A Tale of Two Trumps
Judging by the stock market, the Trump presidency so far has been a grab bag of policy proposals, some good, some bad, some disastrous.
By John Kimelman
As far as the U.S. stock market is concerned, there are two Donald Trumps working side by side in the Oval Office. And market indexes are feeling the effects of both.
Despite a penchant for switching political-party affiliations over his adult life, there’s the Donald Trump who’s a traditional Republican at heart, a career real-estate developer and serial entrepreneur who favors lower taxes and fewer regulations for many industries, most notably energy and financial services. This is the Chamber of Commerce–friendly politician who appeals to investors heartened by both the president’s pro-growth platform and the unusually high number of successful businessmen he has tapped to fill posts in the administration, including former ExxonMobil CEO Rex Tillerson, former Goldman Sachs Chief Operating Officer Gary Cohn, and leveraged-buyout kingpin Wilbur Ross.
It was this Trump who fired up the market in the first trading day after the Nov. 8 election, when the Standard & Poor’s 500 index gained an impressive 1.1%. That was a surprise to many market pundits, including Barron’s, who were convinced that a Trump upset would send stocks into the tank, mainly because of his protectionist positions on international trade.
Indeed, it appeared a selloff was in the making on election night, as S&P 500 futures, reacting to a likely Trump upset, plunged 5% before hitting a circuit breaker. But, at 3 a.m., when Trump gave a victory address that was conciliatory, uplifting, and filled with manna for investors, S&P 500 futures immediately shot higher. In the following weeks, as Trump began making cabinet nominations and issuing business-friendly executive orders, stocks had far more up days than down ones in what some have referred to as the Trump Rally.
BUT THERE’S ANOTHER DONALD TRUMP, one who makes many investors nervous. That’s the Disrupter-in-Chief, a man with little regard for the political etiquette of a traditional presidency. This Trump is not a mainstream Republican but rather a populist politician in the mold of Andrew Jackson, one who seems intent on staying true to the mostly working-class voters who put him over the top in critical northern industrial states like Pennsylvania, Michigan, and Wisconsin.
This is the Trump who belittled the leaders of Mexico and Australia, among others, who issued a hastily executed travel ban on immigrants from seven Mideast nations, who fired off barbed tweets questioning the competence of U.S. judges who rule against his policies, and publicly criticized department-store chain Nordstrom (ticker: JWN), for dropping his daughter Ivanka Trump’s line of clothing and accessories from its shelves.
This Trump also blamed information “illegally” leaked by U.S. intelligence services to the media for bringing down National Security Advisor Michael Flynn. Late last week, two Republican senators were calling for a congressional investigation of any undisclosed ties between President Trump and Russia.
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“You can see the two Trumps in the market action,” says Michael Arone, chief investment strategist at State Street Global Advisors. “The contrasting Trumps play off of one another.” Here are some examples of how Trump has moved the stock market in recent weeks:
• On Monday, Jan. 30, the Dow Jones Industrial Average fell 123 points, or 0.6%, its biggest single-day drop since the election, following a wild weekend in which Trump’s travel restrictions on immigrants caught congressional leaders by surprise and triggered spontaneous protests in the U.S. and around the globe.
• Four days later, on Friday, Feb. 3, the iShares U.S. Financial Services exchange-traded fund (IYG) gained 2.5% after news that Trump planned to sign an executive order that signals an intention to scale back the 2010 Dodd-Frank banking regulations.
• On Wednesday, Jan. 11, the iShares Nasdaq Biotechnology (IBB) fell 3% after President-elect Trump, in his first press conference since winning the election, surprised markets by stating that drugmakers were “getting away with murder” on prices and expressed a desire for the government to negotiate drug prices.
• On Monday, Dec. 12, shares of Lockheed Martin (LMT) fell about 4% in early trading after Trump tweeted that costs of the company’s F-35 stealth fighter were “out of control.”
A casual glance at a three-month stock chart shows that market-friendly Trump clearly has the upper hand over his more cantankerous and disruptive alter ego. Since Trump’s victory speech at the New York Hilton immediately after the election, the Dow Jones Industrial Average has gained 12.5%, one of the strongest rallies under an incoming president in the past century.
WHILE IT’S POSSIBLE THAT more positive developments will emerge from Trump’s presidency, “it does seem that the market has already reacted to most of the good news,” says Ben Inker, head of asset allocation at money manager GMO. “But there are some potential things that the markets would take to badly, such as a trade war.”
Like Inker, many on Wall Street wonder whether the market is too euphoric and not factoring in enough potential negative consequences that could be far more tumultuous than a clumsily executed travel ban. Going forward, will the disruptive side of Trump undermine the market-friendly aspects of his nature and cut the legs out from under stocks?
A second question that’s just as important: Will some of the seemingly pro-growth Trumpian prescriptions that markets are embracing trigger unintended consequences that could depress stock indexes in the months ahead?
Legendary hedge-fund manager Seth Klarman of the Baupost Group made headlines recently with his fears of what a disruptive Trump could unleash on markets if he leads us into a trade war, or worse. “Exuberant investors have focused on the potential benefits of stimulative tax cuts, while mostly ignoring the risks from America-First protectionism and the erection of new trade barriers,” he wrote in his latest quarterly shareholder letter, a copy of which was leaked to the New York Times.
