Many of us are or were taught in economics about the counterrelationship between stocks and bonds in investments. Usually when an investor is seeking diversity, a portfolio will include a mix of stocks and bonds for this traditional adversarial relationship.

    Traditional Market Roles

    The story usually goes that when the stock market is in a bull run, the bonds go bearish, meaning that the demands for bonds goes down as stocks rise, making prices for the bonds g down and yields go up in an attempt to attract business.

    The opposite is (usually) true in a bearish stock market. When there is uncertainty or it looks like the market is taking a negative turn due to poor economic news, investors tend to invest more in bonds, which drive the prices up and sends yields down.

    However, for at least the last two to three years of the Obama administration, there have been some mixed messages to the point that tradition was broken and the stock and bond markets both trended the same – bear to bull and back again. The question is often whether to buy stock in private (but publicly traded) companies, or to buy bonds created from federal or state governments?

    About Stocks

    It makes sense that stocks and bonds would be adversarial in a yin-and-yang sort of way. Stocks are shares of a company – a person who invest in Apple, for instance, essentially owns a piece of the company. If you own Apple stock, you are a co-owner of that company. And if you own the company or want to buy some ownership, that usually means you are bullish about that company. You are betting that your optimism in that company will be well-founded and that you will make money on that bet.

    When the company is doing well, more and more people will want that stock, and as there is no unlimited supply of stakes, the shares that are on the market become fewer and the price goes up. And if you hold your stake long enough and then sell at or near the peak, you can make yourself some money.

    About Bonds

    While companies also sell bonds, stories about stocks vs. bonds usually deal with U.S. government bonds – that which the government puts out to bring in money to pay its bills every year – as the country is averaging an annual deficit of nearly $1 trillion. Bonds are essentially IOUs from the government to those who buy them – it is a promise that if you give the government money on this bond, the government will pay you interest on a regular schedule based on the coupon (interest rate) posted on the bond, until the date that the bond matures. And you get your initial investment returned to you at that time, provided you hold the bond at the date of maturity.

    While taxpayers may not like the federal government offering so much debt every year, investors in a way love it. Federal debt is backed by the federal government, so it is a very reliable investment. It doesn’t make a lot of money (current yields are in the 2-2.5 percent range) for an investor, but as most bonds are 10- or 20-year notes, it can be a reliable source of income over time, whereas even dividend-bearing stocks don’t offer dividends every quarter nor always at the same or higher amounts each time.

    The Trump Economy – When, and How High?

    With Donald Trump now President of the United States for the last month, there has been much talk about what might happen to the economy, based on Trump’s rhetoric and the reality of the molasses-in-winter movement of Congress. The current argument is not really about whether the economy will grow under Trump – the overwhelming consensus is that it will, based on his call for fewer regulations and lower taxes, never mind the sticky tax-reform talk – it is about how fast that growth will come.

    Those on the bond side say the growth will be a little farther down the road, and in fact thre may be more bond-buying opportunities in the next 12 to 18 months, because reduced regulations will take a little while to appear in the economy, and taxes at this point do not seem to be changing much and the effect may not be felt until later this year at the earliest. Even newly minted Treasury Secretary Steve Mnuchin is quoted to essentially say that it’s best to lower expectations at this point.

    On the stock side, the stock market has previously “baked in” Hillary Clinton’s “impending” electoral victory last November, and since Elction Day, the markets have shot out of a cannon upward, trusting that the Trump economy just has to be better than the Clinton econoy would have been. Any glimmer of optimism is enough to push stocks higher – the market is more of an optimism gauge for the future than a current state of the economy. Some say that stocks should be bought now in preparation because there is a sense that this could be another Regan economic boom – and that one didn’t take hold until a couple years into his first term. They think it will be the same with Trump, and jump on board now!

    Who Will Win?

    That is a difficult question to answer. There is no crystal ball, and with the way the economy has transformed and evolved over the last 20 years, what has traditionally been true in the markets and the economy could be completely obsolete and off-base this time. There seems to be optimism on the whole that the economy will improve (could it get worse, honestly?), and both the bond and stock markets are preparing for it. But how fast will the turnaround happen remains to be seen, and how large will the growth be is also hard to predict.

