My letter to clients in 2017 focused on the Challenges and Opportunities for the Trump Presidency. Now that President Trump has had a chance to enact some policies from his agenda, it is time to start evaluating the potential scenarios we could see unfold. I’ll briefly cover President Trump’s inherited circumstances, regulatory actions, global trade policy, taxes and his Fed Chair. Before I begin, a disclaimer from the linked letter:
“… I will spend quite a bit of time on political and geopolitical matters. I will offend both liberals and conservatives on some points. My overall message however, is that if we can meet near the center, with inclusive ideas and policies that benefit the vast majority of people, not just a few percent, then we can avoid the consequences of the dangerous rhetoric that threatens us all.
My views are not wrapped around ideology. I am a deliberate centrist who leans left or right depending on the issue. I believe that dogmatic ideology is among the most dangerous human traits threatening the world. I believe that extremism rises from inflexibility. I think that anybody who can not at least reach near the center in an attempt to compromise, is part of the world’s problems, not solutions…“
President Trump’s Inheritance
When President Obama stepped into the Oval Office, he was inheriting an economy that was essentially destroyed in a world that was begging to find a way forward together. The financial crisis had destroyed jobs, wiped out life savings, force people from their homes and caused a sense of uncertainty that still underlies the emotions of many.
The world was also so tired of war and conflict, that President Obama was given a Nobel Peace Prize before he even stepped into the situation room. There was a hope that we could in fact all just get along.
When President Trump sat in the President’s chair for the first time, he received an economy that was growing slowly, but steadily. Real GDP growth figures from 2010 to 2016 were 2.5%, 1.6%, 2.2%, 1.7%, 2.6%, 2.9% and 1.5%. While not great by post-WWII standards, those GDP growth figures represented a significant rebound from the financial crisis and made sense in the context of my “slow growth forever” argument.
President Trump also inherited a federal budget deficit that had been cut in half since the financial crisis bailouts. While the trend had leveled off in recent years under a more militant Republican Congress, there still is the potential to cut the deficit further now that Republicans control all branches of government.
President Trump also inherited an economy that had become more regulated under President Obama, whose office oversaw approximately 600 new regulations enacted in eight years. Notably, many post-crisis financial reforms were blocked by Congress. While many regulations may have been necessary after the crisis, the feeling broadly emerged that we became over regulated.
President Trump rode in on, a trend of rising nationalistic views in many parts of the world from Great Britain and parts of Europe to Russia and many rogue nations. I highlighted this as the most dangerous threat facing him.
The trend towards nationalism has put pressure on the idea that globalism is good for the world as a whole, nations specifically and individuals broadly, despite the fact that global trade has greatly increased personal wealth and standard of living, albeit very unevenly and incompletely, for decades.
He also inherited an healthcare system that has done everything it can to resist reforms and calls to restrain healthcare spending. That system threatens the financial underpinnings of the entire American economy.
Lastly, of what I will cover, though certainly not last, President Trump inherited a world that empirically is getting better in most ways. I wrote The World Is Getting Better, Seize The Opportunities around Labor Day last year and here is a more recent article on Forbes titled Why The World Is Getting Better And Why Hardly Anyone Knows It.
The narrative that regulation had skyrocketed has given President Trump cover to deregulate. And deregulation is just what President Trump is doing. The Brookings Institute, an independent nonprofit research organization, built a tool to track deregulation under President Trump, you can find an explanation and link to it here.
The list of “deregulatory” actions under President Trump is very long already. Literally hundreds of headlines can be found that describe the list of withdrawn, reduced or delayed regulations. You can find dozens of environmental laws done away with, a stripping down of Dodd-Frank and the Consumer Financial Protection Bureau, a reduction of “good behavior” rules for the financial industry, watered down mileage requirements, reducing oversight and standards for emissions from oil and gas wells, privacy laws thrown under the bus, net neutrality up in smoke, the list goes on and on.
But, from the White House:
The Competitive Enterprise Institute noted that as of December, “1,579 planned regulatory actions, withdrawn or delayed…” The breakdown shook out this way:
- 635 regulations were withdrawn.
- 244 regulations were made inactive.
- 700 regulations were delayed.
