New Era for Markets is Here. And It’s Not Just Because of Trump
Henry Kissinger recently called Donald Trump one of those occasional, critical figures in history that marks the end of one era and the beginning of a new one. The new era represents an equally significant juncture for the financial markets, says Larry Jeddeloh, founder of the Institutional Strategist newsletter and the Minneapolis-based institutional research firm TIS Group. Jeddeloh advises sovereign wealth funds, macro funds, companies, and a range of investors. It has paid off for them: Jeddeloh defied the pundits in 2016 to predict that Trump would win the presidential election and the market would rally. We checked in with Jeddeloh about the risks and opportunities of the new era. Here’s what he said.
Barron’s: Is Henry Kissinger right?
We’ve encouraged clients to look at the national defense strategy published by the Department of Defense every year. The December 2017 report is a road map for the new era. One line that’s different reads, “A long-term strategic competition requires a seamless integration of multiple elements of national power—diplomacy, information, economics, finance, intelligence, law enforcement and military.” I don’t think economics and finance were included in the past. It also cites “the re-emergence of long-term, strategic competition between nations.”
My reading of Trump’s policy approach is guided by this document. National security boundaries are driving economic and trade policy. This is new.
What kind of risk does this pose for investors?
What if the administration changes?
Future U.S. administrations will have to respond to the [longer term] planning of strategic competitors that are marching along the same policy path. China has a 50-year plan; Xi Jinping is now the leader of China for life, allowing for a very long planning period. The U.S. planning cycle is very short because we have elections every two years and new presidents perhaps every four years.
But it’s all quite complex because there are lots of other trends going on. For example, millennials are very interested in pro-environment technologies for cars and energy. Politically that will be an interesting change. In the U.S., a millennial is openly running for office as a socialist. But this is a worldwide demographic trend, and these trends will have more and more impact on how markets behave.
Would the new era have happened without Trump?
If it hadn’t been Trump, it would have been somebody else. But he’s pushing policy buttons that are accelerating the trend in the U.S. of putting things—like trade—under the rubric of national security. Some of the tariffs on specific industries have been described as national security issues. That will continue.
It will surprise some people how much support there is in the middle of the country for that kind of policy. When I go around the U.S., the economy looks terrific, the best it’s looked to me in 30 years. The economies of second-, third-, or fourth-tier cities are absolutely booming. They like the tax cuts. They like the deregulation. This very pro-growth pro-business policy is wildly popular in the middle of the country.
At the same time, when I go to either coast, I see things that are troubling from a social perspective. In Los Angeles, I saw not a small number of people living on the offramps from the highways. I’ve seen more homeless people in New York City than I’ve seen in many, many years. That can’t go on. We don’t just have income disparity; we have a real social problem.
What about the trade wars?
The administration has a two-step approach to trade. Starting on Election Day, the approach was to get the dollar down 20% to 25%. The U.S. dollar index fell 10%, to 89 [in January 2018], but then rallied all the way to 96. I don’t think that was the plan. This is why Trump said recently that the dollar is too high. The way to win a trade war, ultimately, is to get the dollar down. Your export goods are so competitive, the other side wants a deal. There is no deal so far because the dollar still isn’t low enough. That has to come, and we’ll see what sectors are harmed. The dollar is really the key.
Some trade deals will be done this year. My guess is we’ll have one with Mexico, and something will be done for specific industries in China, though probably nothing will be accomplished with Canada in the near term. With China, there could be a deal in late September or October. The main trade-related event with China is who controls the intellectual property of the next century. China is offering incentives to companies to move their intellectual property to Shenzhen. It doesn’t need to do anything more than be an attractive place for tech companies to relocate. IP theft may actually go away.
You’ve been forecasting an economic downturn.
One major risk is what’s going on with Brexit. There’s a good chance there won’t be a plan until March 29, the official date of the United Kingdom’s departure from the European Union. That’s too long. Too many companies in both the EU and U.K. are saying there’s not enough time to plan for this. So companies will hire less, invest less in capital expenditure. Sanofi recently said it was starting to stockpile drugs in case there was a hard Brexit. [Corporate reaction to Brexit] can become a global economic problem.
