Neue Zürcher Zeitung's TheMarket.ch
Marko Papic, Chief Strategist at BCA Research, warns that rising interest rates could stall the rally in equities. President Trump will focus on his true mandates and that does not necessarily mean a massive trade war.
The election of Donald Trump as 47th President of the USA has electrified financial markets. The S&P 500 has reached an all time high, the dollar has strengthened significantly, and yields on U.S. Treasury Notes have risen. The Trump Trade is on.
Marko Papic believes that this is a knee-jerk reaction that could soon run out of steam. The chief strategist at BCA Research believes it would be wrong for investors to follow the script from 2016, when Trump was first elected. The President cannot afford to fuel inflation again. «The economy does not need another sugar boost,» says Papic.
In an in-depth conversation with The Market NZZ, which has been lightly edited, Papic explains what investors can expect from the second Trump Administration and where to find the best investment opportunities.
«Voters didn’t elect Trump to begin a massive trade war.Especially in the context of prices, as tariffs would increaseprice levels»: Marko Papic.
Financial markets have been on a tear since Donald Trump won the U.S. presidential election. Equities are up, the dollar is up, bonds have sold off. What now?It’s all going to depend on the trajectory of bond yields going forward. We’ve only had a few trading days since the election, and bond yields now hover around 4,4%. They went up from 3,6 to 4,3% very quickly since mid-September. If they continue to go higher from here, as the new Trump Administration takes shape, then equity markets will have to respond to that.
Equities seem to get a bit wobbly now that ten-year yields have reached 4,4%. How much more can they take?
It’s hard to say, but I think anything above 4,7 or 4,8% gets us into difficult territory. Looking into 2025, there is concern that Trump’s fiscal policy will be unsustainable from a budget perspective, there is concern that his policies will be inflationary, and there is concern that the Fed would have to change its rate cutting trajectory. There is also the question of whether the economy can sustain this rise in interest rates. Mortgage rates have already shot up. I’m particularly concerned about small companies, because they will have to refinance quite a bit of debt next year. The rally in small cap equities that we have seen since the election is, in my view, a trap.
What should investors do right now?
If you are a trader, if you like to spend your time trading, then God bless you, chase this rally. Momentum is king. If you’re an investor, on the other hand, then you have to start thinking about taking some profits off the table and think about what’s coming next. Valuations are high. The market is pricing in all the positives of a Trump presidency, and none of the negatives.
Equity markets believe Trump will be pro growth and pro tax cuts – all the things that equities like.
Yes, and all the things that bonds don’t like. And that’s a problem, because we are in a world where bonds and equities are positively correlated. The recent sell-off in bonds and simultaneous rise in equities diverges from a very clear correlation that existed for the past two years. Why does that matter? Because the world where bonds and equities are positively correlated is usually the world where there is underlying inflationary pressure. When bond yields rise too high, equities sell off. That’s the world we’ve been in for more than two years, and I don’t think we’re out of the woods in terms of inflation, especially if President Trump were to act on some of his proposals.
Will he?
I actually think Trump is going to modify his proposals to adjust to reality. He is going to be disciplined by the bond market. Much of what he has proposed in his election campaign would be inflationary and would add to economic growth, which is simply unnecessary right now. That’s why I think rising bond yields will force him to modify his proposals. There’s a big difference to the time when Trump first was elected in 2016. Back then, bond yields were not a constraint. They were rising in late 2016 and 2017, but they came from very low levels. When Trump started his first term, economic growth was anemic, inflation was no issue. Markets applauded his pro growth policies, voters wanted it. But today, is his mandate really to give the economy another sugar boost? Is his mandate to cut taxes? I don’t think so.
What is his mandate, then?
In my view, the mandate he obtained by winning the popular vote is built on two points: First, no more illegal immigration, Americans are done with that. Secure the borders, deport illegal immigrants. The second mandate is to curb inflation. Yes, inflation rates are coming down, which means prices are growing at a slower pace, but the increase in price levels over the last four years is still hurting many Americans. Those are his two mandates. Now, ironically, these two things are not good for growth in the short term. If he wants to curb immigration and inflation, we’ll have less economic growth. On top of that, he wants deregulation and a cutback in government employment, which will also dampen growth. These kinds of reforms will eventually lead to higher quality growth some years down the road, but in the short term they will act like bitter medicine.
And you say that it will be rising bond yields that will force Trump to pivot away from his more inflationary policy proposals?
Yes. The bond market will cause Trump to pivot away from pro-growth tax cutting policies towards more of the supply side reform type of policies. I think some of his economic advisors, think Scott Bessent, Howard Lutnick or Elon Musk, would be very much in favor of that. I’m sensing that his team is itching to pivot away from fiscal profligacy.
Let’s assume Trump will pivot towards fiscal restraint: What’s not to like for financial markets? After all, it’s pretty clear that the current path of fiscal policy is unsustainable....
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Related, our last visit to TheMarket.ch, November 14:
Jim Bianco: "It’s Time to Position the Portfolio for Rising Yields and a Stronger Dollar"