Deregulation is certainly going on, but nailing down exactly what it is has become very difficult. This is what the Washington Post’s fact checker reported:
“Trump appears to be counting ”regulatory actions” so many of the items being delayed or withdrawn were not regulations yet. According to a Bloomberg News analysis, almost a third of the regulatory reversals actually began under earlier presidents. “Others strain the definition of lessening the burden of regulation or were relatively inconsequential, the kind of actions government implements routinely…” Bloomberg
In fact, it is unclear whether Trump has cut more regulations in his first year than any other president. When the Fact Checker examined this question, experts said that the amount of withdrawn regulations is not necessarily the best metric, because these are rules that never went into effect. Moreover, often it takes another rule to repeal a previous rule. Research by the Mercatus Center at George Mason University shows that regulatory restrictions actually grew during Trump’s first year, but at a much slower pace than other presidents in their first year.”
Even Jimmy Pethokoukis, at the very right leaning American Enterprise Institute, recently questioned the effect of President Trump’s deregulation.
Scientific American is trying to figure out this whole deregulation thing too:
Why is this all so important? Because it is clear that an appropriate amount of regulation is necessary to prevent some humans from gaming the system in the forms of gouging, fraud or pollution, as well as, to prevent the types of dangerous bubbles that led to the financial crisis.
My own take on what is going on is that deregulation under President Trump has been directed at making political statements and benefitting a very particular set of people, namely business owners. Now, I am not inherently against giving some incentives to business owners, I own three businesses, however, the way benefits have been thrown towards business is curious to me.
Take this from Goldman: “Financial deregulation appears more likely to result in meaningful changes and is likely to be among the most important items on the regulatory agenda for 2018 and beyond… In particular, changes to stress testing, leverage ratio requirements, the Volcker rule, resolution planning, and the treatment of small banks appear possible, with the effects likely to be felt both within and beyond the financial sector.”
Having been in the financial industry for nearly three decades now, what I see is that financial regulations have often been pointed in the wrong direction, that is from the bottom up, rather than the top down.
What do I mean by that? I mean that the rules, products and processes in the financial industry are controlled from the top of the financial pyramids. That is where regulation needs to be tight. Historically we know that hasn’t been the case though. How exactly did CDOs work again? Why didn’t banks have to carry adequate capital?
Many of the same problems that led to the financial crisis are coming back:
A dramatic impact on financial regulation is starting to emerge. More leverage, less oversight and lower financial requirements on banks and securities lending institutions are extremely dangerous. It is not far fetched to think that in a few years we could see a repeat of 2008 and its aftermath.
Possibly the main thrust of deregulation appears to be a push in the American energy sector. It is no secret that President Trump wants to see American oil and gas being shipped all over the world.
There are clearly financial reasons to want to sell oil and gas abroad, however, there are good reasons to be an international leader in renewable energy too. The growth of renewables is far above that of fossil fuels, which when coal is considered, has actually turned slightly negative lately.
Clearly it will take many years for fossil fuels to decline, so it is questionable to me that we are risking the environment, our water and the climate to benefit the oil and gas companies – which I have written extensively about being a place to invest for the next decade: The ‘Last Great Secular Oil Bull Market’ Has Begun
The bottom line on regulations is that there needs to be balance. Given the special interest nature of what is going on, I am not certain that we are finding that balance. I am concerned we are setting up a financial crisis and a serious energy supply deficiency down the road.
Global Trade Actions
Among my noted concerns in my letter to clients about challenges facing President Trump was a fear that his rhetoric against foreign trade partners would turn into trade sanctions. While there is a rare case where tariffs and sanctions make sense, a broad reaching approach to protectionism has historically led to recessions and sometimes war.
The underpinnings of free trade are that it helps bind the global economy in a way that promotes peace and prosperity. While there is no perfection to be attained, our biases and and ignorance can lead to opposite outcomes when we turn away from free trade approaches.
The most concerning move towards protectionism has been President Trump’s attacks on negotiated trade agreements. His scrapping of the Trans-Pacific Trade Partnership has played so into China’s hands that he recently backtracked and said we might go back to it – something GOP Senators are urging.
The attack on NAFTA continues as well, which I can only surmise is born of ignorance of how well the U.S. has done with that trade partnership. NAFTA has become the largest free trade agreement in the world and made the the North American trade block extremely competitive globally. Consider that the supply chain that runs from Canada to the U.S. and Mexico utilizes all three nations comparative advantages using a logistical system rivaled nowhere else in the world. Any major changes to NAFTA run the risk of undermining American competitiveness.
