Trump Trade Unravels

We wrote about the possible scenarios of the Trump administration back in January. Now we will look at how they played out.

Back when the markets responded enthusiastically about the new alignment in the White House and Congress, there was an underlying optimism that Trump would behave differently as president than a candidate on the trail. It was hoped that he would leave the details of governing to a competent staff and instead operate as the GOP’s salesman-in-chief. No longer.

In the few months since the election, equity markets rallied and bond yields rose to match the expectations of tax reform, higher spending, stronger dollar, and rising interest rates. However, the slow divergence of treasury yield, equity, gold, and dollar since March is signaling a shift in sentiment.

Monitoring the prevailing bias as exists in the market is one of the three legs of our trading stool. There is a clear shift in market participants’ belief that the Trump Bump may reverse into Trump Slump, and that the Republicans are losing control of the agenda. Granted, the stock markets kept bouncing higher with decreasing volatility, mostly because of continued upbeat earnings, stimulative environment, and synchronized economic growth around the world. This is going on despite the political setback, but we do see narrower breadth with each push higher.

When we examine the relative performance of S&P, copper, 10Y treasury yield, US dollar, and precious metals (each represents a Trump theme) in the aftermath of the election it became clear that we have recently passed an inflection point. Treasury yield spiked after the election and again in March in the run-up to the Fed meeting, and is now back to the floor of the initial rally. The dollar gained initially before crashing below the November level. Copper rallied in response to the infrastructure spending boost but has now come back to where it started. Gold was dumped immediately but has since recovered to a level above the staring point. That gold is the next best performing asset class in this analysis is an attestation to investors’ anxiety about the macro environment.

Figure 1: BigCharts, Kronos Management

This dislocation points to the eroding confidence for the premises of the initial Trump trade and it could well accelerate into a major theme in the coming months, taking the equity markets down with it. While the length of a bull market is not a good indicator of the timing of a crash, we are wary of the magnitude of the eventual correction due to the amount of accumulated speculative capital.

With crisis seemingly emerging out of nowhere every other day, the White House is spending precious political capital, time, and resources to produce political reality TV shows instead of solving worthy issues. The bungled healthcare bill, the hastily put-together tax plan, and the scandals are impeding real economic reform, threatening to push the legislative schedule out to 2018 and beyond. This administration’s misguided obsession with trade deficit pose a constant risk of damaging trade wars. Once a real geopolitical conflict breaks out we may not be able to adequately respond, creating unintended consequences. History is path dependent. We are in danger of having too much riding on the ego of one man.

For years since the Great Recession, investors have complained about the Fed interfering with capital allocation. Be careful what you wish for. Now that the technocrats are contemplating the unwinding of their balance sheet and passing the baton to politicians, all we can see are incoherent, internally inconsistent policies at a time of structural fragility. Investors would be wise to pay heed to the changing macro winds.

May 19, 2017