Stocks gained yesterday on optimism that Trump’s pick for Treasury Boss will get the job done without too much collateral damage. The yield curve inverted as longer-maturity bond yields tumbled sending mixed signals and leaving traders nervously optimistic.
Which way is up? Last night, WHILE YOU SLEPT, President-elect Trump sent out a message on his Truth Social platform vowing to impose a 10% additional tariff on all Chinese imports and fresh 25% across-the-board tariffs on all exports from Mexico and Canada on January 20th, immediately after being sworn in. Talk about making good on campaign promises. In actuality, the tariffs he threatened have less to do with America First and more to do with the deadly Fentanyl that streams across the boarders into the US. Regardless, a tariff is a tariff, and all downsides apply.
When I saw the news, I thought that I would wake up to a capital markets mess. Yesterday, the most peculiar thing happened in the markets. I spent a good part of the weekend replying to press inquiries about the importance of Trump’s pick for Secretary of the Treasury. As I started my research on Friday morning, Trump had not yet announced his nomination of Scott Bessent. His pick was not really a surprise; Bessent was on a shortlist with two other Wall Street-bred candidates, with one being a likely candidate for Fed chair when Powell’s Chair appointment ends in 2026. That left just two. One, a debt finance wizard and another, known for being part of one of the biggest currency shorts in history.
Let me give you some context. The UK was struggling with high inflation in the early 1990s and was struggling to keep the British Pound Sterling stable within the European Exchange Rate Mechanism (ERM). George Soros, the famous hedge fund manager of his Quantum fund saw an opportunity to profit if the Pound collapsed. He proceeded to short the Pound in a position reportedly worth $10 billion. That is a lot for today, imagine what that was like in the early 1990s. His maneuver put so much pressure on the Pound that the UK Government could simply no longer maintain stability by buying its own currency in the open market. On September 16th, 1992, the UK Government relented and allowed the Pound to devalue and was forced to withdraw from the ERM. It became known as “Black Wednesday,” and Soros reportedly hauled in a $1 billion profit in just one day, earning him the infamous title of “the man who broke the Bank of England.” Great story, right? Well, if you read my note from yesterday, you would know that Scott Bessent was part of Soros’ team on Black Wednesday. SO, I would say that Bessent knows a thing or two about currencies and international economics. 😉 Bessent didn’t stop there, he went on to found his own global macro hedge fund in which he traded, amongst other things, currencies. Most recently, he reportedly made significant returns on selling foreign currencies and buying the dollar leading up to Trump’s victory. If you have been paying attention, you would know that he made some money on those trades. In any case, as global trade is a core part of Trump’s economic strategy, Bessent is, with his experience and pedigree of being part of one of the most infamous sovereign bank breaking affairs, a solid candidate to be Trump’s righthand finance man.
The markets liked Trump’s pick. Bessent is known to be a thoughtful operator, and many believe that he will help the Trump Administration achieve its strategic goals with a more measured approach. That doesn’t mean no tariffs, no sanctions, or no hard bargaining. Traders are hoping that Bessent will be able to smooth the extremes. That was the thesis behind why longer Treasury Note yields pulled back aggressively yesterday, and with it, the US Dollar. So extreme was the move that the 2-year/10-year yield curve inverted temporarily. That usually happens when traders are expecting a recession. That was not the case yesterday as the move in 10-year yields was a positive nod to Trump’s pick hopefully avoiding the now-built-in tumult expected with Trump’s trade policy. Yesterday’s big moves in the fixed income and currency markets are proof that the system works, but that doesn’t make things easy for investors.
As of last night’s close, traders went home thinking, OK, so maybe Bessent’s appointment (if confirmed) could be a good thing. Bond yields are lower, the Dow notched a new all-time high. “Maybe this time around, the Trump administration may be less heavy-handed than it was in 2018,” thought traders as they commuted home. And then came the social media message. The hammer. 🔨Those poor traders would awake to losses and mayhem… BUT THEY DIDN’T. I admit that I was a bit surprised at the markets’ apparently being unphased by the revelation. Treasury yields and the Dollar spiked after the news broke, but they quickly pulled back to where they were yesterday. So, meh, it turned out to be a big nothing burger.
Why am I bringing this up if it is a non-event? Because days like yesterday and today are going to become the new normal. Despite many ups and downs in the markets over the past 4 years, one can step back and make out some relatively straight forward trends with relatively low and decreasing volatility. That norm is likely to change into a regime of higher volatility and more systematic uncertainty. To be clear, you can’t just now go out and by VIX futures and hope to make Soros-like gains. The VIX is around 14.5 this morning which is considered low! The recent everything-but-bonds-and-healthcare rally in the wake of Trump’s election win was swift, but orderly. That makes it a challenge for investors. Much of the potential gains expected from the incoming administration have already been factored into the market. For example, did you think that big, diversified banks like JPMorgan Chase would thrive in a less-regulated Trump presidency, with more transactions and lower interest rates? That’s a good thesis. It is so good that JPM rose some 13% since the election. Do you want to know where the 29 blue-chip analysts who cover JPM expect the stock to go within the next 12 months? I’ll tell you, $236.67. The stock closed at $250.29 yesterday, 5.4% above its 12-month price target. I won’t even attempt to figure out why Tesla is now nearly 28% above its 12-month target. In either case, what is an investor supposed to do if they wish to put money in the market? It is quite a conundrum, isn't it?
If you get in now at these elevated levels with positive animal spirits running high, you risk getting stuck in the mean-reversion that could happen in late January when the music stops… and trade wars really begin. Well, let me calm you down. First of all, there are no guarantees of any trade wars, and second, as we learned last night, perhaps those trade wars have… wait for it… already been factored into the market. That brings us back to square one.
There are two types of risk: systematic risk, or market risk, and idiosyncratic risk, or company-based risk. Idiosyncratic risk can be mitigated through diversification and careful investment selection. You know this! Do your homework and diversify to minimize pain and increase your chances of attaining good results. Systematic risk is unfortunately difficult to minimize. However, history has proven that long-term, strategic, and non-reactive behavior enables us to effectively weather short-term market-based volatility. Did you sell in March 2020 or in 2022 when things got rough, only to sit on the sideline and watch markets come back? Sure there were days that you were happy with your decision, but if you look at where you would have been if you stuck to your strategy, only culling stocks that went down for the right reasons (due to company-specific challenges) and finding new ones that discovers and tapped new sources of income, you can see that, indeed, systematic risk can be mitigated. Please be patient and stay long-term focused. Rushing in or rushing out reactively almost never yields the preferred outcome.
YESTERDAY’S MARKETS
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