One of my favorite literary quotes is “Take nothing on its looks; take everything on evidence.” I think Charles Dickens would have made one hell of a global macro risk manager because he understood the importance of being data-dependent..
Financial markets are nothing more than an information discounting mechanism, which means they are driven by expectations. It’s been eight trading days since Trump became President-elect and sparked a major sell-off in U.S. Treasuries. The sell-off was based on expectations that a Republican-controlled Washington will enact a number of business-friendly policies and, most importantly, ordain massive fiscal stimulus, all of which will be inflationary.
Experience tells me that the greatest opportunities come when public expectation of an event diverges from the highest probable outcome of that event. Trump’s win is that event, and the public’s expectation that inflation is coming to the States in a jumbo jet diverges dramatically from what the evidence tells me.
When the public wakes up to the reality that Trump’s plan isn’t a slam dunk and that his victory hasn’t improved the U.S. economy one bit, the sell-off in U.S. Treasuries over the last eight trading days is going to auto-correct like the time you sent your daughter a text saying “Grandma is in the garage” and your iPhone changed the message to “Grandma is in the grave.”
Evidence #1: Fiscally Conservative Republicans
Based on looks, investors believe a Republican-controlled Washington will make a cakewalk of implementing Trump’s plans for deregulation, protectionism, tax cuts, and especially fiscal stimulus. Trump is proposing to add $5.3T in debt over the next 10 years, which would push the U.S. debt to GDP ratio to just over 105%. Let’s pretend for a second that crossing the 100% debt-to-GDP Rubicon is no big deal. I mean, the economies of Greece, Bhutan and Jamaica seem to function just fine carrying around a Quasimodo-style hump full of government debt, don’t they?
My political science class was at 8 a.m. during my freshmen year of college, so needless to say my political knowledge is limited, but aren’t Republicans on the fiscally conservative side of the aisle?
A unified-party government doesn’t make it any easier when that unified party is Republican, the party of fiscal conservatism. The newbies in the House of Representatives were elected based on platforms geared toward reducing the Federal debt, not jacking it up even more. To that end, just a few months ago the House approved a budget that seeks to cut $7T over the next 10 years, while Trump wants to add $5.3T.
This $12T Grand Canyon-sized gap between Trump’s plan and the House doesn’t mean he won’t be able to enact some stimulus. But the markets are currently priced for perfection, and any amount less than $5.3T will serve as a catalyst for the markets’ auto-correction.
Another, smaller, piece of evidence that flies in the face of current expectations is that none of the stimulus, no matter the amount, will hit the economy next year. All fiscal stimulus plans are set for 2018 at the earliest, and a lot can happen economically between now and then.