end game (iii): if Biden wins…

As I mentioned earlier in the week, the investment implications of a Trump reelection are straightforward. As an American, I’d be deeply shocked and disappointed by the implied repudiation of traditional American values. As an investor, I’d expect a continuation of the “flight capital” market we have been in for some time, with a return of the domestic economy-centric Russell 2000 names to the bear market they had been in for most of Trump’s time in office, until late March of this year.

I find the stock market consequences of a Biden victory much harder to handicap. My thoughts so far:

–the transition of power might not be smooth. Trump has already declined to say he will accept the election result if he loses. He has begun to disrupt mail service on the, perhaps mistaken, idea that this will suppress more votes for Biden than for him. More “dirty tricks” may be in the offing. He may also end up testing the limits of the law by pardoning himself for any crimes he may have committed before or while in office.

Worries about abuse of power may have some negative effect on stocks around election time. It’s equally possible, though, that, sensing defeat, traditional Republicans will distance themselves from Trump in advance (as some seem to me to be already doing this), signalling that party loyalists should no longer follow Trump, thereby minimizing the damage he might otherwise do. It’s hard to know, but it says volumes about Trump that musing about what amounts to a post-election coup attempt doesn’t sound totally crazy. Can we be even remotely similar to Moscow 1991?

–interest rates will likely remain low for a long time. This is a distinct plus for stocks, for three reasons: they will remain attractive vs. the two other liquid asset classes, cash and bonds; bonds are unlikely to fall in price because of rising short-term interest rates, a development that would lead investors of all stripes to rebalance away from stocks; and the cost of carrying the mammoth amount of debt run up under Trump–with more possibly needed to repair damage he has done–will remain low. In fact, as I’m writing this, there are reports that the Fed will soon announce its intention to retain near-zero interest rates for the next half-decade

–income taxes will certainly go up, both for wealthy individuals (this doesn’t matter so much for the economy as a whole because the rich don’t tend to change their spending very much as income goes up and down) and for corporations. This latter means the 50% or so of S&P earnings that come from US operations will fall by, let’s say 8%. The resulting 4% drop in overall earnings is not good, but it comes closer to being a rounding error in analysts’ estimates than a serious shortfall. In today’s volatile stock trading, it amounts to maybe two or three down sessions in a row

–on the other hand, there’s lots of low-hanging economic fruit begging to be picked. The Trump economic program is a hodge-podge of wackiness, whose effect has been to please rich donors but to retard overall GDP growth, not foster it. Closing the borders to immigration, for example, shrinks GDP expansion by more than a third. Placing tariffs on imports has squeezed real incomes; retaliation has decimated the revenues of exporters, especially farmers. Trump’s central concept–restore low-wage manual labor jobs to the US while driving computer and engineering firms out of the country because they employ non-white foreigners–is about as loony as it gets. So too encouraging Detroit to keep on making gas-guzzlers while the rest of the world turns electric. Hard to quantify, but just ending insane programs has got to be good

–there are thornier issues to face, as well. Trump left actual tax reform both out of the name and the provisions of the Tax Cuts and Jobs Act of 2017, which did nothing to address sweetheart industry tax breaks that have long since passed their sell-by date. National infrastructure is four years older and creakier without having been touched …nor have Social Security or Medicare problems been addressed

–then there’s other senseless Trumpish stuff, like the ultra-strange attack on the viability of major domestic research universities, a national treasure, by denying deep-walleted foreigners access to them. The point is there are enough shoot-yourself-in-the-foot Trump things to just stop doing, for the resulting positives to dwarf the losses from a higher corporate tax rate and reversal of the tax giveaway to the rich.

my preliminary conclusion

Delegitimize white racists and let foreign workers back in and the country will be on the road to economic expansion again. No more crazy gains like in 2020 so far, but a shot at +10%. Maybe all the running next year will be in domestic consumer names.

thinking out the end game (i)

The Trump presidency has been an almost incomprehensibly huge disaster so far, both in terms of core American values and the operation of the economy–even before Trump’s worst-in-the-world handling of the pandemic.

