Trump Trades and Trends
When describing the run-up to the great depression, Dr. Benjamin Anderson wrote in Economics and the Public Welfare that: “Every era of speculation brings forth a crop of theories designed to justify the speculation, and the speculative slogans are easily seized upon. The term ‘new era’ was the slogan for the 1927-1929 period. We were in a new era in which old economic laws were suspended.”
To jump into financial assets today, one must throw out all of the hard-earned lessons of markets past and bet heavily on a permanent “new era” of new extreme market conditions. But as John Hussman recently warned, “Amid record valuation extremes, amid the extended peak of the third great speculative bubble in U.S. history, and amid the greatest concentration of market capitalization in speculative glamour stocks since the peaks of the other two bubbles in 1929 and 2000, one thing seems certain. Market conditions will change.”
Make no mistake, the current disconnect between market prices and reality is indeed historic. The valuation of the U.S. stock market, as measured by the Buffet indicator, is now at a record high of over 200% of U.S. GDP. For perspective, at the height of the highly speculative dot.com bull market bubble in March of 2000, the stock market valuation peaked at roughly 146% of GDP. Furthermore, just as in March of 2000, we are again two standard deviations above even a rising historical valuation trend—an extreme that has reliably capped valuations historically.
It’s not just the Buffett indicator screaming for caution. According to Hussman, the U.S. equity market has now “reached the most extreme level of valuation in history based on the measures we find best-correlated with actual, subsequent 10–12 year returns across a century of market cycles… The recent level [of valuations] exceeds every previous extreme, including 1929, 2000, and 2022.”
Before concluding that record high stock prices and record high valuations merely reflect thriving companies in a booming economy, consider that while the Russell 2000 small cap index just made a new all-time high last week post-election, a whopping 43% of the companies in the index are actually losing money. What’s worse, that head-scratching number of unprofitable companies has surged from 17% pre-GFC, and even 14% ahead of the dot.com bust. In other words, financial asset prices and valuations continue to ramp up even as some crucial fundamentals continue to deteriorate. At this point, any disruption to the particular alchemy of this bubble market will likely expose what’s become a gaping air pocket between current prices and current fundamentals. That doesn’t mean markets must crash and crash soon, but it does mean that unless we have entered a completely new era, today’s market poses risks to financial asset prices that may be as great as any time in history.
Within that sobering context, let’s examine the potential market impacts stemming from Trump’s sweeping red wave election victory.
In the short term, we’ve seen the “Trump trades” dominate markets. On balance, those trades have sent the dollar up, yields up, stocks up, cryptocurrencies up, and the VIX volatility index and gold down. The moves in the dollar, yields, stocks, and crypto all seem to be knee-jerk Trump victory reactions. But a cautionary note is warranted. Compared to 2016, this Trump election victory was far less of a surprise, yet counterintuitively it has also garnered a far greater market reaction. That speaks to more of a temporary trade than a sustainable trend. The point is made all the more clear when considering that the forward earnings multiple of the S&P 500 in 2016 was a much more modest 17x—a far cry from today’s bubblicious 22x forward earnings multiple.
The drops in the VIX volatility index and gold seem to reflect the unwind of hedges put in place to protect against potential political uncertainty in the event of a contested election. Adding to the fact that an uncontested election triggered the unwind of those hedges, the gold market was ripe for a healthy technical correction that’s now being assisted by the spike in the dollar and Treasury yields, along with more hawkish comments this week from Fed Chair Powell.
Now, that’s the “Trump trade,” but what about the lasting Trump trend? As former Treasury secretary Larry Summers said this week, “the idea that Trump’s program…is a highly inflationary program generates about as much consensus among people who follow economics as any proposition I can remember in the past 40 years.”
That said, U.S. “True Interest Expense” (entitlements + net interest expense) just hit 121% of tax receipts in October, and has now been running at 103% of tax receipts over the past four months. In other words, The U.S. is already in the position of one of the unprofitable Russell 2000 companies mentioned earlier—we have been reduced to needing to borrowing money just to pay the interest on our debt.
Trump knows this, and has pledged to reduce the deficit. However, with nearly $2 trillion of deficit spending acting as a stimulant for markets and the economy, Trump policies that introduce austerity alone as a means to reduce debt-to-GDP are likely to backfire. Meaningful spending cuts are likely to slow economic growth and slow relentless stock market appreciation. That’s a potent combination that will likely reduce government tax receipts disproportionately more than what’s saved by the austerity measures. In other words, as we’ve seen in past U.S. recessions, Trump spending cuts are likely to widen the deficit rather than shrink it. Ultimately, that’s a deflationary path culminating in a debt death spiral likely to crash the economy and put the pin to what John Hussman called “the third great speculative bubble in U.S. history.”
