Observations by David Robertson, 2/14/25
We seem to be settling into a routine of headline news over the weekend and a work week to figure out what it means. Let’s dig in.
As always, if you want to follow up on anything in more detail, just let me know at drobertson@areteam.com.
Market observations
After a stronger than expected inflation number on Wednesday and a fairly strong producer price index increase on Thursday, markets decided to — rally. An especially weak retail sales number on Friday didn’t seem to dampen spirits either. As a result, it appears we are in a “bad news is good news” environment. I certainly don’t understand why that would be the case, but it is an observation.
This little snippet posted by Mike Green speaks volumes about today’s market environment:
More remarkable is that anyone bothers to try to explain $TSLA overnight moves as "irrational" NOW.... I DO NOT have the proof, but it reeks of manipulation. Intraday TSLA is DOWN 12% since 2010. Overnight up 26,200%
Economy
Bob Elliott posted a nice, succinct summary of the pluses and minuses of policy proposals on the economy thus far. In short, the net effect is likely to be a drag on growth which is especially problematic given extremely high expectations:
Policy shifts to restrict immigration, cut federal spending, and raise tariffs may create positive impact on the US economy over the long-term. But in the short-term these policies will most likely create a growth drag just as markets are pricing in euphoric expectations ahead.
He follows up with a more complete thread here:
Obviously the believers are looking past the short-term right now but it’s hard to believe that will remain the case if and when the drags on growth begin manifesting in lower sales and earnings growth.
Politics and public policy I
As the Trump administration continues to “flood the zone” with news and executive orders, investors are scrambling to make sense of it all. As I noted before, chaos is part of the end goal. The idea is to keep everyone back on their heals so as to minimize push back.
There is more to it than that though and it is becoming increasingly clear that there are two threads of political philosophy in particular that animate the Trump White House. For one, the Atlantic highlights the federal grant freeze and subsequent back down “was no fluke and no ad hoc move. It’s part of a carefully thought-out program of grabbing power for the executive branch”. The ordeal is best understood as “a battle over priorities within the Republican Party”. The article continues:
Trump’s nominee to head the OMB, Russell Vought, wrote in Project 2025, the blueprint for a conservative administration created by the Heritage Foundation, a Trump-aligned right-wing think tank. The strategy is to seize power and dare both Congress and the courts to stop it.
but what really seems to have done in the freeze was the backlash—not so much from the public, but from state and local officials, including many Republicans, who were outraged about the withdrawal of funds and lack of communication. The political team won this round over the ideologues, but there will be more.
In addition, Rana Foroohar ($) wrote in the FT about the “The strange political philosophy motivating Musk”:
one of the weirdest and most disturbing developments is the rise of the “neo-reactionary movement” (NRx), also called Dark Enlightenment.
The philosophy argues that democracy inherently leads to social decline, because of the development of deep state bureaucracies that are unable to control oligarchic forces, and that societies should be run like corporations, with a kind of CEO Monarch in charge.
Richard Waters chimes in by adding:
I’ve always felt techno-libertarianism has been more a product of intellectual arrogance, self-interest and misdirected idealism, rather than any kind of coherent ideology. But I think now, surprised at its own political ascendance, we’re watching a powerful ideology harden in real time.
With this background it is easy to see that Musk’s takeover of Twitter provides a pretty good playbook for what he is doing now with the Department of Government Efficiency (DOGE). He makes sweeping headcount reductions quickly, very intentionally excises staff who have different ideologies, and personally enforces cultural ideals. Nothing about the process is intended to be fair or objective; it’s about power.
Investors can take away several useful insights from these pieces. Although first impressions reveal chaos, there are underlying strategies that provide direction. While plenty of mistakes are being made, the effort to grab power and exert it unilaterally should not be underestimated.
If this sounds uncomfortably outside the norms of democratic politics, that’s because it is. As Richard Waters puts it, “It really does feel like a revolutionary moment. Over-reach seems inevitable.”
In order to gauge the impact of these political philosophies it makes sense to look to precedents. In this case, Twitter is an excellent example. By most accounts, the company had lost about 80% of its value from the time of Musk’s purchase through last fall. This is arguably the best indication of expected results from massively slashing a work force, enforcing cultural homogeneity, and replacing fair process with subjective authority.
While such a course may have its place for a startup company, the risk/reward proposition is wildly out of alignment for government services which should be reliable and inclusive. Most people do not have the same penchant for taking risk that Elon Musk has, and arguably no one has the same capacity to absorb losses when a venture fails.
Finally, as foreboding as these efforts are for people who uphold democratic ideals, there are reasons for hope. The judicial system is blocking a number of efforts that appear to be unconstitutional — which indicates the system is working, at least so far. Such resistance vastly increases the pressure on the Trump administration to heed the courts’ rulings or risk political backlash. And, there is also dissention in the ranks. Much of the backlash from the spending freeze came from “state and local officials, including many Republicans”. It turns out, when you just start thrashing away, you hurt your own team too.
