Some Further Thoughts, and the BAML FMS

Human psychology is fascinating, isn’t it? How quickly has the consensus changed from Trump being a buffoon to Trump could solve secular stagnation? I mean, people should change their views if the facts dictate that they should. But the conviction that some folks maintain, despite doing a literal 180 in a week’s time, is laughable. Strategists have to pretend that they know exactly what’s going on I guess, even if they have no clue. Maybe the pretending gets into their heads. Anyway, last week is a delicious reminder that price action drives the narrative, not the other way around. Here’s a short list of things I think is true about the US political situation, regardless of the price action or the opinion flow:

· Trump is out of his depth. The executive branch is huge, and requires many hardworking, competent public servants. But he will not be able to attract very many qualified political appointees into his administration. His public persona and management style (never accepting blame or backing down) is anathema to many reasonable people who may otherwise jump at the chance for public service.

· But his party has control of Congress

· So the range of possible outcomes is wider

· But given the complexity of the world today, and the low nominal growth rates, mistakes are more expensive.

· Higher vol + negatively skewed outcome distributions is not a good combination

As a result, my assessment of the economic fundamentals has turned more bearish over the long run.

On a separate note, the BAML Fund Manager survey was interesting, even though some responses may have been returned prior to the election. Also note that the sample size has depreciated quite a bit from prior months. Here are a few charts of note:

Inflation Expectations are about the highest they’ve ever been in the 20+ years of the survey:

Historically, readings near these levels have marked highs for inflation breakevens: (early 2004, 2011)

Yield curve steepening expectations are also very elevated.

Historically, that has usually meant a continuation of the steepening already in train.

Unsurprisingly, survey participants also had unusually high expectations for higher 10y yields.

Historical readings at these levels have coincided with or preceded local highs in yields: (late 2003, early 2008, late 2010, mid 2013)

This confirms my view that we are probably closer to the beginning of the end of the rise in yields rather than the end of the beginning.

For equities, the high cash balance which has provided a backstop has fallen somewhat. It’s probably unlikely that cash balances go all the way back down to the low levels last seen in 2011, but on an absolute basis they remain high and will continue to limit the depth of any downside shocks, IMO.

Also supporting this view is the very low levels of allocation to equities:

For the USD, investors are broadly neutral on valuation, but the readings are elevated relative to the past decade. IMO, that supports my view that the USD may not appreciate a great deal more from here – certainly not as much as the 2014-2015 move.

Part of that may be due to this:

Finally, two links:

This is a very concerning read about how almost all Americans have a difficult time getting a day in court: http://www.nybooks.com/articles/2016/11/24/why-you-wont-get-your-day-in-court/

Excerpts:

· whereas in 1938 about 19 percent of all federal civil cases went to trial, by 1962 that rate had declined to 11.5 percent and by 2015 it had declined to an abysmal 1.1 percent.

· over 97 percent of those charged in federal criminal cases negotiate plea bargains with the prosecution, and in the states collectively the figure is only slightly less, about 95 percent.2 In most cases, as a practical matter (and sometimes as a legally binding matter as well), the terms of the plea bargain also determine the sentence to be imposed, so there is nothing left for either a judge or a jury to decide. While the immediate result is the so-called mass incarceration in the United States that has rightly become a source of shame for our country, the effect can also be seen as just one more example of the denial of meaningful access to the courts even in the dire circumstances of a criminal case.

This is a great Chris Arnade interview on Trump supporters: http://www.cjr.org/covering_the_election/chris_arnade_trump_supporters_america.php

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9 thoughts on “Some Further Thoughts, and the BAML FMS

  1. Agree fully with the narrative first para.Don’t know if you saw my version on it too. Agree too that conviction has filled a vacuum of knowledge about the future. Nuts. Cheers R

    Sent from my Samsung device

  2. I spent the day reading your blog. Excellent content. I’m following. Thanks for showing the results of the survey for those who don’t work in the industry. Keep up the good work!

    Cheers

  3. Nice observations, GMS. At some point, the secular stagnation narrative will reassert itself.

    It’s been interesting to see some commentator/managers, e.g. Gundlach and Druckenmiller, talking about way higher rates under Trump (6% on the 10 year?!). The way I see it though, the economy’s debt load can’t be supported at much higher rates unless credit creation kicks into high gear (the newly printed money/credit helps pay interest on and roll the existing debt). That’s not a scenario I’d care to bet on given demographics, the scars to the household from the GFC, and already high leverage of non-financial corporates.

  4. Inflation is getting interesting here, though not entirely due to the implications of Trumponomics. Here’s the story as I see it:

    1) Increasing median wages (check the Atlanta Fed’s Wage Growth Tracker) drives increases average hourly earnings generally
    2) This continues to increase the 25-54 employment to population ratio, which has been rising while unemployment has stuck around 5%
    3) This eventually leads to a fall in unemployment to the mid-low 4s
    4) Anemic productivity growth ensures this will result in some inflation.
    5) Meanwhile, Trump will likely be able to enact tax cuts for the wealthy and push, at most, $200 billion of infrastructure of the tax incentive, private/public joint venture variety. Nothing like the Eisenhower infrastructure boom. So the fiscal position will be mildly inflationary at best.
    6) He’ll make some hawkish appointments to the fed, however, flattening the curve.
    7) We’ll have a classic Fed recession, barring an exogenous shock, somewhere near the end of 2017 (market anticipates new chair) to the middle of 2018.

    1. Thanks for your thoughts William. Inflation is certainly picking up, and seems likely to continue to trend higher, although exactly how far it will go even with a low 4% unemployment rate is a matter of debate. Recent research and commentary from the Central Bank community suggests that global factors may be increasingly important for domestic inflation, even for developed countries. FT Alphaville has noted that just 4 sectors accounted for ~90% of total PCE inflation over the past couple decades.
      Trump’s policies are anyone’s guess, including his, IMO. Your expectations seem quite reasonable, but I don’t think we can rule out a more limited stimulus program. And I actually think the chances of him appointing very dovish Fed chair is quite high. As a real estate developer, he has a keen appreciation for the power of the Fed, and I think we will do everything he can to avoid a recession on his watch. But we’ll see. It will certainly be interesting!

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