A Requiem of the 2016 Election and Market Reaction

by Victor Sperandeo with
the Curmudgeon

Disclaimer:  All analysis and opinions expressed herein are those of Victor Sperandeo.  The Curmudgeon decided to write-in Laurence Kotlikoff for President and endorsed him via Twitter and emails last Monday November 7th. 

Please see Sidebar below for Professor Kotlikoff’s emailed post-election comments. Definitely worth reading!

Background of the Trump Victory:                      

Hallelujah, this truly historic election is over!  That’s what most people would’ve yelled after this Tuesday night before the results were announced.  Others are now somber and/or protesting Trump’s victory.  I rather enjoyed the process and, on a relative basis, am happy about the outcome.

It must be emphasized that Donald Trump was not the critical driver of his election as President. In my view, VP Mike Pence would have won also!  The primary cause of the Trump's win was from people who felt betrayed when they learned that the GOP (Neo-Con) Establishment sells their votes to corporations for campaign contributions rather than represent them. Many Democrats felt the same. Therefore, they wanted an outsider perceived as an “agent of change.”

Consider Sam Johnson, GOP US House Representative for Texas 3rd district from 1991. He gets 98% of his campaign contributions from drug companies, but only 2% from his constituents! Who do you think he votes for?                                                                                                                           

The MARKETS Respond:                                                                                                                           

The equity markets were counseling that a Trump victory was bearish for the economy and stocks. Like the main street media, the elite powers that be talked bearish if Trump won. As head of the FBI James Comey fought the DoJ in what seemed like a World Wrestlers Federation show, the S&P 500 declined 9 days in a row, but it was only a mere -2.50% decline.

I believed the polls were very wrong on Trump, as many who were polled would not admit to a media stranger that they would vote for Trump.

As in the Brexit surprise vote, I believed Trump would win.  I priced the S&P 500 futures Dec 2110 puts with the S&P trading at 2138. The cost was $1575. Then I reasoned, what Trump is proposing would be good for the economy.  For example, huge tax cuts, deep reductions in government regulation, “grand infrastructure spending,” and a big defense spending increase. This was the Reagan policy approach that was very bullish in the 1980's. So, I passed on buying the puts.

On Wednesday morning (US time), Japan’s Asahi Shimbum reported “Finance officials discuss steps for market turmoil as Trump rises.”  I'm guessing the Japanese Central Bank intervened overnight to stop the Yen from appreciating.  I believe the Fed, ECB and BoE were also buying financial assets, as they always have.  In the early morning hours, almost no one trades and markets are very thin.  So, a few big buy orders can cause stock markets to reverse. Voila, a Trump victory was now "bullish?”

Thereby, the elite’s propaganda talk that a Trump win would be bearish has now become bullish.  As an example, Lloyd Blankfein, CEO of Goldman Sachs said on 11/10/16: "Trump's policies are asset friendly and market friendly," and "he would be buying on any Donald Trump dip." The elites were backers of Hillary and she was in their pocket.

Back to the Future -The 1980's:            

On January 20th 1981 Ronald Reagan was sworn in as President, but the House of Representatives was in control of the Democrats (under the legendary Tip O'Neill), while the Senate was under GOP control. Thereby, Congress and the President had to make a deal to get a bill passed.

The deal they struck was what each wanted. Reagan wanted tax cuts while O'Neill desired more federal government spending. The result was good and bad. The good was huge in terms of GDP Growth. The bad was the debt went from $997 billion in fiscal year September 1981 to $2.857 trillion in September 1989 (8 years). That’s a 14.1% compounded annual increase!

However, in combination from 1983 through 1989, President Reagan lowered tax rates to 28% and Real GDP grew at 4.42% compounded (7 years).

The Financial Times wrote on their editorial page 11/11/16:

The right lesson to draw from Ronald Reagan: ‘Reagan proved that deficits don't matter,” US VP Dick Cheney told Paul O'Neill in 2002, when the Treasury Secretary expressed doubts about a round of tax cuts. Donald Trump appears set to test whether the proof still holds-if it ever did.                                                                                                          

It should be noted that the "real “debt in the 1970's was reduced by 56% due to inflation of 8.62% compounded from 1972-1981 (or $997 billion actual -adjusted to $436 billion real).  In that end-borrowing could go up without the normal concern, as more than half of the previous stated US debt was inflated away.

THE BOTTOM LINE:                                                                                                                        

Politics, markets, and monetary policy have CHANGED! Thereby, the economy will CHANGE.

Interest rates are and will be rising, and that will continue as we have said repeatedly. The low yield on the 10 year US Treasury Note went from 1.36% (on July 8th 2016) to 2.14% on Friday.  That means mortgage "payments" are up a minimum 30% from the lows. Also 10 year TIPS yields went from (-0.6%) to +0.27%, and from 0.7% on 10/25/16.

Inflation will return with higher interest rates, and the economy is set-up to go boom when (if) these policies get enacted.

It’s important to note that the CPI 5 year compounded increase is the lowest since 1962, or 55 years at 1.56% and the 10-year increase is 1.87% - also the lowest. This is the BOTTOM of the inflation cycle.  The economic fundamentals have and will continue to change.

