The Great Unwinding has begun. Get ready to see the entire "Trump rally" reversed.
This is a rally that has been totally built on expectation. Also, remember that a lot of people who have been buying the market were the same people who were deathly afraid of a Trump victory. They sold stocks in the months before the election. On the night of the election when it looked like he was pulling ahead in some of the swing states, they sold Dow futures down 800 points. I remember, because I was long and thinking this is insanity.
But since election night, the entire rally has been built on expectation. Expectation of "big, big" tax cuts and a giant infrastructure spending program. It's been almost five months since the election and two months since the inauguration and nothing.
Meanwhile, the economy is slowing. GDP grew 3.5% in the third quarter of last year, followed by 1.9% in the fourth quarter and now estimated at 0.9% this quarter. Credit growth is collapsing. Gasoline demand is at recession levels. Fiscal flows (government spending) are flat year over year. Yet stocks have risen to historic highs in an almost parabolic fashion and valuations are extremely stretched. Institutional asset managers -- a group that year in and year out fails to beat the market averages -- are massively long stock index futures.
Does all that sound bullish to you?
When Trump started choosing his economic team, I told you right away that it didn't look good. A bunch of fiscal and deficit hawks, with the biggest being his budget director, Mick Mulvaney. No surprise, then, that we saw a budget proposal last week that had historic levels of spending cuts on domestic programs. From what I could tell given the percentages of the cuts intended for Education, EPA, Health and Human Services and many other agencies, these would far offset the $54 billion spending increase for the military. Bottom line: The budget is bearish.
Now we are seeing some reflection creep back in. Some reality, I should say. Stocks have gotten way ahead of themselves. The Obamacare repeal and replace effort is not going well and it is starting to make other Trump proposals suspect. Yesterday, there was a suggestion the tax cuts may be in jeopardy if the new health care bill is not passed. That triggered the biggest one-day decline since the election.
I am calling this the Great Unwinding. We are going to see an unwinding of the market rally that has occurred since the election, a rally that has been based on nothing. I shouldn't even say based on nothing because there was something: The economy was weakening the whole time.
I think we will undo the entire rally. That puts the S&P around 2140. Who knows, maybe even lower. Maybe the people who sold on the night of Nov. 8 will be vindicated. With the spending cuts in the new budget, it could easily push the economy into recession. Then the question is, what will the White House's response be? The Trump team is comprised of a bunch of fiscal hawks. They are not going to say, "Hey, we need up to ramp up spending, 'bigly.'" Instead they'll probably feel the debt needs to be cut. This is what I would call the "Europe solution." It's a recipe for endless recession. To use Trump's own words, it would be a disaster.
Sorry to be such a downer, but when I see a policy team like this, so many of whom are out of paradigm, lacking in understanding and so deeply mired in misguided debt fear, then I don't hold out a lot of hope.
Admittedly, a lot can play out from here. Maybe an "un-advised" Trump will understand, intrinsically, that a downturn will need big fiscal stimulus and he will make that happen over the objections of his team and the fiscal hawks in Congress led by Paul Ryan. However, that remains to be seen. For now, we sit back and watch. At some point there could be a setup for a great buying opportunity, but the policy response has to be the right one.
The Great Unwinding has begun. We're in for a helluva four years.