Money Goes Home
If you are having a tough time keeping up with the whirlwind of tariff and trade announcements (on again, off again), no need to apologize—you’re not alone. Last Tuesday, markets got the upper hand as Treasury yields pressed higher, and the bond market started to become disjointed. That got the administration’s attention and, in my opinion, forced their hand to back off their aggressive stance with the rest of the world. The spinmeisters were quick to get in front of the narrative by suggesting this was all part of a grand strategy, but I don’t buy it. Capital markets were reaching a breaking point, and to the credit of some members within this administration, they recognized it and backed off – at least for now.
Last Wednesday the WSJ put out the following article at 9:25am – hitting on the disfunction playing out in the capital markets.
Within 10 minutes, President Trump made the following post on X:
That afternoon, President Trump announced a 90-day delay to the reciprocal tariffs on every country except China. Markets soared, and the President had a time stamp telling everyone to front-run the announcement he was set to make. You can’t make this stuff up. Markets have gone from fearing “reciprocal” to embracing “reprieve.” There is no doubt that despite the bravado, Donald Trump blinked on Wednesday. And while more than 70 countries have lined up for discussions, what seems to be happening now is that the President is walking back his beautiful tariff policy.
Over the weekend, we learned that the administration is giving carve-outs to a wide range of technology products (smartphones, solar cells, processors, laptop computers…) – yet another welcome reprieve, but yet another walk back from ‘everyone gets a tariff. ’ I try to stay clear of the politics of the situation or cast too harsh a judgement on how this administration carries out its policy, but I do find myself thinking there has got to be a better way. But that’s coming from a guy sitting in the cheap seats, who has the luxury of passing judgment. Nevertheless, I applaud the awareness of recognizing the damage being done. Take, for example, the latest carve-outs to tech products. Almost none of these products are produced in the U.S., so tariffing them makes zero economic sense.
The daily swings in markets over the past two weeks have been disconcerting, to say the least. Measures of volatility now place the S&P 500 on par with that of Bitcoin. As for the Treasury market, it has been an unmitigated disaster as the 10-year T-note just came off its most volatile week since 2001 and since 1987 for the long bond. These price gyrations only make sense when contextualized against the backdrop of daily changes to trade policy in the interest of resetting the global world order. All of it merely feeds uncertainty, making it inherently difficult for investors and businesses to plan ahead and make decisions in such a chaotic environment.
Goodwill, like a good name, is won by many acts and lost by one. This is readily seen in the simple fact that U.S. safe assets like Treasury bonds and the U.S. dollar have been the furthest thing from safe — they typically are refuges in troubled times, but not when its government causes the trouble. This also explains why gold has been outperforming everything year-to-date (+22%). It’s often said that gold is the inverse to confidence – when confidence is high gold trades flat or down, but when confidence is low gold does nothing but go up. Well, when you have the U.S. and China, who collectively account for around half of global GDP and together command a $600 billion annual trade relationship, locked into a trade war showdown its bound to create a high level of uncertainty.
My take on the current state of affairs is that we remain in this pin-the-tail-on-the-donkey trade and tariff policy, and the period of elevated economic uncertainty has not gone away one iota. What has happened with the Trump blink is that we avoided a catastrophe, and a bad recession now has the chance of just being a mild downturn. Now, we have to operate in a state of chronic uncertainty, which will weigh heavily on spending plans in the business and household sectors as the rules of the game change by the day or by the hour. While I think last week’s tariff delay has curtailed the worst-case scenarios, I think enough damage has been done that the glass-half-full scenario is that a bad recession has been averted. That’s it.
Unlike 2020 and 2022, where Covid and a bear market in asset prices did not lead to a protracted and deep economic contraction because we had policy levers to pull. Today, we do not have excess pandemic savings to put to work, we don’t have large fiscal bills set to be passed (Inflation Reduction Act and Chips Act), and the government is looking to reign in 7% budget deficits, not expand them. The most significant piece of legislation being worked on is a bill to pass tax policy that is already in existence – that’s not incremental improvement, that’s preserving the status quo. The unemployment rate is already near historic lows, corporate profit margins are at all-time highs, equity valuations are elevated relative to historical averages, and we’re threatening those margins by tariffing low-cost production regions. Not to be a pessimist, but it’s a very treacherous setup for asset markets.
I fully support efforts to restructure the way the global financial system works, but we should not underestimate our adversaries either. All markets are sending clear signals that this will not be a walk in the park. The move to try and isolate China may end up backfiring. Beijing, like Europe, is getting set for a major fiscal bazooka aimed at stimulating structural reforms for its massive consumer base. We should not underestimate the deep economic ties between China and the rest of Asia. The continental supply chain there is intricate and complex and will not go down for the count if Beijing has its way. The one thing we know about China is its ability to play the long game. This administration talks about their willingness to endure some near-term pain, but in my estimation, a lot of votes were cast for Trump because they were tired of enduring pain / economic hardship. There is a risk here that instead of prying other countries away from China’s deep economic grasp, that the exact opposite ends up happening. China has become galvanized and will now very likely move to forcefully restructure its economy to become more of a consumer base for other producers around the world (such a massive shift is already taking place in the form of baby bonuses to reverse the secular decline in its demographic profile). Perhaps starting a trade war with the rest of the world is not the best strategy if your ultimate target is China.
