- Trump has been dropping trade bombs on the rallies, and pumping hope on the selloffs.
- So far, it has resulted in a collar. Trump defines the cap, while the Fed provides the floor.
- However, soon or later when, the majority of market participants get the trick, the beast will break the spell.
(Source: Gage Skidmore)
President Donald Trump is playing the stock market on the trade war. He has been dropping trade bombs on the way up and deescalating the trade tensions when things seem to get out of hand. The chart below shows just that.
Graph 1 – Positive and negative trade actions by the US
(Source: Yahoo Finance with author’s annotations)
With that move, Trump has been playing the stock market against the Fed, effectively influencing Chairman Powell to ease the monetary policy at a time that it should be unnecessary. There are two main consequences of those actions.
The benign effects of the Trade war escalation
President Trump has been escalating trade tensions near the market highs. That is helping to take some steam off the equity bubble. From 2016, until the beginning of 2018, the market was on a clear uptrend, consistently reaching new highs every month. Since Trump went all guns blazing on the trade front, the S&P 500 (SPY) has been, effectively, capped around the 3000 – 2900 level. That, alone, would be a good thing, the problem is that the President’s actions are creating other dislocations.
The malign effects of the trade war
Every time that the Administration enacts new tariffs, the bond market becomes a safe-haven, effectively, propping-up what, many argue, is the biggest bubble in the world. Logically, that’s also messing with the hurdle rate for investments, creating distortions and a fertile environment for malinvestment. That helps explain why stocks have always made a comeback from trade selloffs. After the stock market goes down, yields go down, and market participants assume that the Fed is going to ease, which is bullish for stocks.
The making of the everything bubble
In my view, the current trends point to further volatility inside the trade collar. Investors’ confidence is increasing, as the declines are followed by new highs, and the bull market is gaining an aura of invincibility. At some point, they may even ignore the enactment of new tariffs, breaking the current collar and pushing the stock market into a huge bubble, that will burst sooner or later. The crash may come in the form of a credit event, due to low-quality credit. Or, even from an inflationary outburst caused by world spread tariffs, making the Fed tighten the monetary policy.
Therefore, I keep the hypothesis that the current market will see one more leg up. At some point, a crash will occur, putting an end to the current recovery and igniting a regime change in all asset classes. As the valuations of both stocks and bonds dissipate, that should be good for Gold (GLD).
Disclosure: I am long GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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