When will reality bite?

For investors, the Trump bump can’t last, but it’s tough to know when the Trump dump will begin

Source: LA Times, 1929

My profs in grad school used the phrase “dumb money” to describe surges that sometimes drove stock markets up before a big fall. Investors who took part were either unsophisticated folks who chased market enthusiasm upward or smarties who speculated and hoped to get out before the game ended.

Are we seeing dumb money again?

During Election Week, the S&P 500 gained 4.66 percent, the Nasdaq rose 5.74 percent, and the Dow climbed 4.61 percent, as Reuters reported. The S&P 500 and the Dow registered their best weekly percentage jumps since early November 2023, with the Dow topping 44,000 for the first time. The rally continued on Veterans Day, with the Dow closing 0.7 percent higher, and the S&P 500 and Nasdaq Composite each rising 0.1 percent.

Most analysts credited Donald J. Trump’s election for the gains. They suggested that investors expect lower corporate taxes and deregulation and pointed to rises in consumer sentiment and the Fed’s rate cut.

“The recent stock market rally suggests that investors are either celebrating the outcome of the election, the reduced uncertainty that follows when elections end, or perhaps both,” Alex Michalka, vice president of investment research at Wealthfront, said, according to USA Today. “Regardless, we’re encouraged to see millennials continuing to make smart financial decisions by putting their money to work in the stock market.”

So, with the fever burning, is it time for smart money to get out?

Well, one smart guy, Warren Buffett, appears to be letting much of this rally pass him by. He is keeping an astonishing $325 billion — yes, that’s billion — out of the market, in cash and equivalents, as The Wall Street Journal reported.

Source: Picture Perfect Portfolios

Part of the reason may be that the much watched “Buffett Indicator” — a ratio of listed stocks to the size of the U.S. economy – suggests that valuations are ridiculously high. “Taking the Wilshire 5000 Index as a proxy, it is now around 200%, which would leave it more stretched than at the peak of the tech bubble,” the paper reported.

What’s more, the ratio of share prices to earnings in the Dow, at about 31, is some 47 percent higher than the historical average, according to full:ratio. By that measure, investors would seem to be way out over their skis.

So, let’s stipulate that the current euphoria is well over the top. Perhaps before Inauguration Day, we’ll see the markets slip a bit.

But what’s more concerning is the long-term outlook. If Trump imposes tariffs of 60 percent on Chinese products and up to 20 percent on everything else from abroad, what will happen with Corporate America? American producers who depend on imported components will surely feel a pinch, driving up their product prices, retriggering inflation and perhaps reducing GDP growth in the U.S.

Source: Financial Times

The Peterson Institute for International Economics found that Trump’s proposals – assuming that targeted countries retaliated — would slash more than a percentage point off the U.S. economy by 2026 and make inflation 2 percentage points higher next year than it otherwise would have been, as PBS reported. That could shift the Fed’s interest-rate cuts into reverse and put the White House and the central bank at each other’s throats.

Maurice Obstfeld, a former chief economist of the International Monetary Fund and senior fellow at the institute, warned that the tariffs “would undoubtedly trigger foreign retaliation and fuel a destructive trade war. This factor added to the damage from Trump’s last go at tariffs. As harmful as the Smoot-Hawley tariff of 1930 was to the US, the international trade war it ignited was much worse. If the experience is repeated in today’s far more interconnected world, the costs will be higher still, and US workers and businesses alike surely will lose.”

Yes, Obstfeld did raise the specter of 1930. One can only hope that this is either hyperbole or that wiser heads will be able to forestall what could arise.

But Europeans already are girding for deep problems. Analysts for the giant Dutch bank, ING said of Trump’s election: “Europe’s worst economic nightmare comes true.”

