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Can Trump Build a Goldilocks Economy?

Since Donald Trump’s upset victory the stock market has gone on a tear, with all the major indexes hitting record highs this week. That was unexpected, but even more surprising to us is the great performance of the high-yield holdings in our Personal Finance Maximum Income for Retirees portfolio. While the S&P 500 gained 3.1% in the two weeks following the election, our collection of REITs, MLPs and BDCs posted a total return of 3.7%.

Conventional wisdom says the opposite should have happened. When interest rates rise, which they have since Trump’s win, these pass-thru vehicles should drop in price as higher rates squeeze their profit margins. That’s because the types of securities in our Max Income portfolio are highly leveraged: they use a lot of debt to buy the assets that generate the income that’s paid to shareholders.

However, investors appear to be more excited by the future income that can be generated by a growing economy, and less concerned about the higher borrowing costs. Of the three classes of pass-thru vehicles in our portfolio, only REITs performed worse than the overall market, but they still posted a 0.56 gain.

The best performing category was our quintet of BDCs (business development companies) with a 5.3% average return. BDCs provide loans to private businesses, but often hold an “equity kicker,” or an equity stake in the company that could add value if the company goes public or is bought out. So while an uptick in interest rates hurts, it could pale compared to an equity kicker bonus.  Also beating the market was our group of MLPs (master limited partnerships), coincidentally gaining a nearly identical 5.2% as investors anticipate friendlier regulations  for energy companies—most MLPs are in the energy sector.  

Confirming that this performance was driven by growth expectations and not inflation fears, our lone inflation hedge in the portfolio, the Fidelity Global Commodity Stock, fund grew by 2.5%, less than the gains in both our portfolio and the overall stock market. In every respect the behavior of these disparate asset classes point in the same direction: the economy is expected to grow at a pace that will drive equity values up without triggering a surge in inflation.

Growth with no inflation fears? That’s the definition of the “Goldilocks” economy that every stock market investor hopes for. Of course, just because we hope the economy will be neither too hot nor too cold, but just right, doesn’t mean the bears won’t come. To find that economic sweet spot Trump will need to tread carefully as he cobbles together his ambitious agenda for tax reform, infrastructure spending and renegotiating trade deals.

Most Americans currently believe he can get the job done. According to a poll conducted this week by Quinnipiac University, 59% of respondents said they feel “optimistic about the next four years with Donald Trump as president,” 66% think “he will create jobs,” and 52% believe “Trump’s policies will help the nation’s economy.” 

Are the masses right? Only time will tell. Meanwhile the market isn’t wasting any time boosting stocks based on these beliefs. After two years of watching the stock market tread water, many investors are jumping on the Trump train. Now let’s see if he can build up a good head of steam and keep it from going off the tracks.

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