Yield chasers, don’t blame Trump for your stock slump

The Fed and investors have been clamoring for the return of inflation, but like that old expression goes, be careful about what you wish for, because you just might get it.

We've gone from an environment where investors had to buy yield now because it would be lower tomorrow, to one in which an investor won't buy yield because it'll be higher tomorrow. It's a complete reversal from just over a week ago.

Consumer staples Staff members clear stock from their shop floor in the small Wairarapa town of Eketahuna on January 20, 2014 after a strong 6.3-magnitude earthquake rattled New Zealand
Marty Melville | Getty Images

A little inflation is not only healthy for a capitalist society, it is necessary. But investors who chased yield in sectors like consumer staples and utilities amid persistently low interest rates are now feeling the pain. The ultra-low interest rates took what were otherwise fixed-income investors and moved them up the risk ladder. They binged on blue chips that pay dividends.

That, in and of itself, would normally be a reasonable thing to do. Baby boomers and seniors have flocked to sectors they mistakenly thought of as bond equivalents. You know what's equivalent to bonds? Bonds. Period. Interest rates have been so low for such a long time, it pushed these two generations into consumer staples, utilities and telecoms like moths attracted to a flame.

The reach for yield has resulted in what I believe is a dislocation caused by rates that have been suppressed artificially by the Fed. And it's a dislocation that has happened just at the time the baby boomers started retiring in droves. Retirement is a time when people are most reliant on both their assets and received advice.

My greatest concern is that unless we see a renewed bull market in Treasurys, losses may become long term or even permanent.

"Retirement is a time when people are most reliant on both their assets and received advice. My greatest concern is that unless we see a renewed bill market in Treasurys, losses may become long term or even permanent."

Now, as the stock market rages higher, consumer staples and utilities stocks are being left behind. Telecom hasn't done as poorly as these other yield-rich sectors in the past week — though it has underperformed the market — but over the past three months, the trend in this sector has been down. Since last August, widely owned stocks in consumer staples, utilities and telecoms have retreated by multiples of their annual dividend payout.

This is what happens when investors anchor themselves too strongly with current economic conditions, no matter how long they persist.

The losers

1-week performance (%)
Quarter-to-date performance (%)
Utilities Select Sector SPDR (-5.7) (-6.1)
iShares US Utilities (-5.2) (-5.7)
Vanguard Utilities (-5) (-5.4)
Consumer Staples Select Sector (-3.9) (-5.2)
Vanguard Consumer Staples (-3.5) (-4.9)
iShares US Consumer Goods (-3) (-5)

(Source: XTF.com)

The cost-cutting over the last eight years at industrial, material and financial services firms means that even a slight uptick in revenue equates to a big pop to their earnings. And stock buybacks, which on aggregate have removed trillions of dollars from the public float of stocks, means there are fewer shares to go around in times of surging buy orders. Trump policy is all about the kinds of policies that will be a boon for those companies.

Don't expect them to go up in a straight line, though. And the newly emerged laggards — consumer staples, utilities and telecom — won't go down in a straight line, either.

I don't see these yield-chasing stock plays reaching new all-time highs anytime soon. But now for the good news: The newly emerging market leaders should have a long way to go higher.

The winners

1-week performance (%)
Quarter-to-date performance (%)
PowerShares KBW Regional Banking 15.6 18.3
iShares US Broker Dealers 11.9 13
First Trust Nasaq ABA Community Bank 14.7 16.3
Financial Select Sector 11 15
PowerShare SmallCap Materials 14.4 11.6
PowerShares SmallCap Industrials 12.2 8
Industrials Select Sector SPDR 6 5
Fidelity MSCI Materials 4 2.4

(Source: XTF.com)

Inflation used to be called the "bugaboo" of Wall Street. You just haven't heard it for a long time. Now it's time to know what it has meant historically so you can make better educated decisions about changes to your portfolio holdings.

We are moving from low inflation to accelerating moderate inflation. It had already begun ahead of the presidential election. October hourly earnings posted a 2.8 percent annualized increase, the biggest jump in seven years , according to the Labor Department. Where are we in the inflationary cycle? Very early. Not early innings, but more like a pregame warm-up routine.

Where we (and inflation) go from here

The fundamentals of the leading sectors of this rally haven't changed much in just a week, but they're perceived to grow strongly from out of nowhere and it'll be ahead of short-term inflation forecasts. Eventually, their growth will level off at a higher base, but then the escape velocity of earnings growth won't be enough to outrun the gravitational pull of inflation. That's how the cycle works.

It has long been believed by the Fed that 2 percent is the optimal rate of inflation for the United States. But since 1970, there is an inflation rate that overwhelms stocks, or their earnings: 4 percent, according to S&P Capital IQ.

The Fed may have even done too good a job in fighting deflation worries, which are difficult to fend off once entrenched in investors' minds. Now we have a whiff of inflation, which may be at a level just in perfect balance with steady economic growth and low unemployment, the 2 percent mandate of the Fed, or it may be running a little too high to keep to the mandate. Because once the inflation genie is out of the bottle, it is hard to put it back in. That's when the Fed typically gets aggressive and raises short-term rates more frequently than expected. It normally takes a recession to bring wages back down, also called a "hard landing."

The Fed has a long track record of both inducing recessions and inflating asset bubbles. If history is any guide, market pundits have a way of underestimating the lengths that the Fed will go to in order to follow its mandate and the Fed has a way of overestimating investors' ability to act rationally.

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Not only are stock market investors unprepared for the prospect of higher interest rates, they haven't even been able to conceptualize it. I think that is a classic mistake. If you have a long time horizon, you should be all right. It's just that going from such a low interest-rate base, the time horizon needs to be thought of as longer than what a lot of safety-seekers would be prepared to accept.

One of the main objectives that go hand -in-hand with yield investing is preservation of capital — the expectation that you should get back your principal. That's what bonds are for, not stocks.

By Mitch Goldberg, president of ClientFirst Strategy

Follow him on Twitter @Mitch_Goldberg