“A looming new trade war could push the eurozone economy from sluggish growth into a full-blown recession,” the ING analysts wrote. “The already struggling German economy, which heavily relies on trade with the US, would be particularly hard hit by tariffs on European automotives. Additionally, uncertainty about Trump’s stance on Ukraine and NATO could undermine the recently stabilised economic confidence indicators across the eurozone. Even though tariffs might not impact Europe until late 2025, the renewed uncertainty and trade war fears could drive the eurozone economy into recession at the turn of the year.”

Source: NPR

And it’s not just tariffs that could hurt the U.S. economy. Trump’s deportation efforts will certainly be inhumane and likely will spawn unrest across the country, but economically they could lead to labor shortages that could amp up inflation and drive down gross domestic product.

“Due to the loss of workers across U.S. industries, we found that mass deportation would reduce the U.S. gross domestic product (GDP) by 4.2 to 6.8 percent,” warns the American Immigration Council. “It would also result in significant reduction in tax revenues for the U.S. government. In 2022 alone, undocumented immigrant households paid $46.8 billion in federal taxes and $29.3 billion in state and local taxes. Undocumented immigrants also contributed $22.6 billion to Social Security and $5.7 billion to Medicare.”

Folks who console themselves by believing in Trump’s business savvy and sensitivity to markets might want to look a bit harder. Recall that he bankrupted casinos — something that’s pretty hard to do — six times. And take note that shares in his social media company, Trump Media & Technology Group, are worth less than half of what they were last March, down from above $66 to below $31.

His management skills in government, moreover, are, well, questionable. At least a couple dozen colleagues and aides turned on their former boss after his first term. Both Treasury Secretary Steven Mnuchin and former chief of staff Reince Priebus called Trump an “idiot,” according to author Michael Wolff, as reported by Politico. Former economic adviser Gary Cohn said Trump was “dumb as shit,” and former national security adviser H.R. McMaster labeled him a “dope.”

Of course, Trump is now 78 and one must wonder whether anything has improved for him intellectually or mentally, especially in light of the rambling “weave” he often delivered during the campaign.

For investors, the tricky thing — as always — is timing. The economy has tended to be resilient, but Trump’s moves — if he delivers on his promises as threatened — seem certain to hit it hard. For now, the bulls are running, eagerly chasing Trump euphoria. Eventually, reality will bite.

Luddites revisited — attacking high-frequency traders, speculators and assorted other market “vipers”

Andrew Jackson, the country’s seventh president, was famous for railing against the financiers of the early 1800s. They speculated on “the breadstuffs of the country,” he warned. “Should I let you go on, you will ruin 50,000 families and that will be my sin! You are a den of vipers and thieves. I intend to rout you out and by the eternal God, I will rout you out.”

The quote, a favorite of bloggers who fret about plots to establish a new world order and such, would be at home today in the superheated arguments over high-frequency trading. The latest diatribe, I’m sad to say, comes from a dear friend and former colleague at Bloomberg Businessweek. Peter Coy writes, “The bigger the financial sector, the more dangerous it becomes.” He bemoans the flood of smart people going into the business, noting that a quarter of Harvard’s brainiacs in the early 2000s were drawn into investment banking and like fields. And he complains about banks “cranking up their trading operations in a way that imperils the financial system once again.”

His indictment, based on the May 6 flash crash, is headlined “What’s the Rush?” And his subhed warns “The American financial system is erratic and voracious, and keeps score in milliseconds. Here’s how to rein in the beast.” Among his prescriptions: a transactions tax of a few cents per $100 to “throw sand into the gears of high-frequency trading,” higher margin and collateral requirements, and steps such as new taxes to reduce corporate debt (on the idea that we’re being assailed by waves of “debt-fueled speculation.”)

Oh, come now, Peter. Let’s dial it down a bit. First, while the Great Recession was in part the fault of Wall Street, it was not a high-frequency phenomenon. Rather, we can blame bad securitization practices, flawed housing policies in Washington, poor market oversight and a raft of other well-documented problems. Superfast trading may have helped stocks crater, but it was not the force that drove them down.

