Category Archives: economics

Wall Street and US elections

August 17, 2020 By in Basic Concepts, economics, Portfolio management, stock market Leave a comment

There are two pieces of Wall Street lore about market performance around presidential elections that have passed their sell-by date but which continue to float around. They are:

–the last year of a presidential terms is a good one for stocks; the first year of the new term is a bad one.

The idea behind this is that the incumbent president would successfully pressure the Federal Reserve into a looser-than-necessary money policy in the runup to the election. This would give an artificial boost to the domestic economy, enhancing his reelection prospects. This extra stimulus would be reversed after the election, slowing the economy down in the first months of the new term. Gerald Ford’s refusal to follow this custom is often cited as the reason he lost the 1976 election to Jimmy Carter.

With the exception of Donald Trump, who has continually pressured the Fed to loosen money policy throughout his term, this no longer happens. I’m not 100% sure why. My leading candidates: the world is a much more complex and mutually integrated place than it was a generation ago, so it’s not so easy to use the domestic money supply to give the economy a pre-election jolt; over the past quarter-century there have been a succession of crises, from Y2K/Internet bubble to 9/11, to the Great Recession, to Trump’s wrongheaded tariff wars, to his coronavirus bungling, that have dwarfed any monetary tweaking the Fed might contemplate .

In any event, there’s no reason to believe that the world economy will be weaker in 2021 than it is now or that a post-election tightening in money policy is on the cards.

–Republicans are good for stocks, Democrats are not.

The idea here, from a generation ago as well, is capital vs. labor. A high-level Republican goal is to protect the accumulated wealth of its country club backers. This means having low taxes and low inflation. The Democrats, on the other hand, represent workers whose chief asset is their labor. Their main economic goal is to obtain real wage/benefit gains. The inflation that results doesn’t hurt them because they have no wealth to begin with. And it makes them better off by eroding the real value of the goods and services they need to buy from Republicans.

Again, the class warfare that defined the old Democrat/Republican battle lines is mostly gone. As a former work colleague of mine was already writing thirty years ago, neither party has a relevant economic program for today’s world. Ironically, despite its business roots, the current Republican administration is supported mainly, I think, by workers disenfranchised through the demise of heavy industry in the US (and ignored in a worst-in-the-world fashion by both parties). And the head of the party is a stunningly inept businessman who continues to do enormous economic damage to the country.

A more reasonable worry about the election might be that a Democratic administration would partially reverse the corporate income tax cuts of 2018. That might lead to after-tax results from the S&P 500 next year being, say, 3% lower than expected. 3% is not a big number, though. And there might be positive effects on growth from reopening the borders, a more intelligent approach to the potential threat from China than shoot-yourself-in-the-foot tariffs, removal of some of the white racist tarnish of the American brand abroad…

two common market fallacies

August 13, 2020 By in economics, Portfolio management, Strategy Tags: , , Leave a comment

market cap/GDP

I was reading an article on Yahoo Finance the other day that cited what it claimed was a Warren Buffett rule to gauge whether the US stock market is under- or overvalued. The idea is that if the total market cap of US stocks exceeds annual GDP (of the US) then stocks are overvalued. If market cap is less than GDP, stocks are undervalued.

On the surface, this sounds like it might make sense, since it is the US stock market, after all. And the health of the Treasury bond market is tied to the vigor of the US economy. Also, the idea was big in the 1980s, when market cap/GDP was used by Americans and Europeans as a rationale for not becoming involved in the Japanese stock market during a decade-long domestic economy boom there.

Two issues this idea ignores:

–multinational companies. In the case of the US, a good guess is that half the earnings of the S&P 500 come from outside the US. In fact, a very simple but effective way of approaching structuring a portfolio in the US market is to ask whether the US economy will likely do better than the rest of the world in the year ahead or worse. In the first case, the portfolio should overweight domestic-oriented stocks; in the second, internationally-oriented.

–how much of the domestic economy is publicly traded. In the case of the US, big sectors like real estate and housing have little representation. Germany, whose market cap has seldom, if ever, exceeded half of the country’s GDP, is the biggest counterexample for the cap/GDP idea. Two reasons: almost nothing is listed in Germany, and German citizens have historically had little interest in stocks.

For the record, I can’t imagine Buffett thinks this.

strong stock market = strong economy

Typically, this is the case, in my experience. But there are exceptions, like Mexico in the 1980s–and Germany almost always. In today’s US, it’s easy to see, by comparing the global NASDAQ with the US-centric Russell 2000, that stocks are strong in spite of weakness in domestically-oriented issues. In fact, somewhat like Mexico back then, the US market is underpinned by the near-zero interest rates made necessary by our extreme economic weakness.

A side note: over the past three months, the R2000 (+22.7%) has held its own with NASDAQ (+24.5%). Both have far outdistanced the S&P 500 (+17.5%). Why the R2000 strength? Three possible reasons (translation: I don’t know): counter-trend rally; the worst of the pandemic is already baked into R2000 prices; anticipation that Trump will not be reelected. My guess is some combination of the first two. I think it’s too early to be trying to figure out the election, although belief in four more years of Trump dysfunction should translate into shorting the dollar and the R2000.

the fight over unemployment benefits

August 5, 2020 By in administration economic strategy, currency markets, deprecating currency, macroeconomics, securities markets, Strategy Tags: , , , , Leave a comment

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

July 30, 2020 By in administration economic strategy, economics, government economic policy, Strategy Tags: , , , , Leave a comment

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

July 17, 2020 By in administration economic strategy, economics, Strategy Tags: , , Leave a comment

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.