Disrupting free-trade also have the impact of being inflationary. We have already seen this in solar panels recently. While there were likely political scores to make, the tariffs on solar manufacturing in an age where we need to continue become more electrified is nonsensical.
I wrote about the Trump Solar Tariff’s Winners And Losers (the complete article is available to members of Margin of Safety Investing members and Seeking Alpha Pro subscribers now). One of my points was that “foreign manufacturers will likely counter the tariffs with lower prices, as noted in the chart above, there is not much real support for domestic solar manufacturers. However, as Bloomberg notes, the cost of solar is still coming down rapidly, and the costs to consumers are likely to be overcome rather quickly.”
In other words, the solar tariffs were designed poorly, with a short-term political agenda in mind. Which agenda. I think this one: “There is a reason in my mind that the tariffs are also designed to help protect the coal industry, at least through the next election, as solar is a key competitor to coal, along with wind, and after natural gas.”
Let me ask you, does it make sense to you that we do this? If it does, are you aware that the solar industry employs far more people now than coal? Change your mind? It should.
The President is now pushing for further trade sanctions on dozens of Chinese products. Steel is in the crosshairs. While this might get cheers from some, maybe we ought to be simply helping people find other jobs, rather than trying to save certain jobs at the expense of the big picture.
Maybe President Trump ought to take heed of the 2018 ECONOMIC REPORT OF THE PRESIDENT!
- “Historically, international trade as a whole has on net increased American productivity, standards of living, and American economic growth.”
- “Consumers — and disproportionately, low-income consumers — may benefit as import competition fosters innovation and product differentiation, as well as drives down the prices of goods and services.”
- “Fiscal and monetary policies may be more important than trade policies in determining the magnitude of trade balances. The distribution of trade balances across trading partners is attributable to a variety of factors that are idiosyncratic to individual countries.”
- “Although trade agreements are associated with about twice as much overall trade, the causal impact on the trade balance is unclear.”
- “The United States gets better outcomes via formal WTO adjudication than negotiation, increasing the probability that the complaint will be resolved and decreasing the time it takes to remove the barrier in question.”
- “The United States has exercised leadership in pursuit of a policy of lowered trade barriers and increased market access. The gains from these actions have, as a whole, served to boost income in the U.S. as well as around the world.
President Trump is flirting with a trade war. We all know what happens sometimes after flirting. Sometimes we get… into a bad situation.
Tax Cuts Might Not Stimulate For Long
The Republican passes and President Trump signed “Tax Cuts and Jobs Act” was passed in December 2017 and went into effect January 1st, 2018. Some provisions, such as eliminating the deduction for alimony do not go into effect until 2019.
According to the DonaldJTrump.com website, the tax bill…
- Provides tax relief for middle class Americans.
- Simplifies the tax code.
- Will grow the American Economy.
- Doesn’t add to America’s debt and deficit.
Let’s take these one by one and consider the real impacts. First, there certainly is some tax breaks, at least temporarily unless extended for middle class Americans. According to the Tax Policy Center, not only would the tax cuts favor the rich more absolutely, but would also on a percentage basis:
The question we all must ask is this: does the vast majority of the tax breaks going to those making over $200,000 per year make sense in the context of growing the economy? Because if it doesn’t, then we are simply repeating a mistake of the past as these tax cuts appear to largely mirror those of President George W. Bush and that Republican Congress.
It is also important to understand that the very wealthy will benefit substantially due to the corporate tax cuts as they are the major shareholders and management due bonuses at most companies. Read this to understand the bigger picture of how the very rich will also benefit due to the corporate tax cuts:
As happened with President Bush’s tax cuts, there seems to be a very real possibility that these tax cuts also do not stimulate growth, rather, just allow a big skim out of the economy for the benefit of very few.
While supply-side economics would dictate that putting money in people’s hands will stimulate the economy, the sugar high will be short-lived if aggregate demand and investment into capital development do not rise longer-term.
We know that aging demographics will make aggregate demand growth slow. Increased capital spending over time is also in question as corporations are raising stock buybacks by record amounts, rather than investing much in capex or even reducing debt.
A lot of the tax bill makes little economic sense to me. While I have long called for the employer portion of Social Security taxes to be waived for the self-employed, the 20% deduction for pass through businesses that was passed as part of tax reform is pretty silly.
At another level, it is completely horrific to me that the bill is projected to drive the Federal deficit to over a trillion dollars almost immediately and quite possibly for an extended period of time according to the CBOE. Where were the Republican deficit hawks on this?
