November 14, 2016 / 9:30 PM / 3 years ago

COLUMN-Trump stock rally sits atop pile of "ifs" and "maybes": James Saft

(The opinions expressed here are those of the author, a columnist for Reuters)

By James Saft

Nov 14 (Reuters) - In the Trump era the stock market thinks it smells growth but the bond market is pretty sure whatever happens will taste like inflation.

Stocks have rallied sharply since Donald Trump won, but more striking is the sell-off in longer-dated bonds. Since the election, 10-year U.S. Treasury note yields are up more than 20 percent to 2.20 percent, and market measures of where inflation will be in five years have also spiked.

Both stocks and bonds might be right; President-elect Donald Trump may spur growth via tax cuts and infrastructure spending, encouraging inflation back up towards historical norms.

For that to happen, a lot of “ifs” have to come through:

Trump needs to want to do what equity investors now apparently think he wants to do, essentially all of the benign stuff with none of the nasty trade wars and immigration crackdowns.

Trump’s political partners need to go along with the above.

It all needs to work.

If any of these three fails to come through, we might just get the inflation without the growth, tax cuts and debt without stimulus, or infrastructure spending which fails to deliver as advertised.

“This very move by the markets to price in the reflationary growth in the future from the Trump victory is initially going to do the opposite and act as a constraint,” said David Rosenberg, strategist at Gluskin Sheff.

A stronger dollar and higher interest rates will not re-shore any manufacturing jobs.

“Remember nothing has happened except that a new and unpredictable president has been elected. The actual growth that investors are anticipating, whether prescient or not, is still years away given the legislative work that lies ahead first.”

The first question, that of Trump’s plans, is the one with the highest level of uncertainty. While it is one thing to govern in a less divisive way than you campaign, the idea that the total Trump package won’t include higher barriers to trade and immigration isn’t credible. Trade negotiation partners are likely to face their own political pressures and be a lot less compliant than Trump’s campaign rhetoric predicts. It isn’t hard to imagine Trump imposing some exemplary tariffs on China or Mexico, and less hard still to imagine the great extent to which the bond market will price this into future inflation expectations.

As for immigration, even the two to three million immigrants Trump now says he’ll deport, rather than the 11 million of the campaign, amounts to an economic shock. It will be an expensive exercise and would tighten labor markets. Unless you want to count wall building as infrastructure this is not the stimulus the stock market is anticipating. And Mexico will not be selling another century bond to finance its “contribution” to any wall.

WAGES UP, PROFITS, P/E MULTIPLES DOWN

Wages, already building momentum, would surely rise faster than inflation as the labor force shrinks. Faster wage rises have their merits, but will be met by more quickly rising interest rates and lower company earnings and stock market earnings multiples.

Congressional Republicans may bend a knee to Trump and go along with a deficit-expanding package of tax cuts and spending, but it is also possible that this ends with tax cuts for those least likely to recycle the money.

“The scope for major stimulus will likely be limited by deficit concerns. Of course, if we are wrong, the Fed would probably have to tighten more aggressively than we are forecasting,” Jim O’Sullivan of High Frequency Economics wrote in a note to clients.

O’Sullivan is already predicting a full percentage point of Fed tightening by the end of 2017, about double what futures markets now predict.

Then there are the difficulties inherent in Trump’s infrastructure plan, if it arrives. Trump plans an infrastructure bank as a means to limit public costs, but as former Treasury Secretary Lawrence Summers points out, this limits projects to those which could make a quick commercial return and may exclude things like schools and bridges.

Also of concern is the economic impact of drawing millions of workers into infrastructure work at a time of low unemployment. It might be work with better longer-term payoffs for the economy than what workers are now doing but it does imply rising wages and inflation.

Rosenberg of Gluskin Sheff also doubts that infrastructure will have the hoped-for impact on the economy at a time of high debt. U.S. debt under the Trump plan will rise to over 100 percent of GDP over eight years, according to independent forecasts.

At some point equity markets will catch up to all of this, as usual far more slowly than bond markets. (Editing by James Dalgleish)

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