Monetary policy
New Treasury Secretary Scott Bessent has made it clear that his primary objective is to maintain a reasonably low 10-year bond yield. Kudos to him for focusing on the financial metric that matters most to economic growth. The Kabuki theater around the Fed’s setting of short-term interest rates has been a distraction for too long.
While Bessent deserves credit for properly orienting the investment community, he seems to be revealing a high degree of naivete about politics. Of his three arrows of policy prescriptions (cutting the budget deficit to 3%, having GDP growth of 3%, and increasing oil production by 3 million barrels/day), he has control of none. As a result, he is extremely vulnerable to be blamed for coming up short regardless whether it’s his fault or not.
Increasingly, I see Bessent’s guidance as essentially a hail mary bet that DOGE will be able to massively reduce the fiscal deficit. Either way, progress on reducing the deficit is going to be a critical signpost. If significant cuts can be made, that will create room to renew expiring tax cuts and perhaps to even expand them. If not, the Trump administration will either have to face an embarrassing walk back of tax cuts or storm ahead and risk forcing a “Liz Truss” moment in the US.
One way of monitoring progress on the deficit is to watch for incremental revenue opportunities. For example, Alyosha ($) writes in his Substack:
I am seeing a strategy. Trump’s end game is the “External Revenue Service.” Every time a trading partner hikes tariffs on the US, Trump will “call and raise” existing tariffs and add new ones.”
That may be, but if so, it would also be a strategy that also gives anyone buying US Treasuries less reason to do so in the future. Indeed, this is a point Katie Martin ($) addressed in the FT:
In a report released in mid-January, the researchers dug in to demand for Treasuries among official reserve managers … Drawing on weekly data from the New York Fed, which covers about two-thirds of these holdings, they note a reduction in reserves to the tune of about $78bn from election day to January 8 — only about a third of which has returned since.
This may, they wrote, “reflect waning foreign official demand for dollar denominated safe assets, possibly driven by geopolitical concerns including fear of sanctions and asset freezes”.
One could also add “fear of tariffs”. The main point, however, is that the Trump administration simply does not have unlimited ability to cut costs or to squeeze other countries for more money. While there is some room for improvement, it’s probably more accurate to think of any action as facing an equal and opposite reaction.
This implies a few things. First, the Trump administration is likely to continue to be very aggressive with DOGE because it’s the only play they have to be able to cut taxes. Second, the more aggressive the Trump administration gets, the more pushback it will receive. Third, Bessent is a longshot to last four years at Treasury.
Monetary policy II
‘Debt brake’ reform for Germany risks rattling global bonds ($)
https://www.ft.com/content/b0b7195c-21ca-4c70-b024-a4fa71c3ebf8
After the re-election of President Donald Trump, bond investors looked to the US for signs of the next large sell-off in their market. But are they looking in the wrong place?
Investors should consider whether reform of Germany’s so-called “debt brake” rules on state spending could be a catalyst behind the next market sell-off.
The significant under-investment in public infrastructure [in Germany] has now led to a consensus for change [in the debt brake policy] — even the president of the fiscally hawkish Bundesbank now supports reform.
This is a nice little snippet from T Rowe Price’s chief European economist, Tomasz Wieladek. His main point is that sovereign bond pricing does not occur independently but rather, at least in part, through relative supplies. If Germany increases its supply of Bunds, that will lower prices and increase real Bund yields. He argues such an increase would add “pressure on Treasuries, catching the market off-guard.” Good point.
Gold
While the story for gold continues to play out mostly as I have expected, it’s powerful move over the last year at least merits an update. Bottom line, the thesis remains extremely strong.
As Bob Elliott points, basic supply and demand conditions are quite favorable:
At the same time, gold is attracting growing interest in China as Zerohedge reports:
The Shanghai Futures Exchange gold futures were the primary vehicle behind the spring 2024 gold frenzy, a surge that subsequently spilled over into international gold prices
Fresh off the week-long Chinese Lunar New Year holiday, these traders are reentering the market—just as gold was already heating up without them.
Further, as the FT ($) reported last year, Chinese demand is beginning to exert a more meaningful influence on prices:
“Chinese speculators have really grabbed gold by the throat,” said John Reade, chief market strategist at the World Gold Council, an industry body.
“Emerging markets have been the biggest end consumers for decades but they haven’t been able to exert pricing power because of fast money in the west. Now, we are getting to the stage where speculative money in emerging markets can exert pricing power.”
Finally, as John Authers ($) at Bloomberg illustrates, the rise in gold prior to the GFC was an indication financial assets priced in US dollars were overvalued. Or, in other words, the flat performance of stocks relative to gold was an indication that nominal performance was ephemeral. Higher prices did not mean higher value, they meant less valuable money.
As we see the same pattern of flat S&P 500 performance relative to gold as we saw prior to the GFC, it’s a pretty good warning that stocks are running out of gas. It’s also a pretty good sign as to the value of having gold in a portfolio.
Investment landscape I
While I discussed the costs of unpredictability last week in regard to tariffs, more information and insight has continued to roll in. An FT article ($) described, “Carmakers have been cautious about making costly strategic changes without more clarity on the longer-term direction of US trade and energy policy”. That means less investment.
