Pain Before Gain?
A little over a month into President Trump 2.0 and DOGE cost-cutting initiatives, U.S. economic growth is starting to significantly surprise to the downside. Perhaps it really shouldn’t be a surprise. After all, U.S. Federal government spending (the prime target in the cross hairs of DOGE) amounts to roughly 25% of U.S. gross national product (GDP).
This week, the weakening economic data points stood out. The highly regarded Chicago Fed National Activity Index (CFNAI) disappointed with a decrease to -0.03 in January from +0.18 in December. The CFNAI weakness was followed by January new home sales that were down 10.5% month-over-month (M/M) versus an expected decline of only 2.6%.
Then came the highly reputable Conference Board Consumer Confidence Index, which dropped seven points in February to 98.3. That’s the biggest monthly decline since August of 2021, and it’s near the lowest confidence level since 2022. Equally concerning, the Conference Board’s expectations index for the next six months also plunged to 72.9 (the largest monthly decline in 3.5 years), one of the lowest readings seen in 14 years. According to the Conference Board, the percentage of consumers expecting a recession over the next 12 months also jumped to 67%—a nine-month high—while the share of consumers who are worried about fewer jobs being available spiked to levels not seen in over a decade.
Then there was the Dallas Fed Manufacturing Index that produced a distinctly unpleasant stagflationary odor when it dropped to -8.3 from January’s 14 (way below the 6.4 expected), while at the same time prices paid for raw materials spiked to multi-year highs at 35 from 17.5 previously.
In short, the economy seems to be suddenly seizing up. The Atlanta Fed GDPNow first quarter 2025 real GDP estimate as of Friday had fallen from a positive 4.1% expectation down to a negative 1.5% contraction in just four very short weeks.
All this sudden economic weakness is even more troubling given that the Financial Times reported this week that U.S. companies are falling behind on loans at the fastest pace in almost a decade.
As Torsten Slok, Chief Economist at Apollo Global, summed it up, “Job fears are growing. This could lead households to pull back on big purchases—cars, computers, appliances, and travel—adding to economic risks.” He continued, “stagflation is the backdrop for the conversation that we’re having [at Apollo] in markets at the moment.”
Again, the prime suspect for the very sudden weakening in the U.S. economy is the impact of aggressive DOGE cuts to government spending that amounts to roughly 25% of U.S. GDP. These DOGE cuts are likely long-term healthy, but they’re short-term painful. They might even threaten a plunge into recession.
If DOGE spending cuts provoke a recession, they will prove counterproductive from a deficit standpoint. As HAI has highlighted previously, the last three U.S. recessions saw U.S. deficit-to-GDP rise by 6%, 8%, and 12% of GDP—or $1.6 trillion, $2.1 trillion, and $3.2 trillion—respectively. A continuation of the pattern in a new U.S. recession would perversely drive the U.S. deficit up by at least $1 trillion. Contrary to intent, DOGE-related spending cuts could then actually fast-track the U.S. government debt-spiral dynamics DOGE was intended to thwart.
In HAI’s view, the sudden, dramatic, and consistent downside economic data surprises of late—along with the Atlanta Fed’s latest GDPNow crash—are the most explicit warning so far that the counterintuitive DOGE threat is now a very real consideration.
Furthermore, with inflation still stubbornly well above target, its anyone’s guess as to how quickly and forcefully the Fed could and would move to quell any recessionary flames should they break out. In short, the recent and sudden economic weakness amid ongoing inflation, should it translate to a meaningful bout of extended stagflation, is the first serious warning to markets that radical Trump administration policies to “MAGA,” even if ultimately successful, might not come without significant unwanted consequences.
This week on MacroVoices, Jeff Snider—one of this author’s favorite market commentators—spoke to the positive side of what has become a rapidly growing mainstream awareness of the potential of a Trump administration “Mar-a-Lago accord” attempting radical fixes to massive structural U.S. problems. As Snider put it, “We’ve needed to replace the monetary system for what, ever since August of 2007, so we’re going on 18 years now, and up until recently nobody’s bothered even mentioning it… I think one of the big positives here is the fact that they’re connecting some dots and finally starting to understand that something big needs to be done.” That big something needing to get done, however, as evidenced by the sudden economic weakness previously discussed, goes far beyond merely DOGEing our way to fiscal health nirvana.
The Trump administration plan seems likely to involve disruptive tariffs intended to restructure global trade flows favorably for U.S. interests. It could even include efforts to restructure the post-1971 U.S. dollar-centric global monetary system to weaken the dollar with an aim to facilitate a full-scale U.S. reindustrialization effort.
Late on Friday, February 21st, however, the Trump administration seemed to add another weapon to its regime change policy arsenal—capital flows. That night, the Trump administration issued the “America First Investment Policy” executive order. It seems likely to prompt an accelerated exit of what one can only assume are significant sums of foreign capital out of U.S. dollar-denominated assets. In the executive order, the Trump administration stressed establishing new rules to stop U.S. companies and investors from investing in industries that advance some of the strategic interests of the People’s Republic of China, and stop persons affiliated with China from buying up critical American businesses and assets, allowing “only those investments that serve American interests.”
