President Donald Trump, and the Return of the Orange Swan
The Trump presidential victory, The Orange Swan, has been consistently underestimated by the establishment, press, the polls and the popular consensus.
Few believed Trump could win the Republican nomination.
There was a universal view that Trump could not win the election.
Many still believe, especially after the past weekend, that his controversial agenda has little or a reduced chance to be as transformative as initially espoused in his campaign. Indeed, the president already has backed down on many of the more radical campaign issues.
And, from the night of Trump's election victory, many failed to recognize that the markets would explode to the upside.
Based on the election results, more than half of the U.S. population believed Trump was on the wrong track and something less than half felt that the Republican presidential candidate was a man of action who would keep to his campaign promises.
Regardless of one's view, politics could play a significant role in market psychology over the balance of 2017.
Risk Is Underpriced
The big question is whether the ratchet-up in extreme market optimism readings will be justified by future events at a time when valuations are historically high, the bull market is nearly eight years old (and extended), a debt-heavy world increasingly is vulnerable to rising interest rates and it is unclear when -- or even if -- new policies will be implemented.
My view continues to be that Donald Trump will make volatility and uncertainty great again.
Like with Ronald Reagan's first administration, between the election win and inauguration there was an almost 10% gain in the indices.
It is important to highlight that the recent market advance is occurring at a time when U.S. and global financial conditions are tightening and policy uncertainties are heightened, as seen in the charts below.
I suspect the honeymoon is about over and reality will set in shortly, and I am positioned with a large net short exposure in my portfolio.
Although uncertainty has been ignored by most market participants, the Trump ascendancy comes with a lot of unknowns. A nationalistic and protectionism-based pro-business policy aimed at accelerating the rate of domestic economic growth through less regulation, cash repatriation of overseas profits and lower statutory corporate tax rates also is associated with the likelihood of higher interest rates in a debt-heavy world and the rising possibility of trade and foreign policy wars.
Uncertainty's brother is volatility, who is likely to appear more often in 2017. Risk is a close cousin to uncertainty and volatility, and he also appears to be gaining a larger role this year.
From my perch, the gap between economic reality and expectations rarely has been wider. Above all, the markets are now inattentive to the ideological, logistical and fiscal constraints that represent practical headwinds to the implementation of the administration's proposed initiatives.
As I noted in "Beware the Trumpian Spring Training Illusion," the election of President Trump occurred because people wanted change, from not only from the Democratic Obama administration but from that of the Bush administration and its Republican predecessors.
Change may be what we get, but we might be careful of what we wish for.
My core concerns and current unknowns:
An Untested President Trump. His ability to understand, study and execute/implement far-reaching, complex and cohesive policy remains in question, particularly as evidenced by decisions made during the first 10 days of his administration.
Will the President Really Come to the Rescue of the Middle Class and Fulfill His Campaign Promises? It is unclear to me that repatriation and a lower corporate tax rate will "trickle down" to the Average Joe, just as monetary policy failed over the last seven years.
Will the Trump Administration End Up Being Elitist?At least that could be an early observation based on the Cabinet appointees, who are principally wealthy individuals who are not representative of our broader society.
Animal Spirits vs. Human Spirits
The newest narrative is that animal spirits have propelled the markets higher. Risk and uncertainties have been ignored, and so have most valuation metrics, including CAPE, market capitalization to GDP, price/earnings multiples relative to GAAP and non-GAAP, the wide disparity between GAAP and non-GAAP earnings and other traditional and extended metrics.
But, as I have cautioned, it's called animal spirits rather than human spirits because animals are a lot dumber than humans.
I remain skeptical that the current rising optimism will be justified by events in the future, whether those events are policy (in timing or magnitude), political (I expect growing animus among and between both parties), economic and/or related to U.S. corporate profit growth.