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The world awoke to a new political and economic regime on Jan. 20 as Donald J. Trump took the reins of power from Barack Obama and announced a populist, America-first agenda. Mr. Trump enters the White House with a 37% approval rating while Mr. Obama never saw lower than a 38% approval rating (and entered with a 70% rating). Perhaps this is why investors are taking a measured view of their new president after pushing stocks sharply higher in the weeks following the election. The U.S. stock market plateaued last week, with the Dow Jones Industrial Average falling 58.48 points, or 0.3%, to close short of the 20,000 mark at 19,827.25. The S&P 500 dropped 0.1% to 2,271.31, and the Nasdaq Composite Index lost 0.2% to end the week at 5,555.33. Ten-year Treasury yields rose slightly to 2.47%. The initial repricing of financial assets triggered by Mr. Trump's election may be over.
The most significant market move occurred in the U.S. dollar last week, which dropped sharply after then President-elect Trump told The Wall Street Journal that the dollar is "too strong." After these comments, the U.S. Dollar Index (DXY) fell sharply to 100.81, giving up a significant portion of its post-election gains.
This first assault on the dollar might be just the beginning.
In the coming months, President Trump could very well reverse the dollar's rally completely – and he may do it on purpose.
Trump's Iconoclastic Approach Could Stimulate U.S. Growth
Mr. Trump's denigration of the dollar forces us to question whether the dollar will continue to rally as many assumed. On a fundamental basis, the case for a strong dollar is compelling. Europe and Japan desperately need to cheapen their currencies in order to better compete in the global economy. And Brexit significantly weakened the British pound, which traded below $1.20 last week before rallying back to end the week at $1.2375. But fundamentals can be – excuse the term – trumped by policies designed to weaken the dollar to stimulate trade and help American workers.
A strong dollar is inconsistent with Mr. Trump's desire to stimulate U.S. growth and help American workers, so it is entirely possible that Mr. Trump will not only keep talking the dollar down, but take substantive policy steps to weaken it. There is no reason to think that his comment to the Journal will be his last on the currency that Treasury Secretary John Connally told the world in 1971 was "our currency, but your problem."
A strong dollar is a meaningful headwind for corporate earnings since U.S. companies earn a significant amount of money overseas. If the dollar doesn't strengthen much further, this could provide an unexpected boost to corporate earnings and benefit stock prices. A weaker dollar also relieves pressure on emerging market borrowers who went on a dollar borrowing spree after the financial crisis.
While it is too soon to be sure, Mr. Trump may have thrown a wrench into many of the strong dollar trades put on the books after the election. Mr. Trump already broke the mold for American politicians and it appears that he may do so by again by being the first president to openly trash his own currency.
If Mr. Trump does manage to reverse the dollar rally, one way to profit would be to buy a big foreign exporter that will benefit from a weaker dollar. The top 10 major U.S. export companies, ranked by asset value, are:
- Exxon Mobil ($336.8 billion)
- Apple ($293.3 billion)
- Chevron ($266.1 billion)
- Ford Motor ($224.9 billion)
- General Motors ($194.5 billion)
- Pfizer ($167.5 billion)
- Johnson & Johnson ($133.4 billion)
- Procter & Gamble ($129.1 billion)
- Cisco Systems ($112.6 billion)
- Intel ($105.5 billion)
Of these, Johnson & Johnson (NYSE: JNJ) would be my pick. I'll keep you posted as we move further into the untamed wilds of the Trump administration.
Trump's Designs on the Dollar Are Just The Beginning
There are reports that Mr. Trump plans other radical changes in economic policy. If true, this should not surprise anyone. Mr. Trump campaigned on a platform of upsetting the status quo, and nowhere is the status quo more embedded than the federal budget, which is a roadmap of political corruption and pork barrel spending.
Last week, The Hill reported that Mr. Trump plans to propose a federal budget that cuts $10.5 trillion of spending over the next 10 years. Savings will come from sharp cuts in the Departments of Commerce, Energy, Transportation, Justice, and State. Plans are also being drawn up to privatize the Corporation for Public Broadcasting and to eliminate the National Endowment for the Arts and National Endowment for the Humanities. This plan will undoubtedly unleash a firestorm of criticism from all of the parties whose ox would be gored by the cuts, but the U.S. government wastes unspeakable amounts of money every year and needs to be cut drastically. Some of these cuts no doubt will be used to rebuild the depleted U.S. military, but unless the country gets spending under control, it is going to borrow itself into oblivion. Hopefully the private sector can assume responsibility for funding cultural activities and other important that suffer budget cuts, but it appears that a businessman's sharp pencil is coming to the federal budget (something that is long overdue).
There is now between $50 trillion and $60 trillion of public and private sector debt in the United States. That means that every 100 basis point (1%) increase in interest rates raises interest expense by $500 billion to $600 billion. When Mr. Trump said during the campaign that if rates were to increase to 5% or 6% (he was speaking of the Treasury curve, I believe), "we wouldn't have a country," he knew exactly what he was talking about. There is no way interest rates can rise much higher from current levels without creating a severe recession or a financial crisis. This is why I don't think we will see the 10-year Treasury yield reach more than 3.25% before it slows growth and hits a wall. Rising rates pose a direct threat to the economic future of the United States. Cutting spending is essential to restoring budget discipline, particularly in entitlement programs.
But cutting $1 trillion a year from government spending is not a free lunch. It will reduce economic growth and cost jobs unless it is countered with pro-growth tax cuts and regulatory cuts. Spending cuts must be part of a comprehensive and radical program to reset the federal budget and tax regime, but they are likely to give markets the jitters. We didn't hear much about cutting the budget during the election from either presidential candidate so this is not something for which markets are prepared. Investors should expect higher market volatility when these cuts are announced. Budget cuts will impact many individual companies differently, another reason that Mr. Trump's presidency offers active managers a chance to redeem themselves after eight years of passive investing ascendancy. We are entering a stock picker's market.
I've discussed some of the sectors that will likely be impacted by Trump's policy changes here. We'll be looking in-depth at specific companies within each of these sectors as time goes on, but to start with, you should consider a long position or two in the defense industry – for instance, Raytheon Co. (NYSE: RTN).
The first 100 days of the Trump presidency are going to set a new course for the American economy. Markets dislike change. Despite the fact that stocks celebrated Mr. Trump's victory, they are unlikely to keep rising in a straight line as he rewrites the rules of government after rewriting the rules of politics.
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.