Maybe Trump Isn’t The U.S. Economy’s Savior
Last week’s healthcare bill debacle was perhaps the first major crack in a five-month U.S. equity rally predicated on the anticipated Trump economic miracle. We have made our opinion clear: we did not believe in the “Trump rally” from the beginning. Trump’s election just served as the fundamental catalyst for the blow-off top to cap the stunning eight-year bull market, driven essentially by free money. The magnitude and duration of the “Trump blow-off top” surprised us, as Wall Street was able to sell hard the narrative of stronger U.S. growth under Trump and more free money from the Trump tax cuts. However the narrative is suddenly changing. The Federal Reserve is now tightening, albeit slowly, its monetary policy — one source of free money is drying up. Now some market participants are slowly beginning to realize that the amount free money from Trump tax cuts will very unlikely correspond to the president’s campaign promises. Can a market rally predicated on massive fiscal stimulus continue if Washington disappoints? In this Commentary we assess what we see playing out in Washington and give our favourite “anti-Trump” trades.
Trump’s Inauspicious Début
The first 100-days under President Trump are not quite unfolding as U.S. equity markets had anticipated from November to the beginning of March. Swept into the White House with a Republican Congress to help push through his ambitious campaign agenda, the investing public had a legitimate reason to buy already over-valued equities. Donald Trump, successful multi-billionaire businessman, was going to run the U.S. government as an efficient private sector enterprise and lift U.S. annualized GDP back up to +4%. With rising equity prices, it was easy to get caught up in the euphoria. But cooler heads realized that the U.S. government will never be an efficient, pro-business entity. Trump’s agenda may have pleased some in Washington, but clearly not a majority. And in the U.S. political system based on checks-and-balances, a populist and rather isolated U.S. president, in the end, has relatively very little power. Indeed, the country is deeply dividend and breaking gridlock is Washington won’t be easy….and may border on the impossible.
To sum up Trump’s inauspicious first two months:
- Two failed travel bans
- Failure of a border adjustment provision
- Failure to repeal/replace Obamacare
- Humiliating false charge of wire-tapping by the Obama administration
- Resignation of Secretary of Defense for failing to disclose conversations with Russian ambassador
- FBI investigation into Trump organization collusion with Russia during the presidential campaign
This is not how markets saw the “Trump Revolution” unfolding.
We expect the failure of Trump and the Republicans to repeal Obamacare, perhaps their #1 priority, to be a bad omen for the remaining signature Trump programmes. Trump’s entire economic agenda could be imperiled by the failure to pass an Obamacare replacement. Why? The health care bill’s failure also creates a budget crunch that could make tax reform much more difficult to accomplish. To fund tax cuts and embark on a massive infrastructure spending programme, two things need to occur. First, money has to be freed up from somewhere (Obamacare was targeted as one source of savings, the failed border tax as another source of savings). Second, Congress needs to authorize an increase in the U.S debt ceiling in June. If the healthcare debacle is premonitory of Congress’s attitude toward’s Trump’s agenda, is it realistic to expect Congress to roll with Trump on the debt ceiling? It would seem to us, naively, that when you have a president who can’t deliver his own caucus, then the president’s position will be weakened on all issues. Or perhaps we should listen to Speaker Paul Ryan’s frank assessment of his party’s missed opportunity on health care: “Doing big things is hard in Washington”.
Concretely, Trump once suggested achieving growth of 2% to 4%, but this might look more like 1% to 2% now because of budgetary constraints. And we don’t expect that investors will get to see cuts to a 15% to 20% tax rate in corporate and marginal tax rates such as those Trump has proposed. Some agreement on tax cuts will likely be reached, perhaps closer to the 30% Obama was seeking. Will markets be satisfied with a watered-down tax cut? We would not bet our money on it.
