Interest rates have risen sharply since the election, creating significant losses for fixed income investors. Equity investors have benefited. If rates are rising because the expectations of increased economic activity inspired by a change in political regimes, then a rise in rates is not a bad thing for stock prices if its muted. On the other hand if rates are rising because bond investors fret that the new Trump administration will print money to finance a big increase in deficit spending, then it’s not necessarily a good thing for stock prices. An increase in interest rates without a subsequent increases in economic activity will eventually lead to lower stock prices and a return of the perniferous stagflation economy, low growth accompanied by rising prices.
There are a few scenarios and like any game player, one should think out the outcomes.
Scenario 1 Rising economic activity spurs increased demand for loans. Part of the Trump story is that the return of offshore capital due to lower taxes will inspire a pick up in capital spending. It’s hard to see how companies will use their tax break to build factories in the US at higher wage cost without a real demand for the goods they produce. Do people want to pay more for made in the USA? There’s no historical evidence that they do. Will the government tie repatriation to build in America ideology or will they allow corporations to use their tax break as they see fit, most likely rewarding shareholders with stock buybacks and dividends? If the latter holds true, then stock prices could continue to rise in the near term.
Scenario 2. Buy American, build in America might lead to higher finished goods prices and cause a rise in inflation and an increase in jobs in an already tight labor market. In that case, the Fed might be forced to raise rates at a more dramatic pace than anticipated, causing an eventual market sell off as fixed income investments reach levels that they provide better competition for investor funds. In that scenario prices go down.
Stay tuned in the following days for additional scenarios unfolding.