US Budget Deficit & Debt Set to Increase along with Interest Rates:

The problem is how do you get huge tax cuts and massive spending increases without paying for the interest on the colossal debt increase? If "average" interest rates go to the compounded T-Bill rate (5.5%) since 1961, it will be the largest item in the US federal government budget, or $1.1 trillion!

The solution was hypothesized in the Curmudgeon blog post titled Helicopter Money” is Coming: Will it Work or Add to the World’s Death Spiral?  

The total debt will go up by $2 trillion estimated in the near term, but with virtually no interest expense! The plan, as stated, is for the Treasury to sell $2 trillion of 100-year maturity non-tradeable government bonds to the Fed for -say 0.50% -the bulk of which goes back to the Treasury.   That scheme is a charade of borrowing money, but it is really “helicopter" (printed) currency that looks like borrowing money to fool the public.  Thereby, the government spends the "borrowed/printed" currency which will incur no additional cost!  In 100 years, the $2 trillion will be worth $100 billion.  Presto the debt has disappeared. It’s all free?

What will occur, of course is inflation, but less then as giving printed currency to every person in the USA. What a scheme!

This concoction was confirmed by Larry Summers on 11/4/16, as reported by ZERO HEDGE: “Former Treasury Secretary Summers Calls For End Of Fed Independence:"

The economy now faces secular stagnation, or a chronic lack of demand…. To fight this, the Treasury should be issuing bonds with long maturities taking advantage of current ultra-low interest rates, Summers said. And the Fed should try not get in the way.

Love that threat!!! Fascinating and gripping, and NO this is not a screenplay for a movie.  


Sidebar -- Prof. Kotlikoff’s Post Election Comments:

President-Elect Trump deserves our respect and help. I for one respect his election and stand ready to help.  But if he truly pursues his economic and social policy agenda he will, quite frankly, gravely damage our country and its international standing.

Hiring a climate denier as head of the EPA, choosing a mental midget to run Interior, appointing Bernie Madoff’s money launderer to run the Treasury, pursuing a truly ridiculous tax plan, which will blow a mile-high hole in the deficit and eliminate fiscal progressiveness, eliminating Obama Care without a sensible replacement, starting trade wars with Mexico, China, Canada (and Lord knows who else), undermining NATO, failing to sincerely apologize for his grievous insults to Hispanics, Muslims, and women, stacking the Supreme Court with Justices that the majority of the country just voted to prevent and deporting vast numbers of "criminal" illegal immigrants in the dead of night will all lead to mass demonstrations in Washington that would make the Vietnam protests look tame.

The President-Elect doesn't need to adopt Hillary's do-nothing, fix-nothing positions. But he does need to understand that some of what he's proposing he needs to forget and that there are excellent plans, drawn up by economists, for fundamentally fixing America.  Plans that are bipartisan and that won't leave him as public enemy number one.


The Gold Sell-Off Explained: 

Gold and the precious metals sold off big time on Friday.  In the short run, gold traders have not yet understood the Trump economic plan I’ve described above.

Gold is responding to rising interest rates and the Fed's low inflation projections, which are now likely outdated. Gold's average price in 1981 was $460 and declined to $381 In 1989. The 1981 CPI was +8.61%, which declined to +4.65% in 1989.

Yes, we’ll get GDP growth, but unlike Reagan's policy at the time, we’ll have lots of RISING inflation too.  The debt will rise, but without interest expense on the new debt (which will be a bookkeeping entry of debt on printed paper currency).

My call still holds for now, that after the Fed raises rates in mid-December, the economy will begin to decline until Trump gets his programs enacted by Congress, but with a time lag to let it kick in to stimulate economic growth.   

Also, the effect on the elections within the EU will be of critical importance, with the Italian referendum on 12/4/16 a big clue.  Italians will vote on key constitutional changes that aim to slim down the country’s legislature, speed up lawmaking and attack the bureaucratic morass.

If the Rosenberg/Summers proposal (ala Sam Peckinpah movie) plays out, I may change my prediction of a 40 to 50% decline in the equity markets.  In fact, I may revise my call after the Fed’s December meeting, depending on whether they raise rates as most expect.

This is due to the GOP holding ALL branches of power (President and both Houses of Congress) which was not expected. That dynamic can be a huge banquet of consequences - like a Roman Orgy.

Conclusions & End Quote:

The more Donald Trump listens to the Founding Fathers, and follows the Laws of the Constitutional Republic, the more he will be successful. The essential purpose of government is to preserve liberty as stated in the Constitution.  Here are a simple set of Principles:                 

Liberty over Security; Principle over Party; Truth over your favorite personality; and the law over rulers!

With that in mind, a quote from Milton Friedman's Capitalism and Freedom book is apropos:                                                                  

“The preservation of freedom is the protective reason for limiting and decentralizing governmental power.”  

Addendum: Is the US a Democracy?

Virtually no politician calls the US is a "Constitutional Republic." Instead, they call it a "Democracy."   Really?

AS OF THIS WRITING HILLARY IS AHEAD IN THE POPULAR VOTE BUT IT IS UNOFFICIAL AND CHANGING....If the US was truly a Democracy (which the Founders despised) Hillary would be President if she won the popular vote.  We live by Constitutional laws, not popular votes. We elect "Representatives" via majority, and (in theory) they can create laws within what is allowed in the Constitution!

Good luck and till next time...

The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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