Anti-Trump Trades
The U.S. equity trade has been in vogue since 2009. TINA – there is no alternative to U.S. equities. The U.S. market is the cleanest shirt in a dirty happen. Etc, etc. One thing we know for sure: no asset class outperforms indefinitely. Below is a 45-year weekly chart of the relative performance of the S&P 500 to the MSCI EAFE Index (EFA). The MSCI EAFE region covers developed market countries in Europe, Australasia, and the Far East. Outperformance of the S&P 500 (rising line) versus outperformance of the EAFE Index (falling line) clearly runs in cycles. And this makes sense – as one asset class gets expensive, money rotates into relatively cheaper markets. This is a law of financial markets that no central bank can annul. Our reading is that the U.S. equity outperform has come a mighty long way in historical terms. It will remain a curiosity as to why a new investor, with easy access today to international markets, would chose to buy U.S. stocks over other, relatively cheaper developed market stocks.
The next chart shows a 30-year weekly chart of the S&P 500 relative to the MSCI Emerging Market Index (EEM). Again, why would an investor chose relatively expensive U.S. stocks when high growth potential emerging regions are relatively cheap?
One simple, risk-on anti-Trump is to rotate into select European, Latin American, and emerging Asia equity markets. Our DGR Strategy currently holds positions in our favoured foreign equity markets. For more risk- averse investors, foreign equity risk can be hedged by partial short-positions in the S&P 500 (SPY). In addition, as explained in our next anti-Trump trade below, for a dollar-based investor, foreign equities should enjoy a multi-year currency tailwind.
Another trade that has come too far based on likely false assumptions concerning the reality of seeing Trump’s agenda implemented is the U.S. dollar (UUP). The dollar had already seen a long period of outperform from 2014 when the Fed begin jawboning the idea of tighten monetary policy. We believe, being the world’s reserve currency, that the inevitable, long-term path of the U.S. dollar is down. The U.S. must consistently run balance-of-payments deficits to supply the world with dollars (in academics, this is known as the Triffin dilemma). An inspection of a 40-year dollar index chart shows that since the Plaza Accord in 1985, the dollar is indeed in a long-term down-trend. In sum, the current dollar rally is living on borrowed time. We believe that markets will eventually realize that the Fed will not be able to tighten rates to the extent the Fed is currently insinuating and that the Trump miracle will not be that miraculous when the president’s agenda hits Washington gridlock.
Another anti-Trump trade, going hand-in-hand with longer-term dollar depreciation, is gold (GLD). The gold rally turned too parabolic in the wake of the Financial Crisis, resulting in a bust and almost 5-years of cyclical bear market. However a long-term gold chart shows that the long-term, sustainable trend-line, with a slope of about 30 degrees, remains in place. Gold will be looked to as a safe haven when equity bubbles burst and as an alternative to devalued national currencies, as investors seek a store of value after years of obscene money printing.
A final anti-Trump trade that we propose, and which may work well should Trump continue to disappoint, is Mexico. The national stock market and the peso were both hit hard by Trump’s anti-Mexico rhetoric. If there is a buy-the-dip play, we would prefer going long Mexican equities unhedged. The iShares Mexico ETF (EWW), listed on New York in dollars, has an implicit long peso position versus the dollar. The chart below shows the extent to which this asset class is lagging world markets. To the extent that this lag is due to Trump, we see a big catch-up trade in the EWW.
The multi-year deprecation on the peso versus the dollar would seem long in the tooth. From 2013 to 2017, the peso fell over 80% versus the dollar! For a dollar-based investor, Mexican equities are on a fire sale.
One possible anti-Trump trade we are holding off on is going long U.S. Treasurys (TLT). While Treasurys will likely rally when fear returns to the equity market, the Federal Reserve has so screwed up the U.S. bond market that we prefer not to risk money in Treasurys today. Fundamentally, what will happen with a Federal Reserve balance sheet 4-times as large as pre-crisis levels? Can we decently pretend that inflation will never show up? Or will the inflation risk premium on yields never get priced in? These are strange markets, but betting against common economic sense — in the long-term – does not make sense to us.
Conclusion
As we write, the risk-on trade remains alive and well in U.S. equities, despite last Tuesday’s technical break- down on the Dow and the realization (for some) that Trump’s agenda won’t pass Congress in the form laid out in his campaign. For investors wishing (or needing) to stay invested, we recommend moving into some anti-Trump trades. Our U.S. equity exposure has been reduced to 0%. U.S. outperformance was not meant to last forever, and we see signs now that other developed markets and emerging markets are set to resume leadership.
