Trump 2.0: Back To Basics

By Peter Tchir of Academy Securities

Trump 2.0 – Back to Basics

After a tumultuous week in stocks (Nasdaq 100 down 10%, the S&P 500 down 9%, and the Russell 2000 down somewhere in between), it seems like a good time to get back to basics.

Though it hasn’t just been a bad week – the Nasdaq 100 is down almost 15% in the past month and 17% year-to-date.

Credit spreads were also starting to show signs of wear and tear – the Bloomberg Corporate bond OAS went from 93 to 109 and CDX IG went from 61 to 72. Not alarming, but worth watching. The high yield market, which has been so resilient, also experienced some weakness, with CDX HY rising 100 bps, to 439 since March 25th.

Treasuries performed very well, with the 10-year dropping 25 bps to close out the week at under 4%! Though Treasuries did fade off of the best levels of the day when Powell made it clear that he is watching inflationary impacts from tariffs, as well as watching the jobs data (which was surprisingly solid).

Bitcoin was the standout, as it defied recent correlations on Friday and acted as a “safe haven.” My best guess on this, or at least what I’m thinking, is that the tariff policy demonstrated that this administration will stick to their guns, and one of their guns has been to buy crypto to pay off the debt.

But let’s move on to the basics – the Mission Statement and Tariff Basics.

The Mission Statement

We have been discussing what we see as this administration’s “mission” for months. Whether you want to call it a mission statement, desired legacy, or what they were elected to do, I think this sums it up quite well:

• Rebuild the American Middle Class. Create a larger, more successful middle class than we have seen in a long time, if not ever. Great goal!
  • Bring back jobs to America. This is front and center for the strategy. Jobs of all types should be created by various mechanisms. Drill Baby Drill is just one example. We have expected that to expand more broadly into What is Good For National Security Must Be Produced Domestically. I did think that for many of the things, “domestically” would include close allies, but I think it is now purely domestic. From chips to natural resources of all types, not just the extraction of those natural resources, but also the processing.
  • Reduce the deficit. Deficit reduction is one of the key elements of building a greater than ever middle class. Reduced spending, increased revenue from foreign sources, lower interest rates, etc., all play into reducing the deficit. Which in turn will lower the tax burden on individuals.

I think that accurately reflects the main mission of this administration and two major elements of what they will work towards to achieve it.

Fully on board with this mission but let’s for a moment assume the global economy is a zero-sum game.

In game theory, it is usually safe to assume that a “zero-sum game” should be “win-win” (not impossible to achieve) and “lose-lose” should largely be avoided.

So, in a zero-sum game, if the American Middle Class is to grow and get richer, it benefits the existing middle class and should reach down and help lower income families the most. I don’t think anyone can argue with that. 

Well, where will the income/wealth distribution come from?

• People in other countries. Clearly the strategy of this administration revolves around the concept that much of the world has been taking advantage of the U.S. for decades. The policies are meant to shift resources/money/jobs from those countries to the U.S. So, one source of transfer will be from outside the U.S. Foreign companies, when importing something to the U.S. to sell, will have to pay the tariffs, yet another way to transfer money from overseas to the U.S., in a way that should hurt the stock prices of those companies. Presumably, other countries will do what they can to mitigate such wealth transfer.
• Redistribution within the U.S. The other potential is to transfer wealth within the country. That leaves the wealthy and corporations as pockets of wealth to be redistributed. It would seem at odds with the overall objective of the government to directly take the money (via taxes) from the wealthy (though chatter about taxes for those making above $1 million has emerged). That leaves corporations as the main domestic source. It is unlikely to be through “income taxes,” but it is likely to come down to lower profit margins initially. Whether paying more for workers, more for goods, or paying tariffs, one wealth source will be the transfer of wealth from corporations to the burgeoning middle class. That will likely hit stock prices (it already has, and there are a lot of reasons to think that it will continue), which indirectly transfers wealth from the wealthy. As Chamath Palihapitiya (@chamath on X) points out in a tweet this weekend – the top 10% of households own 88% of the total equities owned by U.S. households. The bottom 50% have virtually no interest in U.S. stocks. Given his success on the investing side, with his All-In podcast, and involvement with this administration, I would take the tweet quite seriously. It would argue, quite strongly, that there is no Trump Put. Which makes perfect sense as the administration if fully on board with the policies. Clearly there is the belief that the brunt of the wealth transfer will come from foreigners, but as investors, we should be aware that some can come from corporations. If the government plans work, that will change over time, as presumably the improving middle class in the U.S. is great for U.S. stock valuations. Also, U.S. domiciled corporations, doing a lot of business in the U.S., have less ability to avoid government actions than (potentially) foreigners have.

I think it is perfectly rational to believe in the mission, and to believe that the policies will be successful, and at the same time still be nervous about corporate earnings and valuations.

We won’t delve into all the policies enacted (and likely to be enacted) to achieve this mission, as it would be too long, and be total guesswork, relative to what we know now about tariffs.

Tariff Basics

We went into a lot of detail on what we considered The New Trump Tariffs in early February. In our Bottom Line in that report, we published “At the moment, I’m not that worried” and went on to discuss our lack of concern about tariffs, as we understood them back then.

