US sovereign risk, rising inflation expectations and heightened expectations of a Federal Reserve rate hike in December. We are high conviction shorters of the longest duration bonds, feeling our thesis of “real return free capital risk” has been triggered in long bonds by the Trump victory.
US 30-year Bond yield chart
To put in context how badly positioned for the sharp rise in bond yields Wall St was, not a single economist or analyst (65 analysts) forecast that US 10-year Bonds would be above 2.00% by year end. Today they are 2.22%.
Why is the world demanding a higher interest rate for US debt?
Quite simply because they think the new US government will issue buckets of long-term government debt to grow the economy via industry exposure. That would also drive inflationary pressure which is the worst enemy of a long bond.
Trump’s economic proposals would result in $5.3 trillion of borrowing and push America’s debt burden to 105% of its gross domestic product, up from 75% of GDP now.
Those numbers are not counting the extra $10 trillion of debt the government will need to cover the rising costs of programs like Social Security & Medicare over the next decade. Net annual interest costs alone are expected to almost triple by 2026.
In my view Trump has brought forward the end of the 35-year bull market in bonds. It’s that simple and we are positioned for bond yields to continue to rise, with widespread implications including for US mortgage rates which are based off the 30-year bond rate.
We also short “long duration” and “bond proxies” in the equity market, with short positions in the Real Estate Investment Trusts (REIT), Infrastructure and Healthcare sectors globally and locally.
We are also watching the negative price action in Junk Bonds (JNK), High Yield Credit (HYG) and Emerging Market (EEM) ETFs, which were the trigger for a deep developed market equity correction in January/February this year. The big question is whether the bond/credit sell off spreads to equities other than the obvious bond sensitive equities, which have been falling.
While we have moved to the sidelines in US technology equities and increased our short position is US Treasuries, we have increased our exposure to certain China-facing consumer equities listed in Hong Kong. We have also increased our exposure to certain Australian industrial growth stocks that have already corrected.
On that basis it was encouraging to get a profit upgrade from APN Outdoor (APO) and strong AGM commentary from Treasury Wine Estates (TWE). Both stocks rallied strongly off recent lows on confirmation of solid outlooks. We await Aristocrat’s (ALL) full year results later this month which we feel should also be very strong. ALL is down -11% this month which we believe will prove an overreaction.
Other Australian stocks we feel other excellent risk/reward potential lies in Link (LNK) and Star Group (SGR). Our approach is to buy and hold stocks that have been oversold in this rotation and wait for earnings and dividends to arrive to confirm our bullish views.
This is NOT the time for passive strategies. In fact, passive bond strategies are experiencing capital losses. In equities, at this moment in time the indices mask a deterioration in market internals that could well lead to indices correcting and passive strategies generating capital losses and underperformance.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.