The impact of higher deficits at this point are two fold. First, the dollar will weaken and that is inflationary. We got a glimpse of President Trump’s idea on devaluation during the campaign and shortly after inaugeration:
This should not surprise us from somebody who has very strategically used the tax code. The problem with devaluation is that other nations will retaliate. There is no global bankruptcy code among nations to let each other off the hook. There will be retaliation if the U.S. tries to begger they neighbor as the richest kid in the class.
The second horrific impact of driving the deficit up during an economic expansion is that it lessons the arrows in the quiver to stimulate during the next recession, which given President Trump’s approach to global trade, could be coming a lot faster than people expect.
Ask this question, who is going to lend to us in a few years after such irresponsible behavior? Let us talk to Federal Reserve Chairman Jerome Powell about that.
Hello Chairman Powell
The linchpin to all things economics in America ultimately falls to the Federal Reserve Chair. Nobody can be as consequential as a good or bad Fed Chair. Enter President Trump appointee Jerome Powell.
Chair Powell will be responsible for the partial unwinding of the Federal Reserve balance sheet. There has been a lot of talk about how terrible it is that the Fed is carrying “so much” debt. I would argue the opposite. I would suggest that it was necessary to take out that mortgage to avoid a great depression ten years ago and that like most mortgages, we should take 30-years to pay it down. Rushing to shrink the Fed balance sheet could have catastrophic impact on the economy and markets.
The simple relationship is easy to see between the Fed balance sheet and the stock market. After the leverage induced collapse, only a transfer of debt to the Federal Reserve could clean up the system enough, fast enough, to stimulate a rebound and prevent a greater collapse. This has been well documented, feel free to challenge me in the comments.
Unwinding hastily will almost certainly have two impacts. The first, which has been talked about by Bill Gross to Paul Tudor Jones, is that we could see a dramatic drop in liquidity. That in and of itself is bad for the economy. That could cause a recession in short order.
The resulting economic weakness of course would hit stocks, but more importantly, could set off unintended consequences. What could those be? I keep coming back to stagflation because I do not see the dollar strengthening for other reasons, some of which I talked about above.
In my mind, the markets and then the economy, yes, this time markets will lead the economy, could both take diggers in the next few years. Goldman talked about a 25% correction. I have pointed out to subscribers and in my blog that S&P 500 (SPY) (VOO) could head to about 2200 and then 1600.
Chairman Powell has a very delicate job to do. I frankly would have preferred that Janet Yellen was asked to stay on.
From Buy the Dips to Sell the Rips
It is becoming my view that the stock market is likely to chop along in a range for the next four or five years. Yes, that means I expect essentially no index returns during that period.
That range will be wide however. The days of volatility (VXX) around 10 for extended periods are over. Average volatility, at least, is here to stay.
I called 3000 on the S&P 500 in a conversation with Mark Yusko a while back:
I am now of the opinion we go a little higher than 300 on the SPY, but not much higher. I believe we have finally entered delusion on this rebound and that it will be a wonderful stupidity we get to experience and then forget again. The Millennials are about to get an education in “the markets don’t only go up.”
If any Millennials are reading, I’ve been telling my subscribers to accumulate cash for the panic sell-off. That includes in 401k plans. You have all heard the phrase, “buy the dips.” Well, get used to “sell the rips,” because that is the new, old thing.
That panic bottom probably does not happen for a few years, but it’s coming. In the meantime, I have gone back to trading a bit more and waiting for my very favorite companies to have stock sales. Why? like I said, volatility is back. I recently bought Nutrien (NTR), Micron (MU) and Sunpower (SPWR) back. Members to Margin of Safety Investing have my “Very Short List” to work from and now a monthly “focus stock” sublist of those that are close or are buys.
I am picking up puts on the SPY. I have been buying the April $265 and $266 puts for very cheap as of today. Aim for the bid. See Options For February/March.
Disclosure: I am/we are long NTR, MU, SPWR.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own puts on SPY as a hedge. I own a Registered Investment Advisor – https://BluemoundAssetManagement.com – however, publish separately from that entity for self-directed investors. Any information, opinions, research or thoughts presented are not specific advice as I do not have full knowledge of your circumstances. All investors ought to take special care to consider risk, as all investments carry the potential for loss. Consulting an investment advisor might be in your best interest before proceeding on any trade or investment.