Our view changed on that back in the middle of February as we evaluated the policies as implemented. Leading up to this week, we were already nervous about the combination of geopolitical policies alongside tariffs but were still, quite frankly, shocked by the tariff policy launched in the Rose Garden this week.

As of Friday afternoon, we backed off being negative on U.S. stocks for a trade (see NFP, Powell and Tariffs).

What does the administration expect tariffs to deliver?

• Revenue. The administration clearly states that tariff revenue will be a primary source of reducing the deficit and tax burdens (in line with their mission).
• Reviving Manufacturing in America. It is also expected that more will be produced in this country. That U.S. companies will produce more domestically to sell into the U.S., thus avoiding tariffs. Presumably, there is an expectation that facing lower tariffs from other countries (once we reach that stage) will create more sales of things already made in America in other countries.

Since it will take time to build up manufacturing capacity in the U.S. (there is some excess capacity, but nothing on the scale that is envisioned by the administration), presumably the initial benefit will be the income from tariffs, and over time that income will dissipate as manufacturing shifts here (the two goals are somewhat mutually exclusive – either import and get the tariff revenue but not the jobs, or build here and get the jobs, but not the tariff revenue). But in an ideal world, the tariffs pay for a lot up front as the U.S. builds the manufacturing base, creating jobs during the buildout and even more jobs down the road, which will replenish any revenue gap from no longer receiving the tariffs.

QED.

But only if it was that simple. It seems, logically, if it was that simple, someone would have tried it already, successfully. That terms like “comparative advantage” would have dropped out of our language due to lack of use. So, let’s examine some of the risks.

Country A produces a widget that they sell for the equivalent of $100 to a U.S. importer. The U.S. now imposes a 30% tariff on that country/product combination.

That is about as basic as it gets.

As described in more detail in the February report on tariffs, 4 things can happen and in all likelihood, some combination of the 4 occurs.

• Currency moves offset some of the tariffs. That was always somewhat tenuous and applied best to inventories already created. But back in February DXY (a dollar-based index) was at almost 110, up from 100 in early September. Now, it has fallen back to 102, so the tariff cannot be offset by currency moves (at least not yet).
• The exporter can reduce their price. If the exporter reduces their price by 23%, then a 30% tariff on $77 gets us back to a price of $100. In this case the exporter loses, the importer is indifferent (its total cost is the same), and the U.S. government makes $23. The ideal outcome for the U.S. Prices don’t rise, and all of the pain is extracted from the foreign entity.
  • How likely is this? If this was the most likely outcome, we’d be off to the races and I’d be pounding the table to buy stocks, but there are many factors that make this outcome unlikely (some of the cost will be taken on by the exporter, but probably not all).
  • Specialty products. Many things are very specialized and have relatively few sources. The more specialized a product is, the more likely the exporter will not “eat” the tariffs. The longer it would take to find an alternative supplier (which could be measured in years), the less likely they are to bear the brunt of the tariffs.
  • Comparative advantage. Presumably, there is a reason the importer was buying this product for $100 from this exporter. The combination of quality, reliability, and price likely made this the best source. If there is a similar company making this for $110, then the supplier probably has to reduce their price, to keep the net cost to the importer around $110 (could be a bit higher than that - does the importer really want to open up with a new supplier?). If the next equivalent supplier is $131, why would the exporter cut their price at all? If it is something that can be manufactured elsewhere at below $130, they have to be concerned (maybe no one bothered making it at $115 because it was uneconomic, but now it wouldn’t be uneconomic, so new supply comes on to the market over time).
    • Many companies took the “anti-China” signal seriously. Many companies have already shifted manufacturing outside of China reading the tea leaves of Trump 1.0, even Biden to some extent, and Trump 2.0. But it wasn’t just China that was tariffed. The likelihood that the $110 producer will also get tariffed, as of the time of this report, is high. Therefore, the $110 item might have a net cost of $130 or higher (depending on the tariff rate listed in the Rose Garden), making substitution more difficult. If you planned for a tariff war, with China as the main enemy, you have been disappointed.
    • The more countries that get tariffed, the less negotiating they are likely to do. Picking on one or two countries would likely lead to more negotiations, but that doesn’t bring industry back to the U.S., it just shifts which country gets the U.S. business.
    • GDP matters. For all the tariffs put on, GDP matters for two reasons. One, “good” deals, with small GDP nations, do very little to move the needle. How much can they import from the U.S.? How many high margin, high value things can they afford? How much can they ramp up production to keep costs down (which is irrelevant if the desire is to end manufacturing elsewhere and have it all be domestic)? By the time you are at the 21st country in the world (according to Wikipedia) you are below $1 trillion in GDP. GDP per capita is also quite relevant as it likely correlates to how much stuff they can buy. Vietnam, according to the IMF, is about $17k per person, while Cambodia is $8k (mentioning them as they were quick to reach out and offer a deal). Vietnam, also has an effective tariff rate of just over 5% and an average tariff rate of under 10% (according to Grok), so seems like it should be easy for them to set it to zero as it seems unlikely that tariff rates were the main reason they don’t import much (lack of wealth seems more likely) to avoid the 35% tariffs scheduled for them. China is already pushing back, and what the EU does next will be critical. The more the EU acts as a block, the more likely they are to play it slow.