Looking solely at narrowly economic factors, real GDP had flatlined, pre-COVID, as a result of his senseless tariff and immigration policies (I’m not necssarily anti-tariff, but at least try to have an objective and think out possible consequences–like destroying US agricultural exports to Asia–before putting them in place). On a longer view, he’s continuously undermining global faith in the dollar and the American banking system, as well as sowing the seeds for Shanghai to replace Wall Street as the world’s stock market capital. This will “hurt” China by speeding its ascent to world economic leadership.

In vintage Trump fashion, those damaged most badly by him have been his supporters.

In addition, Trump’s cognitive fastball, never of more than sandlot quality, seems to me to have regressed over the past year or so to somewhere south of mid-level Little League and slightly north of tee ball.

Despite all this, and in spite of his deeply anti-American cultural values, he may still be reelected.

As a citizen, this is not the outcome I want. As an investor, however, the implications are more straightforward. As I see it, initially:

–the Fed would continue to compensate for Trump’s bungling by running extra-stimulative money policy. In fact, the Fed has just signaled that it would be willing to let inflation run for a considerable while (we should be so lucky) to make up for the damage done by years of price level stagnation

–voter endorsement of Trump’s racism would reduce the attractiveness of American consumer brands in foreign markets; we could no longer say we didn’t know what he stands for

–ultra-low interest rates will underwrite continuing stock market strength

–the pattern of strong performance of stocks with the least connection to domestic GDP and deeply sub-par performance from those with the greatest GDP ties, would continue–as domestic capital continues to flee his incompetence and racism

–technology companies will maintain their Wall Street listings but would begin to shift their highest value-added operations to other countries, if for no other reason than to be able to hire based on talent. If Trump’s current attack on domestic research universities continues, this move could be surprisingly swift. The only plus here is that Xi’s attack on Hong Kong removes the SAR, the obvious non-US destination, from consideration for dual listings by US firms. Singapore?

–investment in cutting edge plant and equipment in the US by multinationals would likely decline.

The stock market I’ve been using as a very rough template for the US today is Mexico in the 1980s. A second aspect of this model, something that would have been unthinkable a few years ago, is the eventual loss of faith in the local government. This shows itself in a number of types of financial behavior: the “capital flight” character of the stock market that we’re now seeing in the US; a deteriorating currency; and eventually, capital controls imposed to prevent citizens/residents from shifting assets out of the country. We’re not there yet. Signs for worry: accelerating trade/current account deficits, national debt so large that potential buyers no longer believe they’ll be repaid in full.

the fight over unemployment benefits

My cartoon version of US politics:

A generation ago the Democrats were the party of the working people and the Republicans the party of the wealthy, especially of inherited wealth.

The Democrats’ goal was to push for strong wage gains, to improve the lot of their supporters. They were also for wealth redistribution–taxing the rich to get the money for social welfare programs like Medicare or Social Security. High wage gains would also eventually create inflation, eroding the value of the assets supporting hereditary wealth–an added plus.

The aim of the Republicans was to defend the status quo, the value of their bonds and their industrial operations, by advocating low wages, low taxes (no redistribution) and low inflation.

Even though both parties have strayed far from their roots, this old picture has some relevance in explaining economic forces at work in the US today.

The Congressional Budget Office estimates that the federal budget deficit for 2020–the amount that government spending will exceed income–will come in at $3.7 trillion.

This is where the current debate on extension of unemployment benefits comes in. Democrats are calling for another $3 trillion in aid to out-of-work Americans; Republicans are arguing for $1 trillion. In simple terms, the difference is between continuing $600 a week in extra benefits vs. reducing that to $200.

In the former case, the federal deficit would come in at about $7 trillion and total government debt would rise to just under $30 trillion. This compares with GDP of about $19 trillion this year–with real GDP growth (even before the pandemic) reduced to close to zero due to Trump’s epic incompetence. That would put us higher than perennial poor soul Italy in terms of debt/GDP and into the same bracket with Greece and Lebanon. Only Japan, with debt of 2.5x GDP would be out of our reach–for now, anyway.