One auto parts supplier noted the likely effect of tariffs:
“There is no reason at all why we . . . absorb any cost like that,” Bratt said at an earnings briefing last week. “Ultimately, it will be higher cost for vehicles sold in the US.”
So, prices to consumers are likely to go up.
One of the less-discussed but more vulnerable elements of unpredictable tariff policy is integrated supply chains. One of the most important ways to reduce costs is to integrate supply chains such that the most efficient manufacturers of various components can leverage their expertise and efficiencies — and bring down the total cost of the final product.
Dave Rosenberg describes (via John Mauldin) that when intermediate inputs make multiple journeys across borders, as many auto parts do for example, they are subject to multiple layers of tariffs. “That means tariffs will have an asymmetric effect on inflation, with industries more integrated into the supply chain far more likely to undergo abrupt price level increases.”
So, not only do prices go up, but one of the most effective ways to lower costs (integrating supply chains) gets undermined. As one executive at the US Chamber of Commerce described in the Economist ($), “‘As prepared, this [tariffs on Canada and Mexico] was a tactical nuclear weapon’ for transnational supply chains”.
As a result, while tariff threats certainly can be part of a negotiating strategy, they also impose a wide array of costs. The net effect, according to Stephen Reitman, an analyst at Bernstein, is: “There’s not many winners in all of this . . . it’s reducing wealth, which reduces GDP, which reduces car sales.”
This discussion provides an interesting background against which to assess the NFIB small business report this week. As the graphs from the Daily Shot indicate, optimism among small business owners is quite high, but is starting to dip.
Such optimism is not corroborated by actions, however. Capital spending plans, which depend on the likelihood of receiving an attractive return on investment, dipped down to nearly the lowest level since Covid.
Of course, we shouldn’t read too much into such a small data sample yet. But it does serve as a huge warning flag that business conditions in the US are rapidly deteriorating, even if sentiment isn’t changing quite as rapidly.
Investment landscape II
Speculators are still running wild when money is no longer free ($)
https://www.ft.com/content/ec452f8e-f2ad-4c98-a150-9eff84b0c692
The mystery of the moment is why rampant speculation persists in the all-American bull market despite the apparent end of easy money.
One answer is that the easy money era ended only in part. It had always rested on a growing web of government and central bank support including market rescues, corporate and bank bailouts, constant stimulus and, of course, record low rates. Only very low rates have gone away. The rest of the culture continues to backstop the basic faith of market speculators that nothing will be allowed to go wrong.
Ruchir Sharma hits on one of the market mysteries by examining why speculative fervor is still so strong even though the cost of money has increased. He lands on two ideas. One is there is an assumption of “state support for speculative risk”. Another is that retail investors are rushing in “to buy stocks like never before.”
What could cause things to change? For one, Sharma conjectures, the price of money could rise further, quite possibly driven by inflation. For another, a fiscal crisis or some other shock leaves the government unable to afford such generous bailouts and rescues.”
This creates an interesting hypothetical. In the past, the best performance has often arisen from the most dire circumstances — because the market expected, and always received, public policy support when things got bad enough. Bad was good.
Now, however, with the fiscal condition in far worse shape, the administration has far less capacity to finance bailouts. Indeed, the whole point of DOGE is to create enough fiscal space to cut taxes, otherwise it would be virtually impossible to do.
As stocks continue to levitate, even when bad news comes in, it seems like investors are expecting officials to jump in. If and when the market receives a jolt and there is no policy intervention to cushion the blow, expectations have a long way to fall down.
Implications
It’s always hard to assess what is really going on in any administration from the outside. It’s even harder when maintaining team loyalty becomes more important than admitting shortcomings. This comment by Matt Stoller provides some useful perspective:
The main point is any administration can make mistakes and any administration can contain elements that are ultimately unhealthy. It seems to be happening in the Trump administration now as it has many times in the past. The best thing to do is to acknowledge the mistakes and course correct.
That’s not what we are getting, however. As Trump’s executive orders and DOGE’s antics receive one restraining order after another, it’s becoming clear the intent is to test the limits of the law, sometimes by exceeding them. That leaves an open question as to how far the Trump administration will go in challenging judicial orders.
Two important implications emerge from this. One is that America’s longstanding reputation as a bastion of law and order is eroding — in the eyes of American’s and foreigners alike. This affects a lot of things, not least of which is the risk premium for investing. As Robert Armstrong ($) writes in the FT, “What I am confident about is that a breakdown in the constitutional order would reduce capital investment, and therefore long-term earnings growth. What global company would not moderate their long-term investments in a lawless America?
Another implication is the risk of political support for Trump becoming fractured. While a number of people surely voted for Trump on the basis of lower taxes or less wokeism or other policies, most of them probably didn’t bargain for aiding and abetting a constitutional crisis. Just as Matt Stoller suggests, this would be a good time “to be honest about what’s happening”.
For the time being, markets are showing little concern. That’s probably a bad sign. Without the market signaling that Trump’s power grab is going too far, he is likely to push until he does actually go too far. By then, of course, it will be too late. That means there is a good chance something breaks in the not-too-distant future.
Note
Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.
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