Revisiting the Trump trade

Posted by Cam Hui - October 26, 2024

Preface: Explaining our market timing models

We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Asset Allocation Model is an asset allocation model that applies trend-following principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Bullish (Last changed from “neutral” on 11-Oct-2024)
Trading model: Bullish (Last changed from “neutral” on 15-Oct-2024)

Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.

Subscribers can access the latest signal in real time here.

The Trump trade

The Trump trade seems to be making a comeback in the markets. While the betting markets have seen Trump’s odds of winning rise and Harris’ odds fall, it has been marred by suspicions of manipulation (see articles in WSJ and Financial Times). Less difficult to manipulate are the factors in the financial markets, shown in the chart below. Each of these charts is designed so that a rising line denotes rising favourability for a Trump victory.

Trump Media & Technology Group: It’s a proxy for Trump enthusiasm as it’s the holding company for Truth Social, Trump’s social media vehicle.
Domestic Revenue stock ETF vs. S&P 500: One of Trump’s main platforms is to use tariffs to bring manufacturing back to the U.S.
Inflation Expectations: Trump’s tariff policies are expected to be inflationary.
Poland vs. Euro STOXX 50: Poland has been a surprise growth engine in the EU, but it neighbours Ukraine, and the relative performance of its market is a measure of Ukrainian anxiety.
Gasoline Price: Gasoline can be thought of as an anti-incumbent trade. Rising prices depress consumer sentiment and it’s negative for the incumbent.

Each has its idiosyncrasies, but taken as a whole, the Trump trade seems to be winning.

It’s time to consider the effects of Trump’s economic policies should he win the White House.

A focus on trade policy

The results of the latest BoA Global Fund Manager Survey could be setting the tone for the market’s reaction to the U.S. election. Respondents are most concerned about changes in trade policy as a result of the election.

In that context, it was stunning that Donald Trump, in an interview with Bloomberg editor in chief John Micklethwait, doubled down on his protectionist leanings and characterized “tariff” as “the most beautiful word in the dictionary”.

What are the effects of Trump’s economic policies should he win the White House?

The bear case

There’s no denying it. Trump is a protectionist. In the interview, he proposed setting tariffs as high as 50%, up from a previously announced across-the-board level of 10%, to encourage companies to bring production to the U.S.

Even if the Trump plan is successful, it takes several years to re-locate a plant, given a brave assumption that local supply chains and trained labour are available. What is there to stop skyrocketing inflation and a recession during the interim period?

Basic introductory course on economics has outlined the perils of protectionism and comparative advantage and cheapest cost. Why force locals to grow bananas if your climate isn’t suitable for such a crop when you can import bananas at a much cheaper price? Why not utilize your economy to make the things that you are better at, as growing bananas in an unsuitable climate is inefficient.

As a reminder, Liz Ann Sonders at Charles Schwab clarified the mechanics of a tariff. They are paid by the importer to Customs by the importer. There are therefore a tax on the importer, who has a choice of absorbing the tax or passing the increase on to the customer. It also represents a consumption tax, or sales tax.

The accompanying chart shows the fiscal math of tariffs. As a percentage of government revenues, the rate of contribution to government revenue has been relative steady since about 1980. Personal income taxes have the greatest contribution, followed by corporate taxes. Tariffs constitute a miniscule portion of revenues.

Trump’s tax proposal includes cutting the corporate tax rate from 21% to 20% and 15% for domestic manufacturers and extending the TCJA tax cuts, as well as dramatically raising the tariff rate. The proposal amounts to replacing income and corporate taxation with consumption taxes, or sales taxes. The tax system, as it’s currently designed, is progressive. Your tax rate rises as your income rises. A consumption tax is regressive. Your effective tax rate rises as your income falls, because lower income consumers spend of their income on consumption than their higher income counterparts. In effect, Trump’s tax proposal shifts taxation from the providers of capital to the providers of labour.

The conservative leaning Cato Institute made the following calculations on Trump’s tariff proposals. Income taxes account for 58% of U.S. imports. Even assuming that consumers don’t substitute other goods for imports and no retaliation from trading partners, replacing income taxes with tariffs would amount to a rate of 58% on all imported goods, which would be enormously inflationary.

