Two Roads Diverged in a Wood: A Tale of Trump, Treasuries, and What’s in Store for 2018

Mandeep Rai

Robert Frost’s “The Road Not Taken” is one of the American poet’s most well-known works, famous for its depiction of two roads diverging in a wood. What I’m most interested in today, though, is how two “roads” in the financial market are now splitting off. That divergence could point toward a host of developments in 2018, particularly with regards to interest rates!

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Let’s start at the beginning: For most of 2016 and 2017, an interesting dynamic was playing out in credit markets – they were tracking the approval rating of President Trump! More specifically, since the election, 10-year U.S. Treasury yields (the white line in the chart below) have followed fluctuations in the average job approval rating of the president (the blue line, per Real Clear Politics).

Why? The president made no secret of his intention to create jobs, growth, and prosperity in a USA-first agenda. His tools: Infrastructure spending, tax cuts, regulatory relief, and more. That’s why the 10-year Treasury yield and Trump’s approval ratings were correlated. Improved ratings increased the chances of Congress helping him pass pro-growth, inflationary policies, while falling ratings had the opposite effect.

But a funny thing started happening this September. The two lines began to diverge. Yields and approval ratings split. That’s because economic indicators showed that GDP growth, manufacturing growth, home sales, and unemployment were all accelerating to the upside. In other words, even without the successful passage of a tax reform bill, the U.S. economy was shifting into a higher gear – a story I covered in more detail last week.

What does this mean for investors like you? Suffice it to say that bond markets have stopped tracking hope for positive policy, and started trading on actual results being seen in the economy. Since those results are getting better, they’re helping to put a solid base under yields — keeping them from falling further and in fact, setting the stage for a renewed climb.

An extreme event like war could always offset growth and inflation factors. But absent that, you’re likely to see rates climb in 2018. If the tax cuts turbocharge growth even further, that ascent will get both steeper and faster.

So, make sure you keep that in mind when making investment decisions. Consider shifting out of longer-term Treasuries, utilities shares, and defensive sectors like consumer staples. They’re among the worst performers in a rising-rate environment. Instead, favor small caps, “growthier” sectors like technology and materials, and investments like bank stocks, which tend to benefit from rising rates.

Happy New Year – and happy investing!

Best wishes,

Mandeep

About the Senior Analyst

Mandeep spent six years on the NYSE trading floor and worked in private equity valuations for General Electric. Today, he mines the vast Weiss database to formulate investment and trading strategies for stocks, ETFs and cryptocurrencies. His strategies boast a proven track record of significantly outperforming the benchmarks.

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