Strapped to the mast

Well, that was a heck of an Inauguration Day, now followed by the famous Davos World Economic Forum! There is excitement in the air, and the tone of the president’s speech on Monday was optimistic, for sure. Even European leaders seem to be falling in line with the Trump’s agenda, or at least not resisting it so blatantly, as they did in 2016. As regular readers of this space know, we’ve been positive on his growth agenda for some time. Bears focused on a “checkers” interpretation of some of his early chess moves, such as tariff threats and deportation of illegal immigrants, declaring these moves, per their Economics 101 textbooks, as “inflationary.” Although the first-order effects of each of these policy actions might be, we think the bears ignore to their peril the longer-term positive outcomes and are sticking with our above-consensus S&P 500 forecast of 7,000 and 7,500 for 2025 and 2026, respectively. If tariff threats result in greater US production at home, that adds to economic growth. If illegal immigration in waves is replaced with legal immigration in controlled fashion, that could produce a bigger and stronger workforce paying taxes and cut government outlays for social services. Lower taxes and lower regulatory costs, on the other hand, should produce lower costs across the economy and, as such, should be deflationary not inflationary. Ditto increased energy production, and even the rumored plan to dump a pile of government real estate on the market (cutting rental costs).

All this said, our analysis of the "baker's dozen” of risks ahead, suggests that, with the market so pumped up for all things Trump, some near-term rocks could be out there that could lead to some volatility ahead. To summarize those rocks ahead that are most top of mind:

1. Ugly sausage making process now ahead. While the President can implement quickly parts of his supply-side agenda, he needs Congress and federal agencies for other critical parts, especially tax cuts. In other areas, especially trade, he needs cooperation from other sovereign nations. A lot of this will be multi-party negotiations that often go down to the wire before being settled reasonably. We think this a big near-term risk for markets in the coming months, even though it’s likely to end well, eventually.
2. Earnings and guidance will matter. We are in the early stages of earnings season now and see two important risks. Ironically, the miss is not so likely to be in fourth-quarter profits, which we expect on balance to be solid and modestly better than expected. Rather, the risk could be on forward guidance. Big Tech’s numbers are decelerating, and hints of that won’t be taken favorably. And the old-economy stocks, where we expect the upside by year-end, might be reluctant to project too much of the positive, though uncertain, tax and regulatory environment into their guidance. This could be disappointing to short-term traders.
3. The Federal Reserve could keep pontificating from their Econ 101 playbook, unsettling markets. Several members seem unusually inclined to weigh in on parts of the president’s agenda. If these siren calls keep up, markets may overreact. Our own view is we’re not listening to the Fed’s procrastinations anymore; we think in the end they’ll be guided by outcomes, not their models.
4. Bond market vigilantes might also overreact. This market is also more short-term oriented, and with the Fed, could easily overreact to the sausage-making process upcoming. If bond yields cross 5%, that would be difficult for equity markets. We wouldn’t expect yields like this to last long, so we’ll be buyers with our cash if a correction develops due to a “Liz Truss” moment.

The upside risks to this market, on the other hand, tend to be longer term in nature and keep us positive on the outlook for equities, which, after all, are a call on the overall long-term trajectory of the global economy. To cite a few from our “baker’s dozen” memo:

1. “Tariff Chess” could work out better than anyone forecasts. Given the aggressive positions Trump has laid out, he could easily come home from his various forthcoming trade negotiations with, on balance, a package of more domestic production and inbound investment, greater US exports, cheaper energy and more (tariff) revenue for the US economy paid for in part by foreign partners. All this would be growth-enhancing by 2026, or at least 2027, which will be in sight by 2026.
2. Inflation could come down, not rise. We’ve made the case before that the balance of Trump’s policy agenda is deflationary, not inflationary. When you lower the costs of doing business in the US, those costs normally get passed through, at least in part, to consumer prices. And there are a whole lot of costs that are about to come down, maybe way down: energy, taxes and regulatory paperwork/approvals, to name a few. In addition, the year-over-year inflation numbers themselves are likely to decline, on our math, starting this spring.
3. Animal spirits could pick up. With all the new optimism in the air, and the positive “tone at the top” coming out of Washington, we expect the IPO /M&A market to really start to heat up. Please note that this “heating up” is not coming against a base set of numbers that is already high. Quite the opposite. We’ve just come through one of the biggest and longest bear markets for IPOs and M&A deals in our nation’s history, so there is a giant backlog of deals that have been waiting for better times. Those times now seem to be upon us. Bears beware: animal spirits are contagious. Once they get going, they can become a freight train.
4. Geopolitical risks could decline. No one seems to expect this, having just lived through four years of one mad crisis after another, but in the game of geopolitical chess, Trump has a lot of pieces to move and is pretty skilled at doing so. Already, he has engineered an unexpected ceasefire in the Mideast, with perhaps a more permanent solution to come. In Ukraine, both sides are running low on soldiers and arms; they might be more amenable to a deal than we think. Interesting that his first trip is to China. If the global backdrop improves (PS: it's coming from a low base), that would be growth-positive and probably deflationary to boot (e.g., lower commodity prices).

Fans of classical literature know well Homer’s story of Odysseus and the Sirens. The Sirens were beautiful fairies, whose songs were said to be so irresistible that sailors inevitably drove their ships right into the rocks beneath the place they’d sing from. Odysseus wanted to hear the sirens but not crash his ship, so he filled his sailors' ears with wax and then had them strap him to the mast. The sailors kept the ship on course through the dangerous strait, and he still got to enjoy the singing. Win-win.

So, to borrow a suggestion from Homer, we’re keeping the ship pointed straight ahead, maintaining our equities overweight, with a tilt toward the stocks that should work but haven’t fully yet in the “Trump trade”: value, financials, small caps and, OK, emerging markets. With our S&P targets of 7,000 and 7,500, respectively, for 2025 and 2026, we think there’s plenty of upside ahead, even if the path there may be rocky. In the meantime, we’re braced for volatility in the near term, as the balance of risks plays out, with money market cash on the sidelines if a buying opportunity emerges. We’re keeping our ears tuned for the siren calls that may be coming from both sides of the straits—the bulls and the bears. But we’re not going to lose focus on the prize.

We’re strapped to the mast.