By Colin Barr, Chris Dieterich and Corrie Driebusch
So much for Wall Street hating uncertainty.
Since the Republicans swept Washington, investors have snapped up stocks and sold bonds, anticipating a future in which President-elect Donald Trump and Republicans in Congress cut taxes, slash regulation and push through a large fiscal stimulus.
While the market moves seem to point to a future in which stronger growth will finally put ultralow interest rates behind us, the "reflation trade" in which stocks rise and bonds fall amounts to a roll of the dice.
That is because investors are betting that the full Trump economic agenda will accomplish what the investment world likes, such as tax relief and deregulation, while largely ignoring the potentially growth-reducing impact of other campaign promises, such as much tougher stances on trade and immigration.
The rush out of long-term Treasurys and into industrial stocks might already have gone too far, portfolio managers warn.
For many money managers, it is the latest sign of the market's eagerness to call an end to the era of low rates, even before a stronger recovery takes root.
Trades based on rising growth and inflation are "probably going to work through inauguration day, but then we have to start dealing with the reality," said Scott Minerd, global chief investment officer at Guggenheim Partners LLC, an asset manager with $250 billion under management.
Price declines in the U.S. long bond, whose yield rose the most last week in seven years to 2.928%, have pushed the 30-year yield near its likely level when the Federal Reserve completes its current tightening cycle in two to three years, Mr. Minerd said. "Rates are not going to continue to go straight up," he said.
Yet investors' embrace of the reflation narrative is evident in the scramble out of assets that benefit from low rates and into those deemed likely to gain from higher rates.
Dispersion, measuring the standard deviation of one-day returns for S&P 500 industry groups, surged on Wednesday to the highest since 2008, according to Macro Risk Advisors.
S&P 500 financials climbed 4.1% that day, as investors bet banks will benefit from rising long-term interest rates that tend to fatten their lending profits and potentially from deregulation that will open new lending opportunities. Utilities sank 3.7%, reflecting a bet that rising rates will diminish the sector's appeal.
It was the sectors' largest daily gap since 2009.
Investors pulled $400 million from emerging-markets stock funds and $73 million from emerging-markets debt funds in the week ended Wednesday, according to Bank of America Merrill Lynch, the largest in 19 weeks in both cases.
The iShares TIPS Bond ETF has pulled in $1.4 billion so far this month, the biggest month-to-date tally on record, according to BlackRock Inc. TIPS are inflation-protected government bonds that increase their payout when inflation exceeds a certain threshold.
Stephen Cucchiaro, chief investment officer at 3EDGE Asset Management, said his firm sold emerging-market equity exchange-traded funds and gold after the election jostled both markets.
"It's a race against time," Mr. Cucchiaro said. "Will the economic piece kick in before the deficit rises and inflation spikes up?"
But buying the financials and inflation-protected bonds are trades that investors have been trying for years with only occasional success.
Sharp rises in U.S. bond yields in the spring of 2010 and the second half of 2013 were quickly reversed, reflecting the persistence of soft global growth, aging populations that limit consumption and rising debt loads that constrain spending.
"Over the longer term, the secular forces on the global economy don't change," said Brian Levitt, senior investment strategist at OppenheimerFunds.
Mr. Levitt said that likely means that even after Mr. Trump's election, "inflation doesn't actually go up substantially."
A Trump agenda likely will provide good news for stock investors at a time of stretched valuations and soft growth. Lower taxes could boost earnings at a time they have been in decline.
Cutting the effective corporate tax rate to 20% from the current 26% stands to double the 2017 earnings growth rate of S&P 500 companies, Goldman Sachs Group Inc. estimates.
The relief would be welcome. Third-quarter earnings are on track to rise 2.9% from a year earlier, snapping a string of five quarterly declines, according to FactSet.Still, some analysts warn that the volatile trading after the election surprise might have led to gains that aren't sustainable.
The Nasdaq Biotechnology Index surged 14% last week, its best performance since 2000, reflecting wagers that a Trump administration will be easier on drug-price regulation than a Democratic one.
Connor Browne, a portfolio manager at Thornburg Investment Management, said that his firm is trimming biotechnology holdings.
"Even within health care, we're not totally convinced that the positive stock-market reaction is the correct one," he said.
--Ben Eisen contributed to this article.
(END) Dow Jones Newswires
November 13, 2016 14:07 ET (19:07 GMT)
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