Policy Game Time

James Juliano Insights

Government economic policies are the driving force behind asset returns, and there are stark policy differences between the two U.S. presidential candidates this year.  The American electorate will soon vote its best interest and, in doing so, will elect a new president and Congress.  The investment ramifications of the resultant policy shifts are enormous.  It’s game time for policy.

Hillary Clinton is promising a set of government economic policies that are weak Dollar and highly economically contractionary via tax increases and regulatory wedge expansions.  Donald Trump is promising a set of policies that are strong Dollar and economically expansionary via lower marginal tax rates and decreased regulatory burden.  Further, Trump is the only candidate touching the arena of monetary policy.  He’s been highly critical of the Fed’s monetary policy actions and methods, and he is supportive of solutions like rules based monetary policy.

One of the main differences between the two candidates’ policy proposals is the role of federal government.  If Hillary is elected the size of government relative to GDP will certainly increase.  If Trump is elected private sector growth will expand, and the size of government relative to GDP will shrink.

Personalities in this year’s election make the outcome appear uncertain. Trump is loathed for his brash talk about women.  Hillary is deeply mistrusted for her involvement in multiple scandals.  At present there are several separate FBI investigations involving Hillary Clinton, with the most recent being the announcement of investigations into the Clinton Foundation.

While there is much to personally dislike about both candidates, their policy menus are crystal clear.  That is why we continue to believe, as we first laid out to RTW members in June 2016, that Donald Trump will win the election in a surprise landslide.  In RTW 6/13/16 titled Surprise Landslide we wrote,

“The U.S. has many political and economic problems.  These, however, are both self-inflicted and remediable.  We believe the American people will self-impose a remedy in this year’s presidential election.

It’s our view that there is really only one critical issued confronting American voters – economic security.  The economy is in far worse shape than raw data or politicians admit.  Voters, however, are aware of their economic anxiety, and they should be.

We had a conference call last week with Art Laffer, the father of supply side economics and one of Ronald Reagan’s top economic advisors.  We will share some of his excellent data about how and why this November’s election will be a game changer.  We completely agree with Laffer’s interpretation that when economic growth and prosperity get this bad, a change in White House leadership follows.  People take a chance on prosperity.

One jarring measure of our economic woe is Real Non-Defense GDP per Adult.  This measure of our economic performance is at the lowest level in almost sixty years.

As Laffer points out, “Even when a president’s term ends on a high note, as was the case with Presidents Kennedy, Reagan and Clinton, it is a challenge for the incumbent party to maintain the White House.  Thus, given that GDP per adult as a measure of our country’s economic performance has ended on very low notes for Obama, “W” Bush and Bush Sr., it is clear that the economy is shouting for a party change.  This does not bode well for the Democratic Party, which continues to endorse the current status quo.”

In the chart below we have highlighted in yellow the consistency with which this measure of prosperity has fallen during a president’s term and led to a presidential party change.


The current sub 2% level happened because government economic policy “wedges” interfering with productive activity have dramatically increased since 2000.  As Scott Grannis has repeatedly shown over the years, one measure of the cost of these failed policies is a $3 trillion gap. As Scott says, “This is the measure of the country’s discontent: $3 trillion in missing income.”


One of the most harmful government policies has been monetary policy.  Artificially low or negative interest rates do not permit the economy to operate correctly.  They misallocate credit and capital in the banking system and destroy the time value of money resulting in less savings and investment.  With investment impaired, our economic capacity for trial and error, experiments, learning and growth has also been corrupted.

The very good news is we have been here before in the 1920s, late 30s, 60s, and 80s.  Some of us are old enough to still remember how those prior catastrophes ended in precisely the same way – a policy regime change to restore currency stability, reduce marginal tax rates and decrease other regulatory and trade wedges that impair economic activity.

Can the middle class afford four more years of no growth, more redistribution and expansion of government?  If so, they will vote for Hillary Clinton running on an economic platform that is a continuation or expansion of many failed Obama and Bush II policies.

But if voters are fed up with economic stagnation and act as the data above show they do during previous “transitions,” Donald Trump is the likely winner.

Trump is clearly the candidate of growth and not redistribution.  He does believe America can be prosperous again, and soon. He is the only remaining candidate with anything resembling a pro-growth economic policy agenda and the only candidate talking about pro-growth ideas like: Lower and less progressive marginal tax rates, elimination of AMT, elimination of death tax, and massive cut in corporate income tax rate (from 35% to 15%).  He is also the only remaining candidate that could reform the Federal Reserve and our monetary system, returning the U.S. Dollar status to “good as gold.”

