“To be clear, we are more non-ideological and practical/mechanical
because to us economies and markets work like machines
and our job is simply to understand how the levers will be moved
and what outcome the moving of them is likely to produce.”
— Ray Dalio
What are the most important investment implications that you and I and your clients might consider post last week’s election? My intention is to avoid a political discussion and look deeper into what the outcome means for the economy, the direction of interest rates and the direction of the stock market.
Let’s keep the intro short and jump right in. Grab a coffee and find your favorite chair. Included are some pretty cool charts (well, at least I think they’re cool). I hope you find this week’s post helpful.
Included in this week’s On My Radar:
- Dalio – Reflections on the Trump Presidency, One Week after the Election
- U.S. Recession (Probabilities), Global Recession (Probabilities) and Inflation
- Equity Returns During Rising Interest Rate Environments
- What You Can Do About Your Bond Market Portfolio Exposure
- Trade Signals – Trend Evidence: Equity Market Bull, Bond Market Bear
Dalio – Reflections on the Trump Presidency, One Week after the Election
In my impatient “get to the point” way, I share with you the key points that Ray Dalio shared in a LinkedIn article this past week. You’ll find the full link below. It is worth the read. What follows are my highlights.
As you read, look past any particular political view you might hold and think in terms of inputs and outputs. Pull this lever and x will likely happen, pull that lever and y will likely happen. To this end, we require all of our interns and research team to read “How the Economic Machine Works.” I also make my young adult children read it… and have gone as far as asking them to share it with their economics teachers. OK – you get the point.
Following are my bullet points:
- We think that Trump’s policies will have a big impact on the world.
- Over the last few days, we have seen very early indications of what a Trump presidency might be like via his progress with appointments and initiatives, as well as other feedback that we are getting from various sources, but clearly it is too early to be confident about any assessments.
- What follows are simply our preliminary impressions.
- We want to make clear that we are distinguishing between a) the sensibility of the ideology (e.g., one leader’s policies might be “conservative/right” while another’s might be “liberal/left”) and b) the capabilities of the people driving these policies.
- To clarify the distinction, one could have capable people driving conservative/right policies or one can have incapable people driving them, and the same is true for liberal/left policies.
- To understand where we are likely to be headed, we need to assess both.
- To be clear, we are more non-ideological and practical/mechanical because to us economies and markets work like machines and our job is simply to understand how the levers will be moved and what outcome the moving of them is likely to produce.
The Shift in Ideologies
- As far as the ideology part of that assessment goes, we believe that we will have a profound president-led ideological shift that is of a magnitude, and in more ways than one, analogous to Ronald Reagan’s shift to the right.
- Of course, all analogies are also different, so I should be clearer. Donald Trump is moving forcefully to policies that put the stimulation of traditional domestic manufacturing above all else, that are far more pro-business, that are much more protectionist, etc. (emphasis mine)
- Whereas the previous period was characterized by 1) increasing globalization, free trade, and global connectedness, 2) relatively innocuous fiscal policies, and 3) sluggish domestic growth, low inflation, and falling bond yields, the new period is more likely to be characterized by 1) decreasing globalization, free trade, and global connectedness, 2) aggressively stimulative fiscal policies, and 3) increased US growth, higher inflation, and rising bond yields.
- Of course, there will be other big shifts as well, such as pertaining to business profitability, environmental protection, foreign policies/alliances, etc.
…the main point we’re trying to convey is that:
- There is a good chance that we are at one of those major reversals that last a decade (like the 1970-71 shift from the 1960s period of non-inflationary growth to the 1970s decade of stagflation, or the 1980s shift to disinflationary strong growth).
- To be clear, we are not saying that the future will be like any of these mentioned prior periods; we are just saying that there’s a good chance that the economy/market will shift from what we have gotten used to and what we will experience over the next many years will be very different from that.
To give you a sense of this, the table below shows that:
a) these economic environments tend to go on for about a decade or so before reversing,
b) market moves reflect these environments, and
c) extended periods of movements in one direction (which lead to confidence and complacency) tend to lead to big moves in the opposite direction.
As for the effects of this particular ideological/environmental shift, we think that:
- There’s a significant likelihood that we have made the 30-year top in bond prices. We probably have made both the secular low in inflation and the secular low in bond yields relative to inflation.
- When reversals of major moves (like a 30-year bull market) happen, there are many market participants who have skewed their positions (often not knowingly) to be stung and shaken out of them by the move, making the move self-reinforcing until they are shaken out.
- For example, in this case, many investors have reached for yield with the upward price moves as winds to their backs, many have dynamically hedged the changes in their duration, etc. (SB here: we have talked a great deal about this in recent letters.)
- They all are being hurt and will become weaker holders or sellers.
- Because the effective durations of bonds have lengthened, price movements will be big.
- Also, it’s likely that the Fed (and possibly other central banks) will increasingly tighten and that fiscal and monetary policy will come into conflict down the road.
- Relatively stronger U.S. growth and relative tightening of U.S. policy versus the rest of world is dollar-bullish.
- All this, plus fiscal stimulus that will translate to additional economic growth, corporate tax changes, and less regulation will on the margin be good for profitability and stocks, though for domestically-oriented stocks more than multinationals, etc.
- The question will be when will this move short-circuit itself—i.e., when will the rise in nominal (and, more importantly, real) bond yields and risk premiums start hurting other asset prices.
- That will depend on a number of things, most importantly how the rise in inflation and growth will be accommodated.
Our very preliminary assessment is that on the economic front:
- The developments are broadly positive—the straws in the wind suggest that many of the people under consideration have a sufficient understanding of how the economic machine works to run reasonable calculations on the implications of their shifts so that they probably won’t recklessly and stupidly drive the economy into a ditch.
- To repeat, that is our