    From an investing perspective, you should have both stocks and bonds in your portfolio if you want to be truly diversified, but if you agree that growth will happen soon, then stocks are a good way to go. If you are more pessimistic, then stick with bonds – they take away much of the risk of stocks and at least give you some modest returns even in down times, which is something you won’t get from stocks in a bear market.

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  2. Thoughts on Trump Proofing Your Portfolio

    To paraphrase Forrest Gump, the Donald Trump presidency is like a box of chocolates, you never know what you are going to get! But with the stock market recording ever-new highs, it’s time to get going.  Protecting yourself means, you have to accept there will be surprises and surprises sometimes can be humbling.

    Having made that disclaimer, lets start with a few obvious things.  Investor confidence is brimming that the Presidents pro business policies will be successful.  Of course, why else would the market be at these levels?  But, there is absolutely no guarantee this will happen either in whole or in part.

    We began by realizing investors are abnormally calm.  Look at the markets volatility index or VIX and you will find a near 45% drop in the index since just before last November’s election. In fact, the index is near a 10 year low.  This doesn’t make sense.

    If there was serious doubt about President Trumps policies or if his image of crazed despot portrayed in the media, the VIX would be fluttering well above 20 rather than closer to 10-12 where it has been hovering lately. During the 2008 financial crisis, the VIX hit 60.

    This lack of volatility has direct implications for one of the ways professionals often choose to protect their portfolios: with options.  In this case we are talking about owning Put Options on the S&P 500 or the Nasdaq.

    Options are not for everyone, but they are an efficient mechanism.  In one single transaction you protect your entire portfolio.

    Right now is a good time because when volatility is low, often option premiums are at a low.  In addition, option prices are fundamentally tied to interest rates.  If interest rates increase this year the price of Puts will rise also.  So now may be a good time to get started.

    For those uncomfortable or simply prefer a sector strategy consider several options.

    The President has made it clear, he wants to boost military spending $54 billion by cutting regulations and other items.  So the defense industry is a natural beneficiary with traditional names like Boeing and Lockheed.  There are many more names to consider.  The caveat here of course relates to Trump getting his military budget through Congress. That‘s a pretty big if.

    Before considering purchase or sale of securities related to any of these companies, check with your advisor.  He/she is whom you are paying for advice.

    Another area could be robotics companies.  Finding a pure play in a public vehicle is challenging but #5 Bosh and #6 Google top the public list.

    The President has had multiple meetings at the White House with the CEO’s of Americas manufacturing biggies.  There seems to be lots of smiling faces around the table at that means good things for bring work back to this country.  But work does not automatically spell jobs. The hourly rate differential in many cases is still to great for this to happen.  In addition there is the question of job training and retraining.  That means demand for robots while the demand for labor most likely will be for building, programming and maintaining the machines.

    Finally, we are willing to bet that healthcare turns out to be way too big a problem to solve even for The Donald.  As he recently was quoted, “Nobody new that healthcare could be so complicated”.  He is now learning that this is one campaign promise he won’t be able to keep.  The natural tendency would be to lean toward the healthcare insurers like United Healthcare, WellPoint and Aetna.  But there is uncertainty over what form the new version of the Affordable Care Act will look like.  The safer bet might just be those damn prescription drug companies where demand growth and pricing power combine to produce above average growth.

    These are only two strategies and clearly not the only options. Of the two, we favor the overall approach offered by options in partial because it takes a global approach to uncertainty.  President Trump starts his term in office with the lowest approval rating ever recorded.  If the suspicions of almost two-thirds of American voters prove accurate, the price of lots of stocks will suffer.

    Up to now those who support Trump accept his brash off the wall style in return for the promise of strong leadership and fundamental improvement in government. His approval ratings may be low but distrust in government is America’s most important domestic issue.  As time goes if the President is unable to deliver, the crowd noise could get very loud and that would not be good for the market.

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