«The market is banking on the idea that the Trump presidency is going to be a giant reflation trade.»
Things rarely turn out the way you expect: The blowout victory of Donald Trump not only took the world by surprise, but also the stock market is welcoming the president-elect with unexpected cheers. The Dow Jones climbed to a record high and the Dollar rallied. Wall Street is betting that Mr. Trump will tack to the political middle and get the US economy humming. «We will see if that’s what they get», says Jim Bianco. The influential market strategist from Chicago who is highly regarded among institutional investors cautions that Mr. Trump is no regular politician and that risks with respect to global trade remain high.
Mr. Bianco, Donald Trump gets a warm reception on Wall Street. What’s your take on the financial markets?
The markets are trading schizophrenically. During election night futures on the S&P 500 tanked to a 5% loss limit only to recover all of that by the beginning of the next morning and then go on to have a strong up day. Futures overnight trading started in 1988 and this is the first time ever that we saw a swing like that. Also, bonds had the biggest one day sell off in four years. So that’s somewhat epic, too.
Originally, the consensus was that a Trump presidency would crash the stock market. What’s your explanation that the reaction turned out to be exactly the opposite?
The market is banking on the idea that the Trump presidency is going to be a giant reflation trade : A bet on higher equity prices, rising interest rates and a stronger dollar. The expectation is that Trump is going to get rid of tons of regulations. He’s going to push through a massive fiscal stimulus either through tax cuts or infrastructure rebuilding or all of the above. And that is going to lead to something we haven’t seen in a decade: economic growth of 3 or maybe even 4%. That would also mean higher interest rates because the deflation mindset is gone. That’s what the market is banking on, at least initially right now.
Do you think that’s a good bet?
I’m a little bit skeptical. First, I want to see how this whole thing plays out in the next couple of weeks. I’m hearing from a lot of people that when candidates win they tend to center: They say things to get elected and then they do other things when they get elected. Trump has already set history. Every President that we have elected in America was either a previous politician or a general who had won a war like Ulysses Grant or Dwight Eisenhower. Donald Trump was neither. So he has already broken that mode. That’s why I think to assign to him all of those traits that you would assign to a typical politician would be dangerous.
What should investors watch out for now?
At this point, we just have to wait and see how the Trump presidency will impact the economy. Is he going to appoint people that he knows and punish those that weren’t with him? Or will he allow people like Mitch McConnell or Paul Ryan to say: »Here’s a couple of people for some posts that might work very well.» That was the hope after Trump gave a very conciliatory acceptance speech. He didn’t come out and say: »We will build a wall and put Hillary in jail». But there is always a risk that he could fall back to that in the next couple of weeks and the markets might have a toxic reaction.
How serious is that risk?
This idea that he’s going to tend to the center could be misguided because he’s unlike any politician we’ve ever seen. He has won the only office he’s ever going to win: the Presidency of the United States. At most, he’s going to run for another political office one more time in his life and that is going to be in four years. He won on everything he said defying all odds. So why should he tack to the middle? What benefit does he get from not doing exactly what he said? I have no reason to believe that he is going to change. He may not do everything he said on day one. But he’s going to do a lot: He’s going to declare China a currency manipulator, he’s going to repeal Obamacare, there’s going to be a wall and there’s going to be an effort to make Mexico pay for it. So it’s going to be rather interesting.
What does that mean for the Federal Reserve? Will it stick to its plan to raise interest rates next month?
The Fed has lost control of rate hikes. The market is in control. If the market prices a rate hike in, it will happen. If the market prices it out, it won’t happen. The Fed follows the market. With that said, we’ve been all over the place: We were at an 82% chance of a rate hike right before the election. Then during election night, we went down to 46%. Now we’re back at 80%. So it looks like the market is still going to let the Fed raise rates by pricing it in.
If the Fed really raises interest rates at its next meeting it would be almost exactly one year after the first hike.
In fact, this is the longest time between rate hike one and rate hike two ever in a cycle. That just underscores the glacial pace at which the Fed is moving. And the reason for that is that the Fed needs to get the market on board and that’s very hard and it takes time for them to do it.
What’s next for Fed Chair Janet Yellen? Trump criticized her sharply on the campaign trail.
Her term is up in 2018 and is not going to be renewed. That’s the first take away. So the next questions becomes: Trump cannot fire her before that date. But will he pressure her to leave? My guess is that he probably will pressure her to leave. Will she take the bait and actually leave? I don’t know. I’m kind of on the fence on that one. But if I would have to guess I would say »no» at this point. What’s more, the next Fed chairman will probably be more hawkish – and that would be a little bit more problematic for the stock market and it could be bothering the bond market. Of course, that change at the Fed probably is not going to happen for a couple of years. But that might be the road that we are heading down.
What does the Trump Presidency mean for the rest of the world?
Trump ran on the same things that Brexit was about: It was about globalization and it was about immigration. The bull market of the last 30 plus years was built on globalization. People and products moved around the world in search of efficiency and lower costs. Until the financial crisis we only saw isolated instances of unhappiness with globalization, the NAFTA debate and the violent 1999 Seattle WTO protests to name two. Even though globalization shipped many unskilled jobs to lower-cost countries, its march continued. Everyone assumed the governments and organizations promoting globalization were fair. It was perceived to be good for the greater whole.
So what changed?
During previous recessions no one got a special treatment. For instance, consider the recession of 2001. People lost their jobs and opportunities failed. It created unhappiness. But when surveying the situation, everyone saw Enron executives go to jail, Arthur Andersen get liquidated as punishment and many of the dotcom billionaires lose everything. In other words: The recession, like all recessions that came before it, was equally unfair to all.
Why was the financial crisis different?
Since the beginning of time there has always been a populist undertone to our politics: the rich against the poor, the elites against the non-elites. There has always been a distrust of government. There’s always been an undertone of skepticism. But we needed a trigger to push us back into a populist mode. I believe that this trigger was the bailouts of 2008: We gave the banks billions of dollars of money to bail them out and the public was stuck with seven million unemployed people and countless home foreclosures and all the pain and misery that came from that. Let me be clear: The bailouts were necessary. The financial system was teetering on the edge. But from a regular person’s standpoint it looked like rich bankers got to remain rich and they got punished. And that is the impression around the world.
What are the consequences of that?
We have to realize that there is a lot of distrust in the system. That gave rise to populist movements around the world. In the United States it was the Tea Party movement on the right and Occupy Wall Street on the left. That bread into Donald Trump and Bernie Sanders. The thing that was really telling about this election was that only two newspapers in the United States out of hundreds endorsed Trump. He was fought against by the Republican Party and the Democrat Party and the news media was very biased against him. Yet, he won the election and the reason he won is that people looked through it. The elite opinion does not count anymore. And because of that the pollsters had their models wrong. They had their models wrong with Brexit, they had their models wrong with this election and they had their models wrong with other elections as well.
So what should investors do now?
The fundamental underpinnings of the long term bull market are at risk: Global trade and the free movement of people through immigration. That is a long term negative. Investors need to understand that. Yes, the market could trade up or down, based on what the trading algorithms decide is the story for this hour versus the next hour. But until we get a clear vision of how much at risk globalization and the free movement of people are, I would be defensive. So I think interest rates have gotten way ahead of themselves and I would look for them to peak and probably start to move down.