No candidate is perfect, and Trump needs to deliver on all the pro-growth ideas he promotes.  But we believe voters will not choose four more years of guaranteed economic stagnation from the same set of failed policies Clinton promises to extend.  Instead, we think voters will take a chance on prosperity through a party change. If the presidential primaries are any indicator, and we agree with Laffer that they are, then voters are already revolting.

Laffer shows, “Using only states with party primaries, i.e. not state caucuses, and only party primaries up to the time when Donald Trump became the presumptive Republican presidential nominee, which was following the May 3rd Indiana primary, there has been a large increase in voter turnout for the Republicans in 2016 when compared to either 2008 or 2012.  In fact, in the 29 state primaries through May 3rd, the total number of Republicans who actually voted in those primaries has increased by 55.1% over 2008 and 66.6% over 2012… But, the situation is worse for Democrats.  When juxtaposed to the Democratic turnout in 2008 and 2016, the 2016 Republican turnout looks even stronger.  Remember, the 2012 Democratic primary was a non-event because President Obama, then a sitting President, was running for nomination essentially uncontested.  We therefore focus exclusively on the change from the 2008 to the 2016 Democratic Party turnout, which, using the same states, is down in total by 22%.  On a state-by-state comparison, Republican turnout is way up, and Democratic turnout is way down.  Someone should ring the Democratic alarm bell.”

The stage is set for what we have been calling the “Death of Liberalism.” As we wrote in early December (RTW 12/7/15 – Death of Liberalism), “A death of liberalism would certainly be associated with a shift in policy to promote, rather than retard, economic growth.  It would strengthen the private sector relative to government as it did in the 1980s-90s. It would expand government revenues while lowering them as a percentage of GDP.  Can it happen?  A better question is, “Can it happen again?  And if so who are this cycles Jack Kemp, Ronald Reagan and Art Laffer? Remember, Jack Kemp went from a backbencher in an unimportant Congressional district to the leader of the supply side revolution. His tax cut bill was defeated six times over several years before a weakened version called the Kemp-Roth Tax Cut was passed on a seventh try.  Clearly, Kemp didn’t take no for an answer.  We don’t know future policies.  Markets also seem to be uncertain although leaning towards a policy improvement.  The key is that policy matters.  Watch policy. In an informed democracy it is the people that ultimately determine the policy menu. Perhaps with a lag, but the people eventually catch on and catch up.”

It appears we now have a presidential candidate in Donald Trump who is willing to attempt carrying the pro-growth economic policy torch.  Primary voters responded in approval of his policy ideas, and we believe the result will be a surprising landslide victory for Trump in November.  A bigger surprise than the election landslide itself would be the unleashing of a U.S. equity bull market and popping of a U.S. government bond bubble that would follow.”

Now five months later we believe the case for a Trump economic policy victory has strengthened in recent months beyond what we wrote in June.  Importantly, many market based “Footprints of Policy” agree.  In fact, some “Footprints” have been signaling that a Trump win isn’t a surprise at all.  Since July there has been a wide divergence in asset prices that do well under a Trump policy set versus a Hillary policy set.

At the asset class level gold priced in Dollars is down 6% since its July high meaning demand for Dollars has been stronger than supply.  Dollar strength is associated with pro-growth economic policies.  Long term Treasury bonds are down 8% since their July highs.  Bonds are a safe haven asset class, and weak bond prices signal better than expected growth policies ahead.  Stocks are up between 1.9% for large caps and 3.6% for small caps since July 1, 2016, the week gold and Treasury bonds peaked.  Equities in general do better when economic growth improves, and small caps are more levered to domestic economic activity.  So three major asset classes (gold, bonds, equities) expect better economic growth ahead, and only Trump’s policy agenda has pro-growth components.

At the industry level the case for a Trump victory is even more pronounced.  Coal stocks are up 43% since July 1, 2016 and have doubled year to date.  Both candidates have been clear about their intentions for the coal industry.  Trump is promising to put coal miners and companies back to work, while Hillary is promising to further attack both.

Similar pro Trump footprints are seen at the sector level.  Healthcare is down 9% year to date and is the worst performing sector this year.  Weak healthcare stocks may signal a Trump victory because Trump is promising to end Obamacare and, therefore, end many of the free money monopoly rents being enjoyed by companies in the space.  In just the past few weeks the healthcare ETF has plunged 5% as Hillary scandals escalated.

These assets, or really the human investors moving capital in and out of these assets, have been factoring a Trump policy set since at least summer 2016.  The election will no doubt impact the government policy “wedge,” and the regulatory policy environment post-election will seriously impact the healthcare, energy and finance sectors.

