Playing the long game

Bottom Line

It’s been a brutal month for equity investors, as growing recession fears due an escalating trade war have driven stocks from record highs into correction territory. After a powerful 20% rally from August 5 to February 19, the S&P 500 has given half of those gains back, plunging more than 10% over the past four weeks through yesterday. The Russell 2000 small-cap index and the tech-heavy Nasdaq composite have been even worse performers, plummeting nearly 20% and 14%, respectively, from their recent peaks. 

We’ve been expecting a pullback in stocks back down to the 200-day moving average, to reduce the froth created by the dramatic outperformance of the Mag 7 compared with the Forgotten 493 over the past two years. Stocks now appear to be oversold. Importantly, we have a fundamentally bullish longer-term view of the US economy, believing that near-term economic volatility will be replaced with stronger growth in 2026 and beyond, as President Trump’s fiscal policy plans begin to bear fruit.

Consequently, Treasury Secretary Scott Bessent has been hitting the road hard of late, conducting lengthy broadcast interviews on Bloomberg and CNBC, and keynoting the Economic Club of New York, which sandwiched Trump’s State of the Union address last week before Congress and a national television audience. Their message is that the use of reciprocal tariffs as a negotiating weapon is part of a holistic economic approach to reduce inflation, strengthen economic growth and shrink the federal debt and deficit.

Repurposing Abe’s Three Arrows Bessent is a huge fan of former prime minister Shinzo Abe, who returned to power in 2012 with a three-pronged plan, dubbed “Abenomics and the Three Arrows,” to revitalize a moribund Japanese economy. Abe’s triple-barrel approach included: bold monetary policy easing by the Bank of Japan; flexible fiscal stimulus through government spending; and a growth strategy from structural reforms that encouraged private-sector investment.

Bessent’s aspirational “3-3-3" plan calls for generating sustainable trendline GDP growth of 3% or higher each year; producing an additional three million barrels of oil or its natural-gas equivalent daily; and reducing the federal budget deficit from 7% now to 3% of GDP by 2028. 

Why is Trump waging a trade war? Our trade deficit in goods hit a record $1.2 trillion in 2024. China accounted for nearly a quarter of that deficit and Mexico had the second most at more than 14%. The goods trade balance deficit for January 2025 rose by 34% m/m to $131.4 billion, driven by a 10% increase in imports of $401.2 billion, both of which are record highs. At this pace, our goods trade deficit would annualize to nearly $1.6 trillion in 2025. To be sure, many US companies have been importing more goods than usual over the past several months (relative to exports), to boost inventories before prices may rise.

With chained-dollar GDP in the fourth quarter of 2024 at $23.5 trillion, a trade deficit of $1.2 trillion last year cost us about 0.5 percentage points in potential GDP growth. What’s causing this trade deficit? Every country is different, but generally it’s some combination of currency manipulation to make currency cheaper and exports more attractive; unfairly subsidizing industries, so they can dump goods into the US market at a lower-than-market price; wage suppression of their workers, to lower the cost of goods; and tariffs levied on US imports, to make their own products cheaper.

All of this is like waiving a red flag in front of a charging bull for the Trump administration, which has threatened to increase tariffs to level the playing field, raise additional revenue, encourage more onshoring and extract more favorable terms and non-economic concessions from our trade partners abroad.

No fear But isn’t the Trump administration concerned a trade war could encourage foreign companies to bypass the US market? Little chance of that, in our view. And, with 341 million residents, the US comprises 4% of the world’s population but 25% of the world’s GDP. It would be financial suicide for countries not to trade with us. In Trumpian “Art of the Deal” hyperbole, we think the US is holding all the cards. Now he is just negotiating terms. 

Three-dimensional chess In our view, all of these issues—including Bessent’s 3-3-3 plan—are interrelated, which suggests that the Trump administration may be playing three-dimensional chess, while the rest of the world is playing 52-card pickup. 

Circling back to Bessent’s 3-3-3 goals:

1. Generating sustainable trendline GDP growth of 3% or higher each year If Trump can successfully neutralize our current balance of trade deficit, that has the potential to increase GDP 0.5% annually.
2. Producing an additional three million barrels of oil or its natural-gas equivalent daily Trump has vowed to reduce Biden-era regulations by 90%, which could reduce inflation, increase economic growth and increase energy exploration and production. More energy on the marketplace could further reduce oil and natural gas prices and drive inflation lower, and exporting some of that energy to our major trading partners might increase exports, thus boosting GDP further. If our trading partners can purchase their energy from us instead of Russia and Iran, that will reduce those countries’ energy-related profits, which they have been using to fund their war efforts against Ukraine and Israel, respectively. That could introduce a massive global peace dividend, which would have favorable economic implications.
3. Reducing the federal budget deficit from 7% to 3% of GDP by 2028 Federal tax revenues as a percentage of GDP are sitting right on their long-term average of 17%, so we don’t have a revenue problem. But we do have a massive spending problem, as federal spending spiked unnecessarily at 35% as a percentage of GDP in 2021, though it has declined to 24% currently. So, the US is running a 7% budget deficit at present, and Bessent’s plan is to rationalize spending back to its long-term average of 20% over the next four years. DOGE will likely assist in this effort to corral spending. That will help to reduce the record $36 trillion we now have in federal debt and the $1 trillion we spent last year servicing that debt. 

Connect with Phil on LinkedIn