Under the scenario of a short-term shock to the taxation system, what happens to the economy?

Let’s consider the most immediate first-order effects. Consumption would slow while corporate profits would rise. Inflation would also rise because of higher import prices. The WSJ conducted a survey of 50 economists, and most believed that inflation would be higher under Trump than Harris or Biden. That’s as close to unanimity as you can get among economists.

The Federal Reserve would respond to higher inflation by tightening monetary policy. If lower consumption doesn’t slow the economy into recession, higher interest rates would be a second blow to the outlook for economic growth.Then there’s the federal deficit. The combination of lower taxes and higher tariffs, which would likely be unable to make up for the loss in corporate and personal taxation, would raise the deficit. A study by the nonpartisan Committee for a Responsible Federal Budget found that the proposals of both candidates would add to the deficit beyond the current baseline under almost all scenarios, but the Trump plan would raise the deficit far more than the Harris plan. Not included in the Committee’s projections are some of Trump’s latest trial balloons, such as deductibility of car loans, the elimination of double taxation for Americans living abroad, as well as the tax cuts for veterans, police officers, and others who serve. These higher deficits would be in excess of a projected $22 trillion in budget deficits under a baseline scenario over the coming decade if Congress does nothing.

Even if the Fed doesn’t respond, the bond market would by raising yields in the long end of the yield curve.

In addition, Robin Brooks pointed out that a Trump win could cause instability and a crisis in currency markets. The widespread imposition of tariffs puts enormous depreciation pressure on emerging market currencies and make any Dollar peg unsustainable.

That’s just the immediate first-order effects. higher inflation, higher interest rates, and slower economic growth and possible recession. I haven’t even factored the effects of trade war retaliation.

The bull case

Here is the bull case. The Committee for a Responsible Federal Budget also project significant fiscal stimulus under the Trump plan of slightly over $10 trillion over the next decade under a central tendency scenario.

Tom McClellan has shown that rising deficits are equity bullish. So why worry?

Less certain are the effects of Trump’s economic plan on productivity, as his proposals are mainly focused on bringing jobs to American shores without regard to comparative advantage, which would not be productivity enhancing.

The U.S. has enjoyed reasonable labour productivity gains over the years. The Biden Administration has tried to encourage U.S. semiconductor production with its CHIPS Act, but flagship projects has found that U.S. labour hasn’t been as productive as their offshore counterparts, and local supply chains nonexistent and critical components need to be imported.

The U.S. has been a global leader in productivity growth. Can it continue under Trump?

Investment conclusions

What are the main takeaways for investors from a Trump victory? Some outcomes are certain and some uncertain.

If Trump were to win the White House, investors can count on higher inflation, which would be negative for bonds and positive for inflation hedge vehicles like gold, which is already breaking out to all-time highs.

Less certain is the trajectory of the stock market and economy. Investors will need to weigh the tension between the bullish effects of fiscal stimulus against the heightened odds of a recession. Jurrien Timmer at Fidelity studied the average performance of the stock market over two and four years after a presidential election. He found that the best two scenarios are either a Republican sweep, or a Democratic President with a divided Congress, which are the most likely outcomes in 2024.

The week ahead

Looking to the week ahead, this election year has experienced an unusual seasonal trading pattern. Usually, the stock market weakens in October just ahead of a U.S. election. This is to be expected especially in the current highly polarized political backdrop when each side believes that if the other side wins, it would be catastrophic for the country. In response, both sides sell ahead of the election and re-enter the market just afterwards. This year, pullbacks have been either either very minor or nonexistent.

This year, stock prices have continued to grind up with no signs of any significant pullback. The S&P 500 implied volatility has been discounting heightened volatility ahead of the election and the FOMC meeting.

That begs the question: If the stock market is rallying now, does that mean investors should be prepared for a disappointment just after the election? Former JPM strategist Marko Kolanovic, who was fired for being too bearish, highlighted the risks to the market.

