The Trump Trade
A third bear steepener, policy easy except for little people like you Clark, stronger growth, real or Memorex, China's challenge, energy & financials
The Trump Trade Catches a Bid
Our highest conviction election related view is for a third Treasury market supply driven price shock since the Biden Administration and 117th Congress broke the government spending 20% of GDP cap tacit bipartisan agreement. Our secular bond bear market call we first introduced in August 2020 isn’t just about supply, though increasing deficits are a critical component. Like the ‘51-’81 bear market that began with the end of WWII 2.5% Treasury rate cap and ended with the Volcker recession, the unwind of the Fed’s longer maturity rate suppression is likely to be slowly, but steadily unwound, which will put persistent upward pressure on rates. Also, like the ‘60s, we expect trend inflation and price instability to increase, faster productivity growth, increased demand for capital to fund physical capital investment, all factors likely to increase the natural rate of interest.
Going back to our days as the head of US Equity Portfolio Strategy at Barclays Capital, in 2010 the Obama Administration and Democratic Congress had passed Dodd Frank Wall Street Reform and Consumer Protection Act and the Patient Protection and Affordable Care Act (Obamacare), effectively restructuring two sectors that generated 30% of the revenues of the S&P 500. In the runup to the 2010 midterms, as it became increasingly evident the Republicans were likely to flip the House, strong relative performance of financial and healthcare sectors was a leading indicator of the GOP’s resounding victory that flipped the House. While the GOP House was unable to stop the regulatory tightening of the financial sector or expansion of government healthcare, they were successful in reducing the growth of government spending after an epic battle in 2011. In 2010 the Obama Administration and Democrats were also promising an increase in the tax on capital gains, as the prospects of the GOP retaking the House improved post-Labor Day, the S&P 500 rallied 17%. As an aside, we wrote a report about the negative impact of higher capital gains, within days we were at CNBC HQ for a discussion with Larry Kudlow on his evening show.
We took this walk down memory lane to provide perspective on the rally in financials despite weaker return on assets and equity of banks this week, in short this is the cleanest read on market expectations for the presidential election. The Biden Administration financial regulatory appointees, who appear to have been a concession to the Senator Warren, have softened their capital proposal, but even with the softening the proposal will reduce bank profitability below a key threshold that will impair credit creation like the ‘50s or the 2014 to 2018 post-Dodd Frank, Basel II reform period. The betting market composite did move 8 points in former President Trump’s favor this week to a 15-point gap, the pushback from Harris supporters is polling, though we would note the trend, polling bias and electoral college suggest the betting markets are not misleading. Small caps are also benefiting from the Trump trade; however, we are skeptical due to weak fundamentals partially attributable to the Fed’s suboptimal policy tightening process. Sectors provide the cleanest read on market participant’s election outlook, and while the range of outcomes is not as favorably skewed for equities as was the case in 2016, in large part due to the historically high level of government spending and implications for Treasuries, the year-end ‘25 expiration of the Tax Cuts & Jobs Act does raise the stakes for corporate profits. In other words, the rally in the S&P is also benefitting from the Trump trade.
In this week’s note we will cover the supply driven Treasury bear steepening, accommodative policy channels except for small businesses, the strengthening economic outlook, China’s challenge, the financial and energy sectors.