Political betting markets predict a 69% chance Hillary wins.  These odds are down from 90% just a few weeks ago.  A 69% chance in betting markets seems solid, but as Brexit proved, betting markets do have inherent flaws.  As late as the day of the Brexit vote betting markets were pricing in an 85% chance of the “Remain” vote winning. We all know what happened; the “Leave” vote won.  Betting markets got it wrong because they did not account for the fact that while large money amounts were being wagered on “Remain,” a dramatically higher number of small money wagers were placed on “Leave.”  A similar pattern is emerging in the U.S. presidential betting markets where over 65% of bets recently placed are for Trump.

We agree with consensus that the Republicans will retain the House of Representatives.  However, we disagree with current consensus that the Senate may flip to the Democrats.  We believe that the presidential candidate with the most momentum going into Election Day will swing key Senate races towards their party.  Thus, we think Trump’s momentum and eventual victory will cause the Senate to remain in Republican control.

We understand that our prediction of Trump winning in a surprise landslide (30+ electoral votes) and the Republicans keeping control of both the House and Senate goes against the polling and mainstream expert opinion.  But we believe the pro-growth versus anti-growth economic policy differences are so vast that voters will easily choose growth.  In our view that decision becomes even easier as Hillary is revealed to be involved in more trust killing and possibly criminal behavior on an almost daily basis.

Now that you have our political predictions, it’s important to know that political predictions don’t equate to investment actions.  In fact, we moved U.S. equities from green to yellow in our subscriber “Allocator” model last week ahead of Election day simply because policy uncertainty is so high.  Nothing is black and white.  In the short term it’s not as simple as he wins buy this or she wins sell that.

For example, if Trump surprises and wins with Congressional majority will he follow through on his pro-growth tax, regulatory and monetary policy plans or will he get bogged down in dangerously protectionist trade policy ideas?  Trump deeply misunderstands how trade works by missing that trade happens between individuals, not countries.  His protectionism could result in disastrous anti-growth economic policies.

If Hillary wins and the Democrats take control of the Senate will they ram through growth killing tax hikes or will they cut a deal with house Republicans?  Our friends at Bretton Woods Research have introduced the scenario where a Hillary administration and Democrat controlled Senate make a deal with a Republican controlled House on an infrastructure spending package tied to corporate tax reform.  No one is talking about this kind of pro-growth policy deal under a Clinton administration, but it could happen.

Throw a potential constitutional crisis in the mix with these policy uncertainties under either candidate, and we think the prudent move is to take most U.S. stock sectors out of the “green zone.”  Look to protect capital ahead of the election.

Bottom line: We predict Donald Trump will be the next U.S. president and Republicans will retain control of the Senate and House.  Once one has the pro-growth framework, as Trump clearly has with taxes and regulations, then it becomes easier to fit the other pro-growth puzzle pieces in like sound money, reduced government spending and free trade.  There is policy hope for Trump that he can listen to correct advice from the likes of Art Laffer, Steven Moore, David Malpass and John Tamny about monetary and trade policies he misunderstands.  Hillary, on the other hand, gives us no sense of hope that she understands or wants any sort of pro growth policies in any domain (tax, trade, monetary or regulatory).  So voters must take a chance, and we believe they will take a chance on prosperity. Ultimately, Congress should reign in the extremes of either candidate. What bothers us about Hillary is her entire platform if extremely anti-growth.  Trump at least has some pro-growth substance to build upon. He needs help to get there.  We think he wins, gets that help and listens.

But predictions, especially political ones, are most useful for bar bets.  For investors allocating capital we urge extreme caution and risk reduction ahead of the election.  It is prudent to wait until the policy set becomes clear to risk capital.  When all is said and done on November 8, the policy map for months and years ahead will have become easier to read.  If voters this election cycle choose the pro-growth policy platform and Trump delivers those policies while avoiding protectionism then a new U.S. equity bull market lies ahead that could result in 30% plus equity market gains in the next year and a doubling of equity markets in the next 3-5 years.  The Dollar would surge, sending gold and many commodity prices down significantly.  The bond bubble would finally burst as real growth rates accelerate and force the Fed to raise interest rates to keep up with economic growth.  Oppositely, if voters choose the anti-growth policy platform and Hillary delivers her growth killing promises without making a tax deal then expect at least four years of negative real returns for U.S. equities.  Commodity and bond prices will do well, but all asset classes will be left at the mercy of errant monetary policy in a world where pro-growth fiscal reform doesn’t exist.

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