"Marko Papic, Chief Strategist at BCA Research, talks about the risk of a bond riot in the US..."

 From Neue Zürcher Zeitung's TheMarket.ch, September 13:

The Future Winners Will Be in Sectors such as Industrials, Materials and Energy

Marko Papic, Chief Strategist at BCA Research, talks about the risk of a bond riot in the US, scenarios for the presidential election, and the most attractive investment opportunities in the coming years.

Deutsche Version

Financial markets are nervous. The question of whether the US economy could suffer a hard landing is nagging market participants. At the same time, hopes are high for new impetus when the Federal Reserve begins to cut interest rates on September 18.

Beneath the surface of the broad indices, a shift in investor preferences is taking shape. Defensive sectors such as healthcare and consumer staples have taken the lead. Shares from cyclical sectors such as materials and energy are suffering from the slump in China and concerns about a hard landing in the US. The presidential election on November 5 is also causing uncertainty.

Marko Papic, chief strategist at BCA Research, is bearish for the coming months. At the same time, he sees opportunities in the ongoing sector shift: «We see two secular, geopolitically driven themes. The rewiring of supply chains, away from China, plus a whole bunch of green energy policies. Both these themes create a multi-year capex boom.»

Markets are feeling shaky, the question of whether the US economy will achieve a soft or a hard landing is back on the agenda. What do you make of the current market picture?

Stocks usually peak six months before a recession. So yes, the question of a hard versus a soft landing is relevant. The problem is that it’s very difficult to predict a recession. That’s why we are in this phase right now. The giddiness regarding the first Fed rate cut doesn’t make sense to me. The time to be bullish was two years ago, when the CPI peaked. The time to be bullish was in December 2023, when the Fed publicly announced its pivot. Now the rate cuts will start, but they have been fully priced in for months. So it could well be that the actual cut will be a «buy the rumor, sell the news» event. I don’t think there is anything bullish about it.

 

Markets are expecting a steep slope of further rate cuts in the coming months. What do you make of that?

It doesn’t add up. Currently, expectations are for 225 basis points of cuts over the next twelve months. Why should the Fed cut by that much? This only makes sense in a recessionary environment. So either we won’t get 225 bp of cuts, because we’ll see a soft landing. Or we’ll have massive rate cuts, but that will mean that we’ll have a recession. In the latter case, you should short stocks, rather than getting giddy about the prospect of rate cuts.

 

The other big event coming up is the presidential election. What will it mean for markets?

To me, there are only two outcomes of the election that matter: Scenario number one would be a sweep by either party, which is unequivocally bad for markets. Scenario number two is a divided government, where one party secures the White House, but the other party secures a majority in Congress. In that case there would be less to worry about.

Why would a sweep, i.e. when one party controls both the White House and Congress, be so bad?
Because both parties will go fiscally crazy, either by adding more government spending and/or tax cuts. This would add to demand in the economy, and it will push up Treasury yields. That would not be good for equity markets. Remember when Trump won the election in 2016? Treasury yields went up then, too. People were talking about the reflation trade. But back then, we had no inflation and very little growth. Markets actually wanted more inflation. This time it’s different: Markets don’t want more growth, because in the supply constrained economy we’re in, this would reignite inflationary pressure. 

Are you worried about an escalation of the trade war with China if Trump wins?
For the past six months, even in his convention speech, Trump only used the term tariffs in connection with his plan to force the Chinese to build factories in America. That’s the playbook Ronald Reagan followed in the 1980s with the Japanese. In fact, I think Trump will pursue a deal with Beijing. He’ll be tough on national security, but in economics, he wants investments into the US. Chinese cars are okay, but they have to be built by Americans in Ohio. And if Harris wins, the trade war would continue like it did during the Biden years. Markets are okay with that, that’s priced in.

So on the one hand you see the risk of a recession, and on the other hand you see the risk of an election sweep, which could lead to rising bond yields. Both scenarios are bearish for equities.
Yes. And to be clear, they are not mutually exclusive. If there is a recession in 2025, which is possible, but hard to predict, Treasury yields would fall at first, regardless of who controls the White House and Congress. So one scenario is a recession, which means you should be short equities. The other scenario is an electoral sweep and no recession, which would also be bad for equities, because bond yields would rise. 

Is there any room for a bullish scenario?
Yes, that would be when the Fed manages to engineer a perfect soft landing for the economy; no recession, and a continued downshift in inflation. Plus a situation of divided power in Washington. In that scenario, 10-year Treasury yields could settle between 3.5 and 3.8%, and stocks could continue to go up. But the path to get there is narrow. And even then, I would doubt that market participants would rush back into the large cap US tech names. Stock markets are undergoing a rotation, other sectors will take the lead, and that means the US equity market will lag other markets.

Let’s stay with the outcome of the US elections for a minute. Why should the bond market suddenly revolt because of fiscal profligacy in America? That’s not exactly a new thing.
True, but the math is becoming untenable. Debt service costs have risen to above 10% of government outlays, and they will rise further. Interest payments are crowding out government spending, they are about to overtake the government’s defense budget. In history, whenever an empire had to pay more for interest than for defense, things went south. We are starting to see anomalies in the Western world that tell us that the bond vigilantes have in fact woken up. Prime Minister Liz Truss in the UK was swept away by the bond market in 2022, the French election in July caused a stir. So it could happen....

....MUCH MORE

Very Related, almost two years ago:

Russell Napier Called It: "The Eyepopping Factory Construction Boom in the US"

 «We Will See the Return of Capital Investment on a Massive Scale»
Market strategist and historian Russell Napier warns of a 15- to 20-year phase of structurally elevated inflation and financial repression. He shares his views on how investors should prepare for this new world.