The executive order pledges to use all necessary legal instruments, including the Committee on Foreign Investment in the United States (CFIUS), to restrict individuals and entities affiliated with China from investing in U.S. technology, critical infrastructure, healthcare, agriculture, energy, raw materials, or other strategic sectors.
Fair enough, but here’s the point. Foreign direct investment in U.S. equities has grown from $4 trillion in 2014 to $16 trillion in 2024, and China has, by orders of magnitude, the world’s largest trade surplus. By extension, China is almost certainly the largest by far recycler of foreign trade surpluses back into U.S. denominated assets—very much including U.S. equities.
With that as context, the Trump administration’s executive order seems to represent a clear U.S. message of “shots fired” at China intended to catalyze a retreat of Chinese capital out of U.S. markets and U.S. dollar-denominated assets specifically.
Now, to be clear, the executive order was specifically focused on banning larger active capital rather than smaller-scale passive capital investment. According to the executive order, “The United States will continue to welcome and encourage passive investments from all foreign persons. These include non-controlling stakes and shares with no voting, board, or other governance rights and that do not confer any managerial influence, substantive decision-making, or non-public access to technologies or technical information, products, or services. This will allow our cutting-edge businesses to continue to benefit from foreign investment capital, while ensuring protection of our national security.”
But in HAI’s view, the use of what amounts to capital controls restricting active Chinese capital investments is also likely to discourage passive Chinese capital investments. At minimum, these new capital restrictions seem very likely to further diminish Chinese capital inflows to U.S. markets. At worst, it seems that these new restrictions on Chinese capital could potentially cause huge sums of outright withdrawals from U.S. equity markets.
In HAI’s view, given what already seems to be the DOGE-inspired rapid weakening of the U.S. economy, any large-scale outflows of Chinese and foreign capital more broadly from U.S. markets risks exacerbating the risk of significant near-term draw-downs in bubbled-up U.S. financial markets already trading at record-high valuations.
That said, if China is no longer welcome to store a large chunk of its trade surpluses in U.S. financial assets, China is very likely to redirect those capital flows into increased accumulation of domestic Chinese assets, assets in non-U.S. markets, and the king of neutral reserve assets—gold.
As such, HAI is increasingly concerned over the threat to U.S. financial asset prices over the near-term while remaining very structurally bullish on much higher gold prices over time. While gold may be near-term overbought and subject to near-term correction, HAI agrees wholeheartedly with highly respected commodity expert Adam Rozencwajg who this week said, “This gold cycle is just getting started… This market [referring to the global monetary regime] assumes that tomorrow will be the same as today and yesterday, but I think, with the highest probability I’ve seen in my investing career, the next six months have the risk of looking very different than the last 20 years.” To the delight of gold bulls everywhere, he continued, “I think you can make a very, very conservative case for $8,000/oz gold [based on multiple historical relationships, including the average historical value of U.S. gold holdings relative to U.S. dollars outstanding], and in a real bull market you could easily get $15,000 to $20,000/oz gold.” While HAI isn’t targeting $20,000/oz golden gravy just yet, this author is in total agreement with the stacked bullish case for much higher gold prices, and with assessing the move in gold so far as being merely in the foothills of its eventual Everest.
In pulling back and widening the lens, here’s the view. The U.S. is a twin deficit economy with a sky-high 120% debt-to-GDP ratio and a hollowed-out industrial base. The U.S. is, on the margin, dependent on foreigners for financing and for driving the U.S. asset price appreciation needed to drive sufficient tax receipts. That said, the U.S. just told China, its biggest trade creditor and a major financier, in no uncertain terms to pick-up its capital and go home. All this while the U.S. economy is suddenly slowing notably as federal spending that’s roughly 25% of GDP is being aggressively cut.
Meanwhile, the longer-term solution to the U.S. dilemma may reside in a dollar-weakening monetary regime change. The current set-up and circumstances are unprecedented. For now, in HAI’s view, that unprecedented set-up translates to downside risk for stocks and upside risk for gold. Volatility is assumed. HAI has been saying for weeks that even if the Trump MAGA plans were successful, the journey from here to “over the rainbow” was not likely to be easy or painless. So hang in there. The next few months might be the first major demonstration of that pain before (hopefully) gain principle.
Weekly performance: The S&P 500 was down 0.98%. Gold was down 3.55%, silver was down 4.59%, platinum was off 5.04%, and palladium was down 7.97%. The HUI gold miners index was lower by 2.50%. The IFRA iShares US Infrastructure ETF was down 0.41%. Energy commodities were volatile and lower on the week. WTI crude oil was off 0.91%, while natural gas got crushed by 10.35%. The CRB Commodity Index was off 3.02%. Copper was down 0.26%. The Dow Jones US Specialty Real Estate Investment Trust Index gained 1.77%. The Vanguard Utilities ETF was off 1.04%. The dollar index was up 0.98% to close the week at 107.56. The yield on the 10-yr U.S. Treasury was down 22 bps to close at 4.22%.
Have a wonderful long weekend!
Best Regards,
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
