Brazil is a good example of this. Historically it has needed a lot of real interest rates in order to stabilize inflation. Sometimes even double digit real rates. That's due the fiscal issues, bad reputation, lower quality of institutions, hyperinflation history and instability. The Fed thinks the US needs only around 1% in long-term real interest rate to stabilize everything. To the extent that Trump damages that in a permanent basis (perhaps by sending the country in a bad fiscal path). The needed long-term real rate will rise and stocks will fall (all else being equal)
I have been focusing in doing these types of long-term and super long-term analysis of US stocks because of a theory that I have. Since 2009 US stock have been through some period where they tank 5%, 10%, 15% even close to 20%. Everybody freaks out, panics and thinks its 2008 all over again. Yet buyers surface and pretty soon, the market goes into a new all-time high (early 2016 was a classic example). The people who freaked out then say 'wow' and don't understand why it all happened. I think that is happening because of this type of long-term and super long-term analysis is still quite favorable to stocks. Until that changes, those 5-20% dips will continue to be opportunities to buy/add to positions. So I want to figure out structurally, if equities make sense, if the enviroment around it is favorable. If it is, then I can pretty much let everyone freak out about what the market is pricing in, what they are not pricing in, what China is up to, if the Fed will hike in the next meeting etc. People will kill themselves with these sorts of analytics but not try to figure out the most important one, which is wether the long-term enviroment for equities is positive
I was thinking about the Gundlach theory that stocks will fall as bond yields rise https://www.elitetrader.com/et/thre...10y-ust-yield-should-send-stocks-down.306056/ I got to do some more investigation about this but its possible that Gundlach will be right (for the short-term) but only because investors would be acting stupidly In the Asness paper I linked in that thread, he talks about how low PEs with high interest rates and high PEs with low interest rates make no sense because stocks are real assets and they resemble more a floating rate bond rather than a fixed rate bond. Floating rate bonds correlate more with credit risk than with interest rate risk But the issue is that since the 60's people have been acting irrationally. Especially when there is a perception that stocks are very risky relative to bonds (Asness quantifies that by looking at the previous 20 year standard deviation of stocks vs bonds) Bonds have been a on tear for years, stocks had two 50% declines in the last 20 years. So its possible that as bond yields rise, people will favor them over stocks and PEs will fall. But it isn't that simple, because if growth (or expected growth) shows up, the perceived risk of the stock market will fall. People will feel more comfortable with being in the stock market during a pro-growth administration. So that could negate that irrational tendency (and indeed, pre-60s that irrationality did not happen as much. That tendency is not set in stone) So its complicated. Its not as simple as saying 3% yields and stocks will fall. That effect has to be counter balanced by the higher growth expectations (and the 20-40% upside that equities would have in that instance) Also, a market that is irrationally falling would present an opportunity to a long-term investor (its a benign risk). Whereas, being out of a market that is soaring will really hurt that investor long-term due compounding
So the stock market 1)Might rise if growth optimism wins out over high bond yields irrationality 2)Might fall if the irrationality wins. 3)Might not rise much or fall much if there is some kind of tie between the two. But you will get paid dividends plus the 'natural updrift' that stocks have In the 1) and 3) scenario the bulls will have made the right choice to invest. In the 2) they would have been better off waiting for the fall to invest but its not a big deal because that fall will eventually reverse as the irrationality won't go on forever (And Asness documents that quite well). Value eventually wins So overall, I feel like the best decision is to be on the bull side
A real risk to the market is that if the Trump policies suck and lead to fiscal problems. In that case the REAL interest rate in bonds will rise and that could be a problem for stocks. That would be a real vs real asset comparrision. If you can earn a 2% real in 30y T-Bonds (from the current 1%ish) that would compare a lot more favorably against a 4% in the stock market and that could lead stocks down. A scenario that would lead to a 2% real 30y T-Bond would be a lot of pork projects from congress, endless useless tax cuts, and other policy mistakes
But one can't just look at the real rate in long-term bonds and compare with stocks, it depends on WHY they are rising. if they are rising because of optimism over growth, then it doesn't matter for stocks. More growth will benefit them geometrically. If that real rate is rising because of perceived risks (inflation, fiscal issues, etc), then that's bad for stocks
http://seekingalpha.com/article/403...ljv:4a6f1fe7bafd376c2cca91be580ef4e0&uprof=44 This guy is an excellent analyst of BRKB (which I own shares and I'm short puts). He talks about how BRKB is a huge beneficiary of the Trump policies. Potentially by a lot more than the market has priced in already. He estimates a 2017 year end book value of $150 per share under a optimistic scenario. Current price is $159. If that scenario plays out that will trigger the Buffett buyback (120% of book value)at some point in 2017 and catapult the stock up. So this is an interesting way to play the Trump market, I'm bullish on stocks but I think instead of SPY, its probably a better bet to buy BRKB. Worse case, it tanks and Buffett will be there buying with the investor There is an additional layer of safety
If Trump tanks this market at some point this year, I might even consider BRKB long as a Druckenmiller type trade. One that I can use some leverage on, with a stop and where I expect gains soon