My inner trader is maintaining his long position in the S&P 500 for now. The usual disclaimers apply to my trading positions.

I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.

Disclosure: Long SPXL

5 thoughts on “Revisiting the Trump trade”

yodoc2003 says:

October 26, 2024 at 9:34 am

This is a reflection of division of wealth. The natives get restless.
What happened to the American dream? It moved offshore because it became cheaper to make things there and we allowed it.
We benefited from lower prices, and most of us with quality being not a factor will choose the lower price. So we can impose tariffs but people will still buy the lower price.
Can America make things better for less than the competitors? What is Boeing telling us about that? The strike settlement does not support the “less”.
Beyond that is robotics and AI. AI will not replace humans imho, but as a self-improving model…bots like Chippy at fast food, and a future generation of bots in assembly lines can displace workers doing repetitive tasks. This is bad news for those employed in those jobs.
Rising unemployment of humans is a consequence of robots empowered with AI.
But humans can vote, bots cannot. So at some point UBI will be established. So what? If organic food is cheap because these little bots (that are made by other bots) are working in the fields for the pay of free energy and repairs, is that bad?
It will be a change for sure, but human nature does not change quickly and there lies our problem.
What I have been wondering about is “mark to market”. My understanding is that it was suspended in 2009 at which point insolvency at some systemic banks became moot. What is going on now? Is it an honor system? We know how well that works. Will some dirt under the carpet at some point trigger another debt crisis?
I have wondered about the lenders of those wonderful sub 3% 30 year fixed mortgages, how they are doing. Notice how not many people want to let go of them? The lenders if they have debt cannot refi at sub 3%, they also cannot print their own money. If we get a boost in inflation (even if it is temporary, although I would argue that inflation is simply the aggregate of many separate transient items), then will the chances of refis at sub 3 % get better or worse?
My prediction is “The Bots are coming”. Hey Plymouth Rock, Thanksgiving time, pilgrims and unfortunate native Americans who saw their world change. So what’s my investment thesis? Well, if the bots are coming, what do the bots needs? They need copper, steel, plastics of some sort, silver etc. Not much gold imho, but people will rush to gold because of its history, until it becomes apparent that the bots need other stuff more.
What has NVDA shown us? It has shown us that perceived unimaginable demand trumps all. What happens when that becomes the perception for those materials that will be required to make those billions upon billions of bots?
Does anyone think that financially strapped people will opt for fast food at 5$ made by humans over 2$ food made by bots? Not in the aggregate.
This change may take decades or be surprisingly fast, it depends on how fast AI evolves for these tasks.
We recently bought a Tesla with full navigation, for much less than a BMW or Porsche. It really is impressive.
I thought of a cheap call spread on TSLA the other day but passed on it.
The bots are coming, keep an eye on the copper gold ratio, and pay attention to what is happening in the Botspace. The market will have its ups and downs, so copper will also go up and down, but if any bloc wants to ban bots, will they doom themselves to losing a race with the others? What has China taught us about comparable advantage?
That’s it, I’m done for today.
1. Ingjiunn says:
  
  October 26, 2024 at 5:47 pm
  
  Watch the movie “Chappie” when you have time.
Ravindra says:

October 26, 2024 at 10:21 am

Constitution vests the authority to protect the US against foreign threats solely in the President. Geopolitical and economic threats have gone up substantially in last few years. Tariffs are one of the tools to encourage trading partners to rethink their own tariff regimes(Europe has 100 % tariffs on US cars). EU is not friendly to US technology companies.
I believe the analysis is skewed to protect the current system.
Inflation is projected to go up under both candidates. So are deficits and total debt. Only salvation is economic growth and government efficiency. I am more confident in Elon Musk than 40 Nobel economists who told us that fiscal spending is not inflationary.
Who pays the price?
1. Ingjiunn says:
  
  October 26, 2024 at 5:52 pm
  
  Again, as an investor, only price charts matter.
  1. Ravindra says:
    
    October 26, 2024 at 8:20 pm
    
    For sure.
    Economic growth or lack of it influences prices in the long run.

Comments are closed.