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Klarman, a registered independent who has donated money to Republican presidential candidates in the past, wrote that “President Trump may be able to temporarily hold off the sweep of automation and globalization by cajoling companies to keep jobs at home, but bolstering inefficient and uncompetitive enterprises is likely to only temporarily stave off market forces.” He added, “While they might be popular, the reason the U.S. long ago abandoned protectionist trade policies is because they not only don’t work, they actually leave society worse off.”
Indeed, last week The Wall Street Journal reported that several prominent hedge fund managers, including Klarman and Tudor Investment’s Paul Tudor Jones, are adjusting their portfolios to hedge against market reactions to Trump’s polarizing and sometimes intemperate actions. Like others, Klarman fears that Trump’s “erratic tendencies” and inflated ego, not just his policies, could slam the markets.
MIGHT KLARMAN AND OTHER Trump critics be underestimating the new president’s ability to rein in the rough-and-tumble style that helped get him elected? Trump has shown that he knows how to dial it back, such as his more tempered remarks after meeting with President Barack Obama after the election. Trump also showed a willingness to consider other viewpoints on waterboarding terrorism suspects. And after getting blowback from Chinese President Xi Jinping, he retreated from his willingness to court Taiwan as an independent entity and potentially overturn what has become known over the decades as the One China policy.
Another Trump retreat, though only partial and carried out in the face of strong opposition: After initially venting on Twitter against the 9th U.S. Circuit Court of Appeals, which refused to reinstate his ban on immigrants from seven countries, Trump is now weighing a more narrowly tailored executive order.
“I don’t think Trump is erratic,” says State Street’s Arone. “Right now, he’s going through a list of things that he promised to his voters and he is tackling them one by one. At some point, he will run out of executive orders and realize that to get some major legislation done, he will need to get more diplomatic and woo people.”
Perhaps the most important question for the market is whether Trump will dial back the saber-rattling on trade and negotiate a “third way” that falls short of erecting a wall of tariffs that could lead to retaliation from trade partners, setting off a global recession. “The fact that congressional leaders are against tariffs makes tariffs a lower-probability event,” says GMO’s Inker.
Trump supporters have long believed that the president’s stated desire to impose tariffs and tear up multi-country trade pacts is ultimately about his desire to make better deals for U.S. workers, not destroy free trade. “One positive interpretation of Trump’s protectionism is that he doesn’t want to shut out world trade but instead wants fair trade,” says Ed Yardeni, the president of Yardeni Research. “He wants to renegotiate trade deals on a bilateral basis and not a multilateral basis. If he can sell that to his base, the world could still be left with a free-trade system.”
Another risk is that Trump’s market-friendly policies have unintended consequences that could hurt stocks and the economy in the coming months. Inker, for example, is among a group of market thinkers who worry that Trump’s desire to stimulate the economy via tax cuts and $1 trillion of additional infrastructure spending could ramp up inflation, thanks in part to a labor force that has relatively few available workers.
“If the economy is at full employment and growing at around 2%, then putting the foot on the gas and asking for [infrastructure spending] could be a recipe for unanticipated inflation,” Inker says. He fears inflation could be bad news for stocks, bonds, real estate, and the economy in general. “The Fed might have to raise rates much higher than expected to choke off inflation,” he adds, and that could hurt economic growth.
Last month, in a piece entitled “Reality Bites,” Morgan StanleyMS in Your Value Your Change Short position researchers mentioned several “unintended consequences” that would come from tax reform. Michael Zezas, a Morgan Stanley strategist and author of the report, says that proponents of enacting some sort of “border-adjustment tax” assume the U.S. dollar will rise high enough to offset an effective tax on imports that would effectively penalize importers, like Wal-Mart Stores (WMT). “But if the dollar fails to adjust fully, as our [foreign-exchange] strategists believe,” net importers will have to raise prices to avoid losses, Zezas adds.
Then, of course, there’s the risk that infighting between the White House and a conservative GOP Congress will lead to less-far-reaching tax reform and more-restrained government spending than the stock market might be anticipating. In recent weeks, we’ve learned tax reform might not be enacted this year. That means taxpayers might not get a break until calendar year 2018.
“We are assuming that both of the Donalds will be tempered by the legislative process,” says Sarah H. Ketterer, CEO of Causeway Capital Management and a former portfolio manager focused on international equities.
HOWEVER, MANY PEOPLE worry the bad Trump will overwhelm the market-friendly one, taking markets and perhaps the country down with him. Veteran investment writer Jim Grant disagrees. In a recent issue of Grant’s Interest Rate Observer, he wrote that American investors should ignore “the doomsaying consensus” on Trump, whom he refers to as if it the president were a stock with the ticker DJT.
“Cover your DJT shorts,” writes Grant. “We do not say, necessarily, own DJT itself, only entertain the possibility that there is useful information in its rising price.”
A lot will depend on whether President Trump remains open to changing some of his more strident campaign promises because of negative market reactions, public protests, or the advice of his White House team.
As the old saying goes, “Politicians propose, markets dispose.” Let’s hope that’s still true.