(Bloomberg View) -- With 2017 mostly said and done, it’s instructive to put the bond market in perspective so we know what to reasonably expect in 2018. Recall that at the start of the year there was no shortage of calls for the yield on the benchmark 10-year U.S. Treasury note to soar to 3 percent -- or even 4 percent -- by this time. That didn’t happen. Instead, the yield started the year at 2.45 percent and was at 2.49 percent Wednesday.
The high for the year came in March, when the yield touched 2.63 percent, according to data compiled by Bloomberg, while the low was 2.01 percent in September. This puts the variance at 23 percent. The main forces in play were the Federal Reserve pushing for a return to a “normal” monetary policy that never existed by raising interest rates and the “pixie dust” money created by the major central banks, which stands just shy of $22 trillion.
Between this push and shove, we ended up not far from where we started. Looking forward, I take the minority tack that the Trump administration will do all it can to make clear that higher rates are no friend to the notion of growing the economy. Incoming Fed Chairman Jerome Powell will be much for accommodative to the White House than current Chair Janet Yellen, and I do not see a spike in yields on the horizon.
I’ve had three themes for the year, largely based on the money manufactured by central banks: “higher equity prices, relatively low yields, and risk assets compressing against their benchmarks.”
The performance of the Bloomberg Barclays US Corporate Bond Index underscores the compression in risk assets. It began the year at 2,727.26 before dropping to as low as 2,719.72 in March. Since then, it has been a steady march higher, rising as high as 2,903.16 on Dec. 15, before easing back to 2,875.49 on Tuesday. This shows the compression at 5.2 percent, which is larger than the move in Treasury and demonstrates my thesis.
In equities, the S&P 500 Index began the year at 2,243.50 which was also the low for 2017. It closed Tuesday at 2,679.25. Here we have a 19.7 percent positive move as the money manufactured by central banks flowed into the world’s securities markets. In other words, this year has been all about “following the money."
One can play the “Tax Cuts and Jobs Bill” that was passed by both houses of Congress due to be signed by President Donald Trump many ways, but the bottom line is, more money will be flowing into circulation, both for individuals and for companies. Consequently, my mantra continues and the principles that I have outlined are still the way to go.
One of the great miscalculations for 2017 has been in regards to inflation. The Fed thought it was forthcoming and many analysts projected it and the European Central Bank also jumped on the bandwagon. Yet, it has not occurred and even Yellen has scratched her head in public and wondered why. There is a solid reason for this, and it is because the central banks’ printing press money has gone into the financial markets, and not used for expanding plants or buying equipment or other goods or services that would cause inflation. There is a lesson to be learned here, when the central banks are funding the world.
The “Big Short” for 2018, I believe, will be the trillions of dollars of bonds globally that still carry negative yields, as Japan and Europe begin to hit the limits of their funding activities. You may think it is a forever game, but it’s not.
The pending Catalan elections in Spain are a risk, as well as the Italian elections on March 4, which could not only rattle Italy but the entire European Union. Italy is in dire straits and Silvio Berlusconi’s crowd and Beppe Grillo’s crowd are going to hold sway in Italy soon as they both toy with some kind of EU exit. I add to my list of avoidance the Spanish and Italian banking systems, which are teetering on some very serious problems that may come to light in 2018. And don’t forget European banks’ “mis-sold bonds,” which I wouldn’t touch regardless of yields or circumstances.
The “Big Longs” for 2018 will continue to be equities, carefully chosen closed-end funds yielding more than 10 percent and paying monthly, certain master limited partnerships, or MLPs, that just got a huge bump from the GOP tax plan, some real estate investment trusts that also got a major tax break, and the high-tax companies that will see their effective rate fall to 21 percent.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mark Grant is a managing director and chief strategist at Hilltop Securities.
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