Two esteemed publications, The Economist and Grant’s Interest Rate Observer, weighed in recently with their typically well argued, yet in this case, opposing views on a subject that the entire financial world is obsessing about. The subject of course; what will be the likely impact of the policies of the newest occupant of the Oval Office on global trade and by extension corporate earnings and financial assets?
James Grant likens the President’s policies to a “…heavily shorted common stock DJT on the Big Board”. Even influential hedge fund heavyweights like Bridgewater Associates’ Ray Dalio, and Seth Klarman who runs Baupost Group, roundly denounce DJT fundamentals. And yet, despite seemingly widespread vilification by the street, DJT continues to climb the proverbial wall of worry. One imagines the last thing bears hear as they are steamrolled is The Donald himself expressing, in a recent interview, how honoured he is by markets’ vote of confidence.
Grant observes that the intrigue of a proverbial consensus short trade is its paradoxical ability to cause extreme financial pain to so many; as has clearly been the case thus far with DJT. But, Grant teases, “What if – just this once – the choir of conventional opinion were correct?” Skipping to the punchline, DJT bears will not be pleased as he concludes that conventional wisdom is in fact wrong…again. Grant does not make the case to be long, but he does argue unequivocally that DJT shorts ought to cover their position. A sensible position in our view but only on the basis that markets can remain illogical longer than shorts can remain solvent. A hallmark of the uncooperative short trade is a dearth of bullish counter arguments. So whether one agrees with Grant’s argument or not its as refreshing to contemplate as it is scarce.
Grant credits Biff Robillard of Bannerstone Capital in Minnesota who compares “globalization” defined as “unfettered economic cross-border exchange” with “globalism” defined as “trade encumbered by politics, complexity, favoritism and rent seeking”. Because it is the latter that is on DJT chopping block he concludes that while Globalism indeed faces tumult the former will do just fine. And the theory is not without some observed market supporting data. Robillard cites the performance of a basket of shipping stocks that are up 15% year to date as confirmation of the underlying thesis. After all is it possible that companies on the front lines of global trade could rally if DJT is really a bonafide threat to global trade?
While an argument based on a distinction between globalization and globalism has theoretical appeal its hard to conceive of these as truly separable domains in practice. The Economist warns that in light of the withdrawal of American support of globalism that DJT represents “the machinery of global co-operation could well fail”. Moreover “Because habits of co-operation that were decades in the making cannot easily be put back together again, the harm would be lasting. In the spiral of distrust and recrimination, countries that are dissatisfied with the world will be tempted to change it—if necessary by force”.
Moreover The Economist argues that a reversion of multinational companies from their zenith predates DJT but that DJT will nevertheless intensify its pace.
“Central to the rise of the global firm was its claim to be a superior money making machine. But that claim lies in tatters. In the past five years the profits of multinationals have dropped by 25%. Returns on capital have slipped to their lowest in two decades”
Klarman’s argues that while coerced repatriation of global companies may be good politics, unwinding the remaining vestiges of competitive advantage gained from globalization and automation is unlikely to make sound economic policy.
We find it extremely difficult to reconcile valuations of major market indices such as the S&P 500 that are populated by such global firms with the combined themes of global companies being demonstrably in decline and Klarman’s assertion that DJT only makes a bad situation worse.
S&P 500 5 yr Comparative Valuation - Data Source: S&P Capital IQ
So, as it has for the past many years it all comes down to monetary policy and the, by definition unpredictable, black swan tail risk event. In the current everything is fine until its not environment maybe the DJT bulls are right. Its the only game in town so long as returns available to investors from interest rates amount to expropriation of return on capital.
With respect to monetary policy DJT is likely to have a benign effect on financial asset pricing. DJT is fundamentally a borrower whose self interest ultimately favours the continuation of cheap money. DJT has also clearly demonstrated a willingness and ability to wage and win a public opinion battle if necessary to prevail over an already enfeebled Fed (Recommended reading: The Dollar Trap; How The U.S. Dollar Tightened its Grip on Global Finance, Eswar S Prasad, Princeton University Press).
Against a backdrop of, limited alternatives, a benign Fed, and USD primacy, we arrive at a similar conclusion to misters Grant & Klarman. Namely that large flows of capital seeking cheap passive equity index returns are likely to continue for some time and that valuations quite possibly only become more stretched and shorts more stressed.
This all starts to resemble a blow off phase but as we are in possession of only a cracked and flawed crystal ball we are as unable as any to say if a material correction is just inevitable or imminent. We don’t like realizing the morning after that we were short the chaos put the night before, so we find it prudent to take steps now to address what we perceive to be increasingly unattractive risk adjusted return potential.
As they saying goes. the pain trade strikes where the market is most crowded and thus where it can inflict the most pain. To varying degrees we are all playing musical chairs…and the band plays on.
Managing Director Wealth Management & CEO