(An aside: hard to believe one man could do so much damage so quickly–and that’s not considering his white racism, environmental recklessness, the secret police roaming Democratic cities…)

Anyway, the question wealthy Republican backers seem to be asking is at what point will creditors balk at continuing to fund the Federal government. Their answer can be seen in the Republican negotiating stance–we’re already there. In my view, a lot depends on whether Trump is reelected despite his devastation of US aspirations and value. I think we’re already seeing the first indications of the world’s worries in the decline of the dollar vs the euro. For wealthy holders of dollar-denominated assets–real estate, industrial plants, fixed income securities–losses could be very large.

debasing the currency

what debasing is

“Debasing” is goldbug-speak. In past centuries, when gold was actually used as money everywhere, when countries minted gold coins and kept reserves of the yellow metal as symbols of their ability to repay borrowings, governments in trouble would sometimes dilute their gold by blending in inexpensive base metals. So they would repay creditors substantially less than they’d borrowed. That’s debasing.

The modern equivalent of physical debasement is running a highly stimulative money policy, the idea being to create lots of inflation, which would allow a government to repay borrowings in inflation-debased currency.

A report from Goldman Sachs strategists came out this week suggesting that this process is at work in Washington right now, as a consequence, intended or not, of pandemic-fighting fiscal and monetary stimulus. Its conclusion: buy gold.

relevance for us as investors

I haven’t seen the report itself. I’ve only seen coverage in the financial press. (I’m not a Goldman client. For what it’s worth, I think the firm does top-notch factual research but struggles to find interesting investment conclusions from what it unearths. For you and me, Merrill Edge is the best I’ve found.)

I wrote about the gold issue in May. Except for China and India, where gold is still money, I don’t think holding gold achieves much of anything. The fact that a major brokerage house, typically a stronghold of Republican political sentiment, is willing to suggest–and seek publicity for–this idea, with its implied criticism of Trump’s dumpster-fire handling of the economy, is the most interesting aspect of its publication.

I think inflation is the least of our worries. Last year the federal government took in $3.5 trillion in taxes. Pre-pandemic, Washington was thought to be on course to spend about $1 trillion more than in 2020, due in large part to Trump’s failure to offset tax cuts with removal of special interest tax breaks for politically connected swamp creatures. The actual deficit will more likely be around $8 trillion. This would mean a total federal debt of, say, $28 trillion, or about 135% of GDP. That would place us up there with Italy among the most indebted nations in the world.

Yes, debt this high creates worries about devaluation as a way of not paying creditors back in full. Historically, however, such high levels of government debt are also associated with much slower GDP growth and emigration of the best and the brightest to make a life where economic opportunities are greater.

From a purely financial point of view, Trump’s threats to renege on government debt held by foreigners (basically making us look like Argentina) and his use of the banking system to attack political enemies are also giving new impetus to the search for alternatives to the dollar as the go-to currency for international trade and as a store of value.

I could go on about the other ways Trump continues to severely damage the US, while failing to provide any support for the left-behind rural citizens who support him. But I think the key question for the rest of the world is whether the US electing a white racist incompetent was a disastrous mistake or whether he really represents what the country stands for. If the latter proves true in November, the currency and securities markets reaction will likely be strongly negative.

playing cyclical recovery

Yet another slow-motion human catastrophe seems to be starting to play itself out in the US. Yes, Trump’s strange attempt to undermine the finances of the American university system, one of our crown jewels, by barring its highest-paying students from attending, disappeared almost as soon as it was unveiled (to be fair, my guess is Trump had no idea what he was doing; he just wanted to burnish his xenophobe credentials). But the real economic/social issue is the rolling start to the national school year next month. Just as with mask wearing, Trump appears to be insisting on resuming school in person and on schedule, which seems to me to be a recipe for another surge in coronavirus cases, similar to the one resulting from Trump’s urging southern and western states to reopen too early.

I think the stock market reaction to this will be twofold: to stop the rotation away from secular growth to domestic cyclicals, and to reconsider whether or not the latter’s current prices are too high.

What I have tended to forget is that, possibly ex the UK, the US response to the coronavirus has been by a mile the worst in the world. Europe and Asia are already starting to rebound at the same time equity investors are coming to grips with the fact that Washington–and a number of state governors–are about to inflict another round of damage to GDP.

Anyway, my thought is to reduce my exposure to what I see as very expensive tech names and build up cyclical exposure–in the EU and Asia.