The importer can reduce margin or pass on higher costs. Whatever the net cost rises by it either hits earnings (the importer eats it) or it is inflationary, as prices increase. Yes, in theory it is a “one-time price increase” but at already high price levels for many things, that might hit hard.

This is already complex enough, but there is one more big question that we are getting mixed signals on – how long will the tariffs stay in place?

If tariffs are viewed primarily as a negotiating ploy two things are likely to happen:

• Potential shortages over time as importers are hesitant to order new stock subject to high tariffs that they expect to be reduced if they wait.
• The primary benefit from the U.S. won’t be from tariff income, it would have to come from increased sales of U.S. goods, once the tariffs are reduced. How much are U.S. sales into other countries affected by tariffs, vs. other factors? (design, price, regulations, etc.). U.S. jobs will only increase if we have the capacity to meet higher foreign demand (if such demand increases as tariffs are reduced).

If tariffs are going to bring back jobs, they need to be long-lasting.

• To meet the administration’s goals (tariff income to replace other forms of tax and to bring jobs back to the U.S.), there needs to be a strong belief that the tariffs will last long enough to cover the cost of building out manufacturing in the U.S. and turning a profit. There is some sparce capacity that can be used right away. There are some things that can (maybe) be retrofitted or developed in months, that could come online. But in the end, many things will take years to build. While the buildout itself will create jobs, will companies believe that the tariff policy will last long enough to turn a profit on building out facilities in the U.S.? Again, some of this occurs naturally and is already in the works, but based on the mission, it is a dramatic shift and will take time. If the commitment to build is there, then the U.S. can get the tariff revenue, and then the jobs, but that is a lot of assumptions.

Basically, if this is just negotiating, the stated goals don’t really work (unless you believe that tariffs really are hitting sales of U.S. made goods globally really hard). In which case, the markets need to start pricing in long-lasting tariffs. The end game could work, but it will not be an easy path, and the world is likely trying to figure out alternatives (so far China isn’t coming to the table, so much as upping the ante).

Everyone is free to see how these scenarios play out, but for now I’m stuck in the camp:

• No major deals that make it clear that the administration is making big strides on jobs, so tariffs likely stay to provide the tariff revenue to the government.
• Profit margin erosion across the globe, but the U.S. is harder hit than China.
• No big boost in jobs on sales of U.S. brands in the near-term (let’s call near-term a year).
• Inflation and some shortages in the U.S. causing some angst in the next year.
• New trade alliances formed, partly due to tariffs, but also due to concerns surrounding geopolitical posturing in and around the globe.

I cannot get bullish stocks, beyond just for a trade, while I see tariffs playing out this way (as my base/maybe even good case).

Bottom Line

Since we focused on mission/legacy goals and some thoughts on how tariffs might work (I think I laid out a more optimistic case than I expect, and I don’t think it is great for risk assets globally), I wanted to include one chart in this section.

The “soft” data all points to extreme fear. CNN Fear and Greed Index. AAII Investor Sentiment. You name it, but I look at these 4 incredibly important ETFs and some had almost record inflows into the selling after April 2nd. It is great to be a contrarian, but is the contrarian trade really that it is oversold? That everyone is bearish?

The “hard” data/fund flows don’t seem to support that. If you get bored and have a Bloomberg terminal, find any ETF you want (the more speculative, the better) and append SO (shares outstanding) at the end of the ticker and hit <index> <go>. Massive inflows into risky funds and big outflows out of inverse funds.

Whatever we might think, there is still a lot of belief that stocks are cheap and that the plans will all work out. Down 20% from the highs, it is difficult to argue with that, and I’m long for a trade, but I think we have another 10% downside and when I look at the massive dip buying still occurring, I’m sadly more comfortable with that outlook in the next week or two.

Credit has “joined” the fray as we thought last weekend. That could turn, but as so many other factors (not discussed today, but that we’ve touched on repeatedly) point us towards recession, maybe even stagflation, I don’t think we’ve seen the wides yet.

At some point I will be bullish again on risk. Either I find the scenarios (as I probability weight them) point to better conditions for stocks, or we finally get so oversold that it is truly the contrarian trade to buy.

In the meantime, I expect more downside.

Rates are tricky, as they should be lower, but inflation pressures could be real if the tariffs go ahead as planned (and are semi-permanent). But my bigger concern, which applies both to stocks and bonds, is that the wave of capital repatriation has only just started.

It will be curious to see if (or when) retirees (or those getting close) decide that maybe it is prudent to reduce stock exposure for safety? I don’t think that has happened yet (though, it probably has occurred with Democrats already as the gap between the parties on so many fronts has never been wider at any time that I can think of).

Good luck, I hope I’m right about the bounce to start the week, and I hope I’m wrong that we won’t see enough of a policy shift, or signs of “winning,” to make me bullish beyond a trade.