Second, we are having a mini-emerging-market bust in Turkey. The inflation rate there is headed to 30% from 15.4% in July, so they will have to tighten monetary policy. That will send the 10-year yield from 20% to about 25%. Half of Turkey’s debt is foreign-currency denominated, and a third of the bank loans to Turkish companies are in foreign currency. I hope I am wrong about this, but history suggests if the interest-rate picture outlined is right, contagion can spread to other emerging markets pretty quickly.
What about in the U.S.?
In the U.S., the economic slowdown will be driven by the market. The Nasdaq may have topped here. We recently took out our position in Invesco QQQ Trust exchange-traded fund [ticker: QQQ]. It was our single biggest position. I think the market is rudderless for a while and sells off into the fourth quarter. At the same time, there will be a lot of pressure for rates to go up. One: Oil is continuing to march higher to $85-plus. That raises transportation costs, which are already going up because they can’t find enough truckers. Two, there’s a risk of higher inflation from tariffs. Three, you are seeing wage pressure now.
A couple of weeks ago, I drove exactly the same route I did two weeks before the elections in 2016—through Winston-Salem and Raleigh-Durham and Charlotte, N.C., up into the Shenandoah Valley in southwestern Virginia and then up to Washington, D.C. One reason I thought Trump would win was that almost every lawn had a Trump sign. It went on for miles. Now it has completely flipped—there are no Trump signs, but there are large numbers of Help Wanted signs. We are going to get some wage pressure. The Fed will be pushed to raise interest rates. The natural rate for 10-year Treasury yields is more like 4% to 4.25%, not 3%. The last time the 10-year took a run to 3%, in January and March, the markets started to wobble. The speed of the move is just as important as the level. So the market can drive the economy in my view.
How long would a downturn last?
The low for the market should come in the fourth quarter. The low for the economic numbers won’t come until the first or second quarter [of 2019]. The administration will take steps to regenerate growth, whether it’s some new deregulation or a tax cut. We’re at 2858 on the S&P 500 today; up 41% since Election Day. The S&P will fall to somewhere between 2600 and 2650—a 7% to 8% decline; the kind of correction we would normally get but haven’t because of all the economic stimulus.
What are some other risks?
In January, I said two risks had yet to be priced in. One was the 10-year Treasury yield going over 3%. We’re entering that territory. The other was that multiple investigations will hit a peak. If you look at the news flow, the stress is starting to build. The market has ignored the Mueller probe or any other probe. I think it’s going to get really messy. I started investing at the time of Watergate and saw what happened to the market. A lot of things were going on at the same time: New York City went bankrupt, oil prices and inflation were skyrocketing. But the similarities are quite striking. That isn’t priced in yet.
How should people be positioned?
For several years, I’ve told people to buy every dip in defense stocks. We’ve used the iShares U.S. Aerospace & Defense ETF [ITA]. They’ve had a little pullback here. It was up 35% last year, about 9% this year, driven by defense budgets. In the U.S., that spending will only go higher. Here’s an interesting side point: We hear the NATO meetings actually went very well, and the media got it totally wrong. One reason is that Trump pushed all the countries to expand their spending as a percentage of GDP. The people who work inside NATO are really happy about this. If they follow through, the European defense industry may not have the capacity to fulfil all these orders that are coming. Who get the business? U.S. companies.
We like oil a lot; we could see $100 oil next year. We’ve been in the SPDR S&P Oil & Gas Exploration & Production ETF [XOP]. It’s up 12.5% this year, but will go much higher. We also like ETFMG Prime Cyber Security ETF [HACK]. The checkbooks will open to start plugging the holes we have in our corporate and government infrastructures. The valuations don’t matter. And we’re very interested in China from a contrarian standpoint. We’re probably seeing the lows right here. They’re cutting rates quite aggressively, taking some of the pressure from the deleveraging taking place. They’re encouraging banks to direct more lending to small companies. The S&P 500 is up 6%, and China is down 20%. I wouldn’t be surprised if those numbers reverse in six months.
What would you avoid?
The QQQ ETF.