The following is a summary of our recent interview with Jim Bianco, which can be listened to on our site here or on iTunes here.
We’ve seen a divergence between “hard” economic numbers and relatively strong “soft” data including sentiment readings, and the consensus is for an economic reflation under President Trump’s direction.
To parse what this might mean for investors, we spoke with Jim Bianco, president of Bianco Research on FS Insider to get his take on the "reflation trade" underway and how he thinks 2017 will play out for the economy and financial markets.
Data Divergence May Signal Inflation
Though sentiment and other “soft” economic indicators are signaling growth ahead, the hard numbers coming out aren’t as strong, Bianco stated.
“According to a lot of the sentiment data … consumer confidence is at a 17-year high,” he noted. “Markets have a narrow definition (of positive news). They care about profits and they care about businesses doing better. In that respect, they see a Trump presidency as an unabashed positive.”
However, most of the positive information coming out is in the form of surveys, he added. Here's a short clip of what he had to say:
If we look at the hard data, such as industrial production, retail sales, non-farm payrolls, and other metrics, taken as a group, these are showing little evidence that things are getting much better, Bianco stated.
“A couple of numbers here and there are getting better,” he said. “We’re nowhere near a recession or anything. We’re kind of in that funk that we’ve been in for the last couple of years, according to the hard data. But the surveys say, ‘check back in 6 months or 12 months.’ They expect it should get better.”
Less Growth, More Inflation
We’re going to get reflation, Bianco said, but he has a nuanced view of the form it will take. Are we going to get real growth returning, or just an increase in inflation?
In his mind, we’ll see more inflation than real growth, though we will still see real growth in the mix.
“That matters because for the stock market, if we say … the economy’s going to reflate and there’s going to be a lot of inflation, stocks will probably go down,” he said. “If we say the economy’s going to reflate and there’s going to be a lot of real growth, that’s going to lead to high earnings and stocks should be OK.”
Bianco favors the inflation scenario for a few reasons. For one, wages are finally starting to move higher. We’re seeing 2.5 to 3 percent wage growth, which is the highest it’s been in the post-crisis era.
Also, the rising populism we’re observing both in the US and abroad may lead to increased friction in world trade, Bianco noted, which could lead to higher inflation.
If that happens, it might mean higher interest rates, rising for the wrong reason, which is something we haven’t seen in 20 years, he added. That could be a real drag on risk assets such as stocks or corporate bonds … because inflation erodes purchasing power or earnings.
“If we wind up getting the inflation part of the equation, I don’t think it’s as good as getting the real growth part of the equation, but yes, we’re going to get a reflation,” he said. “The question is, what kind?”
Bonds and the Fed
If we do see more inflation than real growth, Bianco stated that we should see the 10-year Treasury note, with is trading at 2.45 right now, go to somewhere close to 3 percent at the end of the year.
“I will fully concede that that is probably the most consensus call you can make right now,” he said. “Everybody is positioned for some kind of reflation taking bonds to 3 percent.”
If we look at the sentiment data in the bond market, we see one of the biggest shorts of all time right now, he added. But he doesn’t think the move to 3 is going to happen right away. Rather, he expects we’ll see a short squeeze to cast some doubt on this idea that we’re going to have reflation, and then we hit 3 by the end of the year.
“Yes, it will be an extra volatile year if that forecast plays out,” he said. “But I do think it really revolves around how much inflation we’re expecting.”
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