The stock market soared in the weeks following President Donald Trump’s surprise election. All three major indices — the Dow Jones industrial average, the Nasdaq composite and Standard & Poor’s 500 index — rose between 7.7 percent and 9.9 percent between Election Day and Feb. 3.
When annualized, those gains would be between 35 percent and 46 percent in a year. If you could earn those returns consistently, you’d be the best fund manager of all time; indeed, you’d be the best (legal) investor in the world.
But you can’t put in a performance like that, and neither can the larger market. That reality is borne out by recent Goldman Sachs Group (ticker: GS) analysis that paints a picture of shareholders realizing the rally is looking long in the tooth.
[Read: 5 Reasons Donald Trump’s Presidency Will Include a Recession.]
In fact, many are cashing out their investments in equity-heavy mutual funds and plowing it into bond funds, seeking greater security.
Goldman: Trump rally showing its age. Goldman believes the so-called Trump Effect — the post-election, policy-based rally — is coming to an end. A bit ironic perhaps, given the fact that Trump himself has assembled a small army of ex-Goldman employees, including Steven Mnuchin, the nominee for Treasury secretary, to execute the growth-focused economic strategy that began the rally in the first place.
While the Trump Effect has nonetheless done wonders for the GS stock price — share prices are up 32 percent since the election — the signals are all there to support Goldman’s thesis that the rally is losing steam.
Expectations versus reality. While cash flows into bond funds — especially when considered alongside cash flows out of equity mutual funds — provides a good idea of broad market psychology, it’s far from the only way to take the market’s temperature.
For example, one striking fact hinting that share prices may be too high is the difference between so-called “soft data” figures like business and consumer confidence measures and “hard data” numbers that measure things like the labor market, housing, and retail growth.
The difference between the euphoric highs seen in the “soft data” and the actual progress of the economy as measured by the “hard data” is at its highest level in six years, according to Bloomberg.
According to Goldman Sachs, prices have risen a little too ambitiously and investors are simply a little too confident right now. They need to get back to reality, and Goldman thinks that process is beginning. Here’s some behavioral evidence:
Bond funds are hotter than stocks. One measure of mutual fund flows into U.S. bond funds is at a six-month high, according to Charles Himmelberg, the chief credit strategist for Goldman Sachs. The mad dash into stocks at the expense of bonds seen after the election has almost entirely reversed itself, Himmelberg says.
In the four weeks of data points between Jan. 11 and Feb. 1, equity funds (excluding exchange-traded funds) had net outflows of $7.5 billion, while taxable bond funds (again, excluding ETFs), had net inflows of $4.9 billion.
That’s a night and day difference — and in a rising interest rate environment like today’s, it’s remarkable that so many people are rushing into bonds, which lose value as rates rise.
Why would you buy bonds right now? Well, income investors don’t seem phased by potential rate hikes, and may be enamored by how much rates have already moved, according to Arturo Neto, founder and chief investment strategist of Orenda Partners.
“Typical conservative investors previously looking for yield in equities are now finding it more attractive to rebalance a portion of their portfolios back into fixed income. After all, the 10-year yield has almost doubled in a year, making it more palatable for yield-seeking investors to invest in bonds,” Neto says.
“Recent comments by the Fed may also have given investors the impression that rates may not rise as quickly as anticipated just a few months ago,” Neto says.
Losing a popularity contest with bonds isn’t the only way stocks are reflecting less chutzpah and more practicality on the part of investors.
[See: 7 Stocks to Buy When a Recession Hits.]
Cyclical stocks, investments that tend to outperform during times of expansion and healthy economic growth, are suddenly underperforming defensive stocks, according to Goldman’s Himmelberg. Investors generally view defensive stocks as safer, more conservative bets — and potentially even buffers for financial downturns.
Not coincidentally, many people end up investing in bonds (or funds consisting of bonds) for the exact same reasons: they offer a sense of security, manage risk through diversification, and in the case of bonds, usually offer some yield or income stream.
What’s changing investor behavior? So, subtle changes in capital flows at equity and bond funds — the types of trends that the average retail investor frankly pays no attention to whatsoever — are emerging, and GS thinks it could spell the beginning of a reality check for markets.
That’s all well and good, but one question still remains: Why is this happening, and why now?
The simple reason is that Wall Street is beginning to get a sense for Trump’s real agenda, and in the eyes of many professional fund managers and investors, it’s raising concerns.
“Initially I think most investors were excited about the possibility of tax cuts, stimulus plans and regulatory relief, and they still are. But the additional concerns about immigration and possible trade wars — as well as concerns about the timing of those pro-growth policies — have become more important,” says Kate Warne, investment strategist with Edward Jones.
“I think that’s led investors to be a little more skeptical and to reconsider, and that’s part of why you’ve seen the markets pause instead of continue to move higher,” Warne says.
Goldman agrees, seeing the prioritization of nationalistic trade and immigration agendas as potentially disruptive for markets. Slapping a 20 percent import tax on Mexico for instance, would only hurt blue-collar shoppers at Wal-Mart Stores ( WMT) and Target Corp. ( TGT), while Silicon Valley has been in virtually unanimous outrage over the refugee ban.
Executives at more than 100 Silicon Valley companies signed a so-called “friend of the court” brief to oppose the seven-country refugee ban. Nearly every prominent tech company has either signed the brief or publicly denounced the executive order, including companies like Apple ( AAPL), Alphabet ( GOOG, GOOGL), and Amazon.com ( AMZN).
Goldman’s warning that the waning days of the Trump Effect may be upon us is further buttressed by what the Wall Street bank sees as a slow political process that will put pro-growth policies on the back burner.
Specifically, the failure of GOP lawmakers to make progress on Obamacare repeal and replacement doesn’t bode well for other big-ticket items on the Congressional agenda like tax reform and increased infrastructure spending. It could be until 2018 before corporate America sees that come to fruition, according to Goldman.
Whether the Trump Effect will come to an unceremonious end, continue on indefinitely or fizzle out slowly remains to be seen. But Goldman Sachs — the staff at Goldman still remaining, at least — has made its position clear: It’s the beginning of the end.
[See: 7 of the Best Stocks to Buy for 2017.]
With the stock market’s honeymoon period now on thin ice, an unpredictable policy schedule from Capitol Hill, and an aging baby boomer population desperate for decent interest income, seeing more money funnel into bonds and bond funds might become a trend of its own, even as income investors watch rates rise over time.
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Goldman Sachs: Bond Funds’ Popularity Signals Peak Trump? originally appeared on usnews.com
