I'm (stock market) confused

The recent big rally has me wondering if I'm thinking about this wrong

About a week before President Trump began his trade wars by attacking our friends in Mexico and Canada, I called the guy who handles my retirement accounts and told him to sell a fairly large percentage of my stock holdings.

My theory was simple and hadn’t changed since before the election: Trump would impose tariffs, and not just small ones. It wasn’t a difficult prediction — Trump had been saying not just for months or even for years but for decades that he liked tariffs and saw trade as America getting “ripped off.” (I think that’s a ridiculous view but today I’m not going to debate the economics of it all.)

I was so convinced of this that for the first time in nearly 15 years on the radio I told my listeners that I was selling stocks. That said, my listeners know that my background is as a short-term trader not an investor so I almost never try to make market calls like this and historically I’m much better at picking spots to sell than to buy. (I only have this sort of opinion once or twice a decade…even when I was trading for a living, as an options market-maker my trading was more about volatility and the size of market moves rather than the direction of those moves.)

As you know the market plunged shortly after Trump made that announcement. It rallied briefly and I sold more. Then about 2 weeks ago I sold more. The market went down at first after that last sale but has rallied in a straight line for over a week since then. So I’m up money on the first two sales and down on the last. But the point of this note isn’t about the trades themselves. It’s about this recent rally.

I just don’t understand it. And when I don’t understand something, I don’t assume that I must be right. I can definitely be wrong and have been plenty of times in the past as anyone who has been a financial markets professional has been. (If you’re good at trading you can make a good living even being wrong much of the time.)

I note that the recent US gov’t jobs report was a little better than expected and it covered the first part of the time that the trade wars were kicking off in earnest. On the other hand, consumer sentiment has plunged to multi-decade lows. And, like the three-handed economist, on the other other hand, there’s some evidence that consumer sentiment surveys have turned into measures of political partisanship: after Trump won the election, Republicans’ consumer sentiment surged and Democrats’ sentiment plunged even though really nothing happened that should have changed that number very much. Indeed, the partisan difference between how Dems and Republicans feel about the economy has never been higher. (See chart number three in this great note by

Bruce Mehlman

.)

Six-Chart Sunday – Where You Sit Is Where You Stand

My thinking has been that trade wars are extremely destabilizing to the global economy (and to global politics) and that starting them is not like turning on a light switch that you can just turn off if you change your mind (not that I expect Trump to change his mind on the overall concept even if he might tinker with the implementation.) It’s not even like a dimmer, that you can control easily and smoothly. Rather, it’s like throwing sand into the gears of a machine: even if you stop throwing sand in, the gears are going to move slower and might even stop. Even if you try to clean out the sand you threw in the gears, you’ll always miss some and it can take a heck of a long time for operations to get back to normal.

I share this gentleman’s viewpoint, but at least for the last week the market is pointing to “maybe you’re missing something”: Ted Oakley: 'They're Giving You Another Chance to Get Liquidity. You Should Take It'

So, with that as the context, what could the recent rally represent?

• Short-covering after a very aggressive sell-off

• “The public” buying as “the pros” are selling, as particular groups of individual investors (see the commentary about “boomers” in the video linked above) who, despite a couple of very ugly periods like 2000-2002 and most of 2008, believe that the stock market always recovers and therefore is always a good buy.

• And the most interesting case: I am overestimating either Trump’s commitment to trade wars and/or the impact of the sand already thrown into the gears of the US and world economies.

And what’s the right response to those bullet points, in the same order?

• If it’s just short-covering, this is likely a good short-term selling opportunity

• If it’s “dumb money” buying because “the market always recovers”, this could be a strategic mid-term or long-term selling opportunity. For example, if you bought stocks (as measured by the S&P 500) from mid-1967 through mid-1969, you didn’t get back to even until roughly 1991. (That does not include your gains from dividends during that time, but also does not include your forgone gains from not earning interest on your money.) If you bought the S&P from mid-1999 to mid-2000, you weren’t back to even for about 15 years. If you could have doubled your money by just earning interest over a period of time where you gain nothing in stocks, even though the market rallies later, that’s a massive real loss for the investor. The idea that “the market always comes back” is not true in a way that actually matters. Sure, it OFTEN comes back quickly, and surely has in recent years. But recent years shouldn’t be our only guide.

• Every time I hear Trump talk about trade in recent weeks, even if it’s offering an “exception” (that he later says isn’t an exception) to a tariff or talks about his Treasury Secretary negotiating with “over 200 countries” even though there are fewer than 200 countries in the world, he reiterates his commitment to a long-debunked mercantilist economic policy that is not just incompatible with, but actively harmful to, this global economy that America is dependent on, whether folks of certain political viewpoints believe it or not.
  
  But what if the Trump supporters are right that it’s really all a negotiating tactic and 5-D chess? (Used to be 4-D chess, but I guess Trump got 1-D smarter recently according to his fans.) What if he’ll back off all but some very low level of tariffs and the global economy will be a little worse but not too much worse, and here in the US some (or a lot) is offset by gains from better trade deals so that the US exports more than it was prior to all this and gains from some level (it won’t be what Trump hopes but it could be a measurable amount) of increased manufacturing in the US?
  
  And what if Trump supporters are right that foreign manufacturers will absorb much of the cost of tariffs so that final prices to American buyers will only be slightly higher than pre-tariff? And what if tariff revenue really is a measurable offset to the federal deficit and yet does not slow the economy?
  
  And what if Trump policy can spur American manufacturing without causing, or relying on, higher prices for customers?

I’m in a quandary here. I think my analysis is right that what Trump has already done is going to hurt almost the whole world including American corporate earnings. The degree of that will be related to how insistent Trump is on imposing tariffs and at what level. And, to the extent that trade with China is particularly disrupted, how soon will American consumers and businesses (don’t forget about intermediate goods that American companies import in order to make things here!) be able to find affordable sources elsewhere, which will likely involve building factories elsewhere which can’t be done overnight? I think that my “what if” scenarios about how this could all work out well are maybe 10% probability outcomes.

I mean, consider that Trump wants an increase in American manufacturing caused by tariffs which can only happen by raising the prices of imported goods dramatically, but he also doesn’t want to be responsible for higher prices. His tariff policy is internally inconsistent in multiple ways, it seems to me. But what if I’m wrong?

One more thing: Our federal deficit and debt are immoral, irresponsible, and unsustainable. I’m grateful to Trump and DOGE for highlighting that and looking for cost savings and for shrinking the size and intrusiveness and cost and head-count of government. But, as with the (probably apocryphal) Willie Sutton answer to “Why do you rob banks?” — Answer: “Because that’s where the money is”, the driver of American national insolvency is entitlements, particularly Medicare and Social Security. And we have a Republican president who has campaigned against reforming them. He is grousing about possible modest reforms to Medicaid.

As President Nixon’s economic advisor Herb Stein (father of actor Ben Stein) noted, “if something cannot go on forever, it will stop.” Our current situation cannot go on forever. What will it mean for the economy and markets when it stops, and for how long can American governments go on kicking that can down the road? After all, this has been a known problem for a long time but the market hasn’t cared at all. Will it ever? If so, when? (To be clear, the answer to this is so uncertain that one can’t trade on it but it’s something I wonder about.)

As far as today’s economic issues, especially trade, and markets, what do you think I’m missing?

As it stands, I’ll probably sell a little more this week and, for the sake of the country I’ll have to hope I’m proven wrong.