Then, there is the overriding issue of whether the Administration has overplayed its dominant hand. Keep in mind that while America is the world’s wealthiest and most powerful nation on earth, it still represents just 4% of the world’s population — in other words, 96% of the world’s potential customers live elsewhere. And while America dominates with a 30% share of world GDP, that also means that most of the global economy resides outside of U.S. borders. Not to mention, foreigners own $19 trillion in US equities, $7 trillion in Treasuries, and $5 trillion in US credit (see chart below, courtesy of Tosten Slok). That corresponds to 20% of US equities, 30% of Treasuries, and 30% of credit outstanding. This represents a sizable seller of US assets if this trade war turns into a capital war or if foreigners decide that their capital will be better treated at home.
Look, I don’t disagree with the administration's ambitions to shift its focus towards domestic policy and away from global policy. I do think the world has become complacent on the trade front, and something needed to be done. And while the tactics being used make for entertaining dialogue at cocktail hour – should it have been done in a more nuanced way, possibly in partnership with our global trading partners, or is shock and awe the only way to bring it the attention it deserves? It is what it is, and the process has now started. No matter what gets negotiated and then re-negotiated in the coming weeks, the global economy has forever changed.
On a go-forward basis, I simplify the quandary to this: the rest of the world can produce less, in which case we have a global depression. Or the rest of the world must find a way to consume more—in which case, we have a more balanced and rapidly growing global economy. This is a direct challenge to many international leaders, large corporations, and everyone else about to have their lives upended. Many are upset, and many will push back as their existence is based upon selling products to the largest consumer base on the planet. After a period of chaos and reflection, I think the world will choose to consume more, if only because producing less is more painful.
After all, there are many more policy options to consume more (lower taxes, direct payments, subsidize big ticket outlays, enhance credit creation…) than to produce less (austerity). Increasing consumption isn’t hard. However, it’s a political decision. US policy provided a road map for the rest of the world during Covid where we did more fiscal stimulus than any other G-20 nation, and it super-charged US growth relative to every other nation in the world. My guess, is that other countries around the world are going to adopt their own interpretation of this roadmap and apply it accordingly.
If this is the course the rest of the world takes, it's not deflationary. Perhaps on a near-term basis, it could be as the transition initially saps growth, but if/when the fiscal spigots around the world get opened, I suspect inflationary pressures will mount. Most investors think inflation is good for stocks, but it's way more nuanced than that. When you look around and reflect on history, inflation has historically been a depressant to equities because it causes multiples to decline. Sure, nominal economic growth will be higher, and that will help top-line revenue for some companies, but the rising input costs will be a death nail to low-margin businesses that are unable to pass along these rising costs.
I think you want to hide out in companies with cheap starting multiples and either strong pricing power or fixed assets trading at fractions of replacement costs but with minimal maintenance capex levels. Hard to find many of those businesses in a US equity market dominated by Mega Cap Tech, a collection of multi-national companies that have extorted global labor and resource arbitrage better than everyone else. Well, if the potential change that’s afoot fully runs its course, I don’t think these companies will command the multiples and margins investors have gotten used to seeing. I keep thinking that the sectors that did well in 2022 are the sectors to start sifting through in search of opportunities (energy, commodities, real assets, infrastructure, utilities, power supply…).
The past few months have been frustrating and challenging for investors, and unfortunately, I think the next few quarters may be even harder. Speaking frankly, I think the best option here is to de-gross (downsize the amount of capital you have at risk), and wait it out. The undertow from bonds trading erratically, yields rising, a weakening US dollar, and a declining stock market is a sure fire signal of capital fleeing US markets. When and where it stops, nobody knows, but as we’ve seen above there is a lot of foreign capital parked in US markets that is now questioning if it should be there.
I realize it was only a week ago that I was advocating investors put money to work as many of the indicators I follow were registering buy signals on a twelve-month basis. That was the right call, but man how quickly things have changed – mainly market prices. Last Monday, the S&P was trading as low as 4,835 and closed below 5,000 on Tuesday. Fast forward a week, and the S&P 500 is trading almost 600 points higher at the close on Monday (5,405) – that’s a 12% gain, which changes the tactical calculus for this humble analyst. While I do think this rally has more room to run, I’m more inclined to reduce equity exposure than I am to add equity exposure at 5,400 or higher. Positioning (see chart above) and sentiment have experienced a proper washout, and my guess is that if we push above 5,500, then there is a reasonable chance we can move back up to the pre-liberation day highs around 5,650 – 5,700 – maybe even trade all the way up to the 200-day moving average around 5,750.
But I have a hard time envisioning catalysts that would improve fundamentals in a manner that would support equities above that level. I am open-minded to being wrong on that front and will change my mind if my lack of imagination fails me, but things have changed. Changed in a manner where the risk/reward favors capital preservation over capital appreciation. This isn’t a sell-everything call, but rather an admission that a low-risk 4% yield on 1-year isn’t a terrible option given the broad swath of un-modelable outcomes on the forecast horizon. I still advocate a well-diversified portfolio of stocks, bonds, commodities, and gold, but with less than full allocations of each, with the balance nestled in cash and short-term T-bills. You don’t have to play every hand, sometimes its best to sit back and watch – while being comfortable with the choice that foregoing upside also means minimizing downside.
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