Bond rout points to new normal, if Donald Trump gets his way

What’s an investor to do in a bond rout? First thing, figure out what on earth the term really means.

Cash rate

What’s an investor to do in a bond rout? First thing, figure out what on earth that term really means. If bond prices start falling and bond yields start going up, this is all very exotic stuff, but most people don’t own any bonds, so why give a care?

Here’s why. A bond rout means interest rates will go higher, your debts are about to become harder to service, and stocks we treat as bonds — the banks, leading blue chips and property trusts — are going to come under selling pressure.

On the other hand, savers, pensioners and investors should be more appropriately rewarded in the months ahead as the markets revert to what US president-elect Donald Trump describes as “normal”.

If Trump gets his way, here’s what the new normal scenario will mean.

• Holding money in cash should become a better option.

• Investing in “growth” assets — stocks and other investments where profits outpace inflation — will be more lucrative.

• Fixing loans, including mortgages — at current rates that are at their lowest in a generation — may also become much more popular.

• Ultimately, property investment — with its very low rental yields — will be less attractive.

To put it another way, the ­upside-down investing world following the global financial crisis that led to negative interest rates may be ending.

While large individual exposure to bonds is rare — we have an underdeveloped retail bond market in Australia — just about everyone who has superannuation with a major institution will have some indirect exposure.

In this respect the impact of the bond rout is largely second-hand. Most investors will be unable to ­influence whether their super funds should stick with bond holdings or seek to sell out now.

Still, behaviour patterns that start among professional and very wealthy investors, who have been selling heavily since Trump was elected last week, can quickly move across the investment landscape. If the rout extends from here, it will certainly mean the move away from “fixed income” securities is likely to continue. That means less demand for fixed rate bonds (which dominate the market), and also bond proxies such as hybrids and stocks, which can pay dividend yields double current cash rates.

What investments are likely to win in this scenario? Those with term deposits should benefit soon, as cash rates will inevitably rise in tandem with higher bond yields.

Investors in floating rate bonds (which should raft higher with rising bond yields) are set for better days and also traditional insurance companies, which are mandated to invest in fixed interest even when rates are negative.

In the medium term, the outcome for banks and other industrials is more mixed. As the “hunt for yield” eases and investors go back to cash and newly issued bonds at higher yields, the winning stock investments will come from companies that can drive higher total returns when faced with gradually higher financing costs. Put simply, companies that have been rewarded for merely dishing out high dividends will no longer find favour.

Of course, all this is predicated on the sort of financial world promised by Trump coming to pass — just now the bond market is signalling furiously some version of this new reality will emerge.

Remember, no less than four months ago, the bond market after the Brexit surprise was signalling that US 10-year yields were about to go lower again.

It turned out bond traders were wrong — they were only betting on a likely outcome.

And they are only betting now.