In the end, whether the Trump program is inflationary or deflationary seems to come down to the sequence of policy enactment. If the Trump administration can manufacture a weak dollar and work to contain Treasury yields at lower levels before they materially cut spending and implement tariffs, then—all else equal—the larger Trump trend is likely inflationary and likely supportive of nominal U.S. growth. If, however, the new administration tries to materially cut spending with a still strong dollar and rising bond yields, then the deflationary debt-spiral dynamics will threaten to take hold and the Trump trend will likely be toward deflation and a popping of the massive financial asset bubble. Again, hard to get around the fact that risks to financial asset prices in this market are massive.
But to truly understand the ultimate potential implications of the Trump election victory, we have to step back even further, widen the lens, and think bigger.
In HAI‘s view, the overriding U.S. policy regime of recent decades can best be understood as one of aiming to provide support for the post-1971 structure of the U.S. dollar’s reserve status and for the role of U.S. Treasurys as the primary global reserve asset. The post-1971 U.S. dollar-centric “petrodollar” system required the exporting of dollars, the offshoring of the US industrial base to China and other emerging markets, keeping zero tariffs on China, and relaxed immigration policies to keep enough slack in the labor market to ultimately help keep U.S. inflation low. Again, that was required to keep U.S. Treasury yields low, to keep U.S. debt and deficits relatively affordable, and to maintain a relatively stable dollar as well as a functional and liquid bond market. Instability in U.S. currency and debt markets would have compromised the “system.”
This was the petrodollar “dollar recycling” system, and it was great for Washington, Wall Street, and, for a period of time, China and other emerging markets. It wasn’t good, however, for the U.S. middle and working classes on net.
Now, if Trump means business and his policy proposals are taken at face value, his policy prescriptions—viewed in the context above—point to the fact that the structure of the post-1971 U.S. dollar reserve status must change. The post-1971 U.S. dollar reserve status structure requires the U.S. to run deficits to supply the world with the U.S. dollars and U.S. Treasurys it requires for trade. The U.S. can run the deficits the world needs under the current dollar reserve system, or the U.S. can reduce deficits meaningfully, put up tariffs, strengthen immigration policy, and reshore an industrial base to benefit national security and middle and working class Americans neglected by the old system. However, the U.S. cannot do both. In other words, Trump’s proposed agenda implies a state-sanctioned transition away from the “dollar recycling” system in which U.S. Treasurys are the global reserve asset toward a “gold recycling” system in which gold serves as the primary neutral global reserve asset.
If Trump succeeds in implementing his agenda, if he can reprioritize U.S. policy objectives away from those strictly demanded by the current U.S. dollar system, then the world will have to use something other than U.S. Treasurys as its primary reserve asset—but there is no other sovereign debt that is willing or able to serve the role. The only asset fit for duty is gold. And, as HAI has pointed out previously, recent record global central bank gold purchases are a clue that the process of a shift towards gold as the primary reserve asset has already begun. It’s a trend, and one that the Trump policy platform appears, by default, to support wholeheartedly. In short, if Trump does even a fraction of what he says he wants to do, gold must continue moving back into the “new system” as a neutral reserve asset, and that should continue to drive gold’s price significantly higher over time.
So, while the Trump trades have sent the dollar, yields, stocks, and cryptocurrencies up, and the VIX volatility index and gold down, the initial moves might not reflect the ultimate Trump trends. As for stocks, HAI favorite economist David Rosenberg said this week that the post-election “Trump trade” has pushed stock valuations from “an egregious equity market price bubble to something that is more like flying over the cuckoo’s nest.” He added matter-of-factly that, “this equity bubble is going to burst. I will say with 100% certainty this equity bubble will burst.”
Now, HAI is certain that financial assets are a massive bubble with equally massive risk, but HAI doesn’t know whether Trump policies will further inflate or suddenly deflate that bubble. That seems to depend on the sequencing of specific policy implementation as well as other factors outside of his control. That said, given the enormous risk in financial assets presently, HAI continues to favor investing in the greater Trump trend—the dollar recycling system transitioning to the gold recycling system. In the context of a Trump administration aiming to reprioritize a changing of the “system,” the most underappreciated, under-owned, and undervalued Trump trade looks like an investment in the larger Trump trend towards gold.
Weekly performance: The S&P 500 lost 2.08%. Gold dropped by 4.63%, silver was down 3.23%. Platinum was off 3.41%, and palladium was hit by 4.93%. The HUI gold miners index was crushed by 8.62%. The IFRA iShares US Infrastructure ETF was off 1.54%. Energy commodities were volatile and mixed on the week. WTI crude oil lost 4.92%, while natural gas was up 5.77%. The CRB Commodity Index was off 0.77%. Copper was volatile and lower, down 5.61%. The Dow Jones US Specialty Real Estate Investment Trust Index lost 2.28%. The Vanguard Utilities ETF was nearly flat, up 0.18%. The dollar index was up 1.64%, to close the week at 106.61. The yield on the 10-yr U.S. Treasury was up 14 bps to close at 4.44%.
Have a wonderful weekend!
Best Regards,
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
