Liberation Day became Liquidation Day.
I’ve noted a few times now, that MAGA is decidedly not bullish US equity prices. In fact, in my year-end posting, I mentioned that for the first time in ages, I was buying downside protection—even shorting individual names. In the days leading up to, and immediately after, Liberation Day, I unwound the last of my downside protection for a decent win. Long-time followers of this site will note how unusual it is for me to short anything, but the setup simply looked obvious. However, that is in the past; as an investor, I look forward. What comes next??
To start with, I feel strongly that we’ve been abused by many of our trading partners. An artificially strong Dollar, and punitive tariffs on our goods have hollowed out much of the country’s industrial base. You can argue on if tariffs, or a Mar-A-Lago Accord, or some other method is the right approach. You can argue if Trump plans to negotiate from here?? Or if he will let these tariffs stand?? Clearly, something needed to be done. It could have been done in a more nuanced way, possibly in partnership with our global trading partners, but this is Trump, and he doesn’t do subtle. It is what it is, and the process has now started. No matter what gets negotiated, and then re-negotiated in the coming weeks, the global economy has forever changed.
At its core, the problem is that America consumes too much and produces too little. Meanwhile, the rest of the world produces too much, then demands that America consumes it. They’ve bought our bonds to finance this consumption, and then recycled the profits into our equities. They’ve put a forever bid under our risk assets, pushing them far higher than they deserved to be. This caused a reflexive feedback mechanism, as global capital sought out the bull market in US equities, forever pushing our assets and Dollars higher. This was unsustainable, and unhealthy. Trump’s first actions in office, offensive to many of our global friends, began the process of reallocating capital back out of America, with the express goal of weakening the Dollar. However, that isn’t enough. Much more is needed. Liberation Day is now the fork in the road.
Trump has stated, in his rather dysfunctional manner, that America will not be the sole consumption engine of the global economy—it will not be the place where others dump their excess production. From now on, the rest of the world can produce less, in which case we have a global depression. Or the rest of the world must find a way to consume more—in which case, we have a more balanced, and rapidly growing global economy. This is a direct challenge to many global leaders, to large corporations, and to literally everyone else who’s about to have their lives upended. Many are upset, and many will push back—as their whole existence is based upon dumping product on the US. I don’t think there’s a going back now—the die has been cast, and Trump seems rather defiant that we’re not going backwards.
So, which will it be. Will we have a global depression?? Or will everyone else consume more?? I feel rather strongly that after a period of chaos and reflection, the world will choose to consume more, if only because the other option is so bleak.
Besides, it’s not that hard to consume more. If you lower taxes on the bottom half of income earners, their propensity to consume almost all of the tax savings is quite high. If you subsidize low interest loans for cars and homes, people will take them up and consume more. If you do direct payments, people will consume more, as we learned during Covid. If you do massive infrastructure programs, then the nation consumes more. Increasing consumption isn’t hard, however it’s a political decision. A decision to have the oligarch class share a bit more with the peasant class. Naturally, these sorts of difficult decisions can only come about during a crisis. Trump has created the necessary crisis. Will global leaders take him up on their chance to push consumption and fix the global imbalances?? If not, do they just sort of shrug their collective shoulders, and accept a collapse?? One thing is for sure, the old model of stimulating production and then dumping it on the US is not going to work this time. Everyone needs domestic demand. They need to run it hot.
What about fiscal constraints through balance sheets?? What about inflation?? What about currency collapse?? Here’s the thing, to re-set the world’s trading patterns, we’re going to need inflation. The inflation itself is a de-leveraging event for national balance sheets. If everyone does it at roughly the same time, currencies remain somewhat stable. Trump is even giving everyone a carrot to try it, as he’s focused on pushing the USD lower. I’ve always been quite skeptical of Modern Monetary Theory (MMT), as it sounds like pseudo-economics to justify governments spending too much. However, MMT notes that the constraint is political, not monetary.
To date, we’ve seen China try out some small measures to increase consumption—it’s nowhere near enough. Germany has committed to building green energy and tanks (possibly the two items with the lowest economic multiplier in any economy). Japan continues with its anemic stimulus. These actions won’t solve for the missing US consumption. Everyone must do far more. Unless these guys want to experience epic depressions, they need to spend. It will have to be kick-started at the governmental level. Corporations can then follow if they know that governments will be spending first.
I realize that to many, the past week feels like the first week of COVID, or like springtime, just before the GFC. I think there’s a good chance that things get worse before better—maybe a lot worse. You cannot rewrite the global financial system without some real pain first. You need a crisis to get governments to act. A few mean Tweets, aren’t enough of a crisis for real change. You need this to really hurt. You need to see politicians get deeply unpopular, and in need of bold actions. You need to see one brave country try it, which then emboldens others. You need countries committed to blowing out their balance sheets, and inciting inflation. Global austerity just won’t work.
2022 was a dry run. The US did more fiscal than any other G-20 nation and got impressive nominal growth out of it. Unfortunately, every other country did far less fiscal. We didn’t get balanced global growth. Instead, it simply super-charged the pattern of everyone else dumping excess production on the US. The tariff barriers and a weaker Dollar are meant to stop them from doing that again. This time, if they stimulate, it’s to stimulate domestic consumption, instead of more factories for export.
As you can imagine, this is all simply terrible for fixed income. 2022 showed inflation rearing its head. Governments are naturally terrified of inflation, and they’re trained to fight back at it. Inflation is unpopular amongst citizens, and it increases government borrowing costs. But what if inflation is the cure for what ails the over-indebted world?? It’s hard to grow nominal GDP faster than nominal debt levels, but outside of default, it’s the only solution. Governments will likely be forced to intervene in their domestic bond markets to massage this all through. Fiscal Dominance and Financial Repression will become household terms before this cycle ends.
This is going to be terrible for global equity multiples. Go and look at Brazil’s equity multiple. I think this is where many Developed Market multiples will contract to. Naturally, this blows up many highly levered cap structures. You’d think that Private Equity and Private Credit are dead men walking, though they’ll probably be marked at par until a minute before midnight. Of course, you’ll get nominal growth out of it, so equities themselves may be a muddle, once the multiples compress enough. Call it a giant klusterfuk for most investors.
I think you want to hide-out in companies with cheap starting multiples, and either strong pricing power, or fixed assets trading at fractions of replacement costs, but with minimal maintenance capex levels. I keep thinking that the sectors that did well in 2022, are the sectors to own again for the rest of this process. Those that got sold off in 2022, are the ones to avoid—but first, it may get ugly for many assets. The undertow from bonds crashing, with increasing financing costs, may matter far more than the attributes of individual companies, especially during the first phase of this process. A global margin call is bound to be messy.
Ever since I grew skeptical on risk assets in August of 2022, I’ve been of the view that “Project Zimbabwe” would have a pause. You’d need a crisis, before “Project Zimbabwe” could really take off. This is that crisis. Max out too early, and risk annihilation. Show up a bit too late, and risk devaluation of your investing capital. As a Macro trader, this is the moment I was born for. The past few quarters have been frustrating. The next few quarters may be even harder. Personally, I think the best option here is to de-gross, and wait it out. Once it turns, it will be obvious. I’m here for this moment…
Trading “Project Zimbabwe…”