Trump’s Programs Should be Fairly Stimulative
Despite the ongoing controversy over the President-elect, I believe that when you get through some of the rhetoric and look at the programs as proposed, it is going to be pretty stimulative if they get enacted in large measure. For example, there is a program of large tax cuts–both for corporate and personal income. Loosening the regulatory noose is also on the agenda. I believe those two things combined will be fairly stimulative. Alternatively, depending on how far Mr. Trump goes on the trade protectionism, some of those positives could be offset. I believe the program overall will be quite stimulative to the US economy, which has already begun to pick up a little growth towards the latter part of 2016.
The Fed Will Modify Its Slow Pace
I think the Federal Reserve is going to be facing a situation in which they will modify their slow pace. We saw one interest rate hike in 2015. I believe the second interest rate hike will be in December, 2016.
Considering the fact that we are nearly at full employment, the inflation data (while not very high yet) is definitely turning up very near to the Federal Reserve’s goals, if you look at personal consumption–core CPI is already over 2%. With the fiscal stimulus on top of the current situation, I think the Federal Reserve is going to be faced with faster hikes in 2017.
We have seen the dollar reach new 13-year highs over the last part of 2016. I believe it is going to continue for a while. I believe that relative growth rates in the US are going to pick up compared to the rest of the world. I believe that relative real rates will also pick up faster in the US, compared to the major developed countries, like the euro region and Japan, where I think monetary policy is likely to remain very accommodative. Therefore, I believe the dollar is going to continue this cyclical upswing.
Environment Should Favor Higher Earnings, Lower Defaults
The credit markets are interest rate sensitive. I think the sort of absolute returns we saw in 2016 will be hard to repeat. High yield, as measured by the BoA Merrill Lynch US High Yield Index, is up to mid-double digits so far this year and credit in general has done very well. I do believe, though, in the environment we are expecting (faster growth, better corporate earnings, still-modest interest rate hikes from the Fed and very few, if any, overseas) that corporate credit will continue to be pretty good. Earnings are likely to go up in this environment. We have already seen corporate earnings turn up and with the fiscal stimulus on our doorstep, I think defaults are going to be very low next year and therefore corporate debt will probably outperform US Treasuries and Sovereign debt.
More ‘Wood to Chop’ on the 10-Year Treasury
That’s a good question and you can come at it in several ways. Frankly, I think, inflation is already running at 2% in the US and GDP has been running at nearly 2%, so nominal GDP has been running at 3.5% and is probably likely to be over 4% next year. Historically, that has been a pretty good indicator of where 10-year yields ought to be. Even if you take a more pessimistic view of slower global growth, a real rate of 1% on a 2% inflation rate (and rising) still gives you 3%. So with rates still in the low twos, I think we have a little more wood to chop on the 10-year Treasury yield.
Corporate Credit, Bank Loans May Offer Most Compelling Value
Going into 2017, I think we are unlikely to see the sort of aggressive capital gains we saw in 2016, given the benign interest rate environment we had. Therefore, given my prospects for positive corporate earnings and better credit conditions in terms of corporate earnings, I believe that sticking with corporate credit is a good idea. Also, given the more difficult interest rate environment, I really like bank loans going into 2017. They have very short durations, as they are tied to short-term interest rates like LIBOR. Given the steep rise in LIBOR in 2016 due to regulatory shifts in the US money market arena, I believe this looks like a very good opportunity to seek some decent income and try to preserve capital at the same time, even if interest rates rise.