"Is Trump aggressive and thoughtful or aggressive and reckless?"
- Ray Dalio, Davos World Economic Forum, 1/18/17
And we sit and we wait. How will Trump preside? The market and market players would have been more at ease with a Clinton presidency. She would have been easier to predict. Trump is different. He does not have years of governance or position papers in order for us to decipher his next move. Judging by his Inaugural Address, which will be forever known as the American Carnage speech, we can see that he intends to be aggressive and populist. The question remains: Is he going to be thoughtful in his aggressiveness or reckless? Is his aggressiveness just the first shot in a never-ending negotiation? We get the feeling that everything Trump does is a negotiation, and everything he says is a means to an end in that negotiation. Will it be a thoughtful negotiation or a reckless one? Businessmen like Trump tend to get their way, and get it quickly. Let's see how he feels after the first 100 days of getting bogged down in the swamp. What starts off thoughtful could become reckless.
If it feels as if we have been waiting two years for some resolution to the current market environment, it's because we have. With the exception of a 1-month rally that started on Election Night 2016, the stock market has gone nowhere since the ending of QE3 in late 2014. Central bank policy here in the US has been one of tightening, and that has kept a clamp on equity pricing. It is with the possibility of an administration that would spend fiscally to stimulate the economy, along with committing to tax reform and deregulation, that the market has seen further fuel for the latest rise in equity prices.
If you haven't read our Quarterly Letter, the synopsis is that the combination of experimental central bank policy and the new administration's stated goals raises the odds that we are going to have some sort of error in monetary and/or fiscal policy. Any policy error could resolve itself in one of two ways. If central banks drag their feet and raise rates too slowly, then that policy error could insight animal spirits and drive equity valuations even higher, possibly to bubble-like valuations. Raise rates too quickly, and equity prices fall sharply. The current populist rhetoric has us thinking of the 1930s. The 1930s had tremendous rallies and stumbles in the stock market. Not to say that we will repeat the pattern of the 1930s, but things certainly rhyme with talk of income inequality, trade barriers and populist rhetoric.
Equity valuations are high, and bond prices could be in bubble territory. We do not think equity prices are in bubble territory yet. We continue to lean away from bond-like equities and more towards seeking value where we can find it. As for bonds, we believe the bottom to be in for yields in the 35-year bull market. Our duration is quite low and we look forward to rising bond yields, as they will allow us to reinvest at higher yields.
Keep an eye on Washington and on Twitter. In the next 100 days, we may find out if Trump is going to be thoughtful or reckless. The idea of the return to the 1930s does not make us feel warm and fuzzy, but we believe the pendulum swings to extremes and back again. A populist uprising is the natural evolution of globalization. It should be expected that once populism's peak has been reached, the pendulum will swing back - but for the moment. Trump and populism are in full swing.
If you would like to read more of our thoughts and a deeper dive into what we see coming in 2017, follow the link above to our first Quarterly Letter of 2017.