Yes, one must admit that May 6 was not a good day for the high-frequency set. No matter how short-lived, the $800 billion plunge in the value of U.S. stocks that day was worrisome. Stocks such as Accenture slipped to a penny from $40 (before bouncing back) in trading patches as short as eight seconds. Clearly, something was amiss in the superfast computers at the likes of Getco.

But let’s keep a few things in perspective. First, after going haywire the market did correct itself. Prices came back, in most cases rapidly. The Dow lost 1,138.69 points from its high in crazed intraday trading on May 6, but closed just 341.9 points down, and regained all that and then some by May 10. Erratic? No doubt. Voracious. Okay, but when have traders been anything but?

Let’s concede that there’s something bizarre about high-frequency trading. Its relationship to real value in stocks is remote at best. So, too, is its connection to fundamentals such as corporate strategy, earnings power, savvy management. All that good stuff that financial journalists, MBAs and CEOs – and maybe even the odd stockbroker — prize is a few solar systems away from the zippy stock-swapping at Hard Eight Futures, Quantlab Financial and such. Those guys, snapping to the beat of their own algorithms, don’t give a hoot about such things. It’s all numbers, bro.

Let’s concede, too, that the liquidity the HFT pack supposedly brings is an illusion. It is most likely gone when most needed. The simile Peter uses – “like a swimming pool that dries up just as you jump off the high dive” – is apt (hat’s off to his wordsmithing). It’s hard to see just what value the high-freqs bring to anyone but themselves.

But, so what? Speculators, those oft-reviled folks who put the zing in stock markets, have always been in the game for the gamble. They see Wall Street as a massive roulette wheel and believe that any way they can tilt the spin to their favor – legally – is fair play. In an odd way, they are cousins to technical analysts who have long played markets free of the burden of fundamentals. Are we to ban the technical folk because their charts are more like astrology than investment? They, too, are an odd subculture of market players whose powers over stock movements one could decry.

Surely, there needs to be policing to make sure high-freqs don’t misuse the power they have to move markets. They do swap millions of shares in ridiculously short periods of times, all but blind to fundamental values. At times, they account for disturbingly high amounts of volume. If they intentionally – or through glitches – knock stocks down to absurd levels to profiteer in some market-cornering way, they need to be rapped hard for that. Fines, perhaps, or suspensions of trading privileges could be used to rein them in.

But imposing transactions taxes or worse seems like overkill. Such steps would penalize all players for the perfidy of a few. Let’s use the scalpel instead of the meat-axe and target the bad boys, not just the folks looking for an edge of a few milliseconds on the next guy.

By the way, it’s passably ironic that Peter’s employer, Bloomberg, as well as Dow Jones and other data-providers are tripping over themselves to serve up market data ever more quickly to the high-freq bunch. Some go so far as to rent space to traders — at premium prices — so they can house their computers cheek-by-jowl with providers’ machines and save milliseconds of transmission time. What these providers know, just as traders do, is that timely information is still everything in this game.

Every technological advance that changes the playing field makes folks nervous. Luddism is a natural reaction. Moreover, the markets have long been the playground of innovators and, as a consequence, the targets of critics. In 1887 the head of the Chicago Board of Trade forcibly removed telegraph gear from the floor of the CBOT because he couldn’t abide the electronic links to notorious Chicago bucket shops, as recounted by Rutgers historian David Hochfelder. One NYSE broker in 1889 complained that the “indiscriminate distribution of stock quotations to every liquor-saloon and other places has done much to interfere with business.”

We may not like the high-speed folks. We may deride them as little more than turbocharged gamblers, as Rain Man-like idiot savants unfairly using their powers to enrich themselves while adding nothing to the game. But they will be players so long as there’s money to be made. We can take the profit out if they don’t play by the rules (and, by the way, maybe some of those smart Harvard types in finance can cook up better rules to keep market ripples from becoming tsunamis). Let’s not, however, make life onerous for everyone in the process.