To the Victor Go the Spoils

What a Trump victory means for markets next year

Happy Thanksgiving to our faithful readers! This month’s election was historic by many standards. Trump is the only man besides Grover Cleveland to be elected to nonconsecutive terms. They both won the popular as well as electoral college when doing so, indicating a clear mandate from the people.

And it really was a repudiation of the Biden-Harris agenda with Trump winning every single swing state and picking up ground in all 50 states compared to 2020. And it wasn’t just Main Street that voiced support for Trump—Wall Street did too.

Earlier this year, in a leaked letter to his investors, Scott Bessent (the next Treasury Secretary) observed that markets were rallying 10x when Trump led in the polls compared to when Biden led. (This was before he dropped from the race and endorsed Harris.) Bessent said that Trump would be better for business, better for return on investment, and better for earnings. “All pullbacks this year should be bought,” he urged.

The day after Trump won the election, the Dow Jones Industrial Average exploded by 1,300 points, indicating Bessent was right.

But the gains are not evenly distributed across all sectors nor throughout the entire S&P 500. That’s because the Trump agenda is not going to benefit every business equally. As with any administration, there will be some winners and some losers. Here’s what we’re thinking about where the economy and markets are heading.

First off, many things are likely going to get worse before they get better. Elon Musk gave the same ominous warning in a recent interview. The Treasury and Federal Reserve have been holding together the financial system, especially Treasury markets, with bubblegum and bailing wire. And things are starting to unravel.

Yellen and Powell effectively kept a lid on tremendous inflationary pressures in the economy over the last four years through extraordinary measures. Believe it or not, inflation would’ve been much worse without these maneuvers. The problem is that they’re all only temporary fixes—Band-Aids, really—and the inflation isn’t done.

There is still about $2 trillion that has to work its way through the banking system, and that will further grow the money supply. (M2 has been on the upswing for months.) Growth of the federal deficit also isn’t slowing down. Banks are still sitting on hundreds of billions of dollars in unrealized losses and, perhaps most worryingly, the repo market is likely going to require a massive liquidity infusion from the Fed in the near future—like the Fall of 2019, but on steroids.

In many ways, the next president is being handed a ticking time bomb. Well, more like several ticking time bombs, all of which should go off sometime in the next year.

This means that even with pro-growth policies, the economy and markets are still facing significant headwinds. Furthermore, the once and future president has made it clear that he intends to buoy certain flagging industries while taking a sledgehammer to others. So, how to determine which is which?

Let’s start with energy. While the incoming Trump admin intends to go all-in on domestic production, it’ll be the small producers and start-ups that see the fastest growth rates. Believe it or not, several big energy companies actually supported Biden admin regulations that hampered production because those changes put many small producers out of business—this is why rig count has been falling. Their market share was promptly snapped up by the biggest oil and gas companies in the industry.

So, expect ExxonMobil to do well, but don’t overlook the fledgling firms that are going to have red-letter years very soon. Lots of wells have been shut down, even as other wells ramped up production, over the last four years because regulations made those wells unprofitable except at $100+/bbl. Deregulating will return profitability to $40/bbl for many wells.

Financials are likely the opposite of energy—there’s much more pain in store for the little guy and bailouts for the big players. We still don’t want to touch commercial real estate with a 39-and-a-half-foot pole, and that asset class is mostly financed by regional banks. While large banks’ balance sheets are only about 7 percent CRE, it’s almost a third of small banks’ balance sheets.

And although there are some big players (Bank of America is likely one of them) with massive unrealized losses on their balance sheets, the Fed under Powell will almost certainly jump in and bail out their friends. Small banks, on the other hand, have no friends at the Fed—some of them aren’t even in the Federal Reserve System.

Then there’s manufacturing, where we expect to see broad-based improvements. Everything from legacy to venture capital is fair game here, which is why we like diversifying within the sector and dollar cost averaging as a way to hedge this investment.

The thinking here is that more deregulation and an advantageous tax environment is coming. That includes both reforming the domestic tax code and new tariffs. (Trump is already threatening massive new tariffs on Canada, Mexico, and China on day one.) Manufacturing is a sector that has been hit particularly hard by regulation, with manufacturers paying around $50,000 per worker in annual regulatory costs today—and that’s on top of what’s known as “costs of compensation,” meaning wages and benefits. Throw in the thinning margins from inflation driving up costs and the sector has been in recession for a while, hemorrhaging jobs.

A lot of those job declines haven’t hit the books yet, which is skewing analysts’ perspective, but the previously announced revisions will be incorporated with January’s data release. When those numbers hit the tape, it’ll likely create buying opportunities, which will benefit those following the dollar-cost-averaging strategy.

Changing gears, Real Estate Investment Trusts are still good buys, but only for certain locations. Do you due diligence before plowing money into REITs that are heavily invested in overbought markets. Miami is one such metropolitan area—although it’s been on an absolute tear for several years now, it’s at risk of a pullback or at least stagnating.

One thing that’s not overbought is gold. It’s difficult to overstate how much inflationary pressure is built into this economy. Regardless of who is president or Treasury Sec. next year, we’ll still be dealing with the fallout of Yellen and Powell screwing around with financial markets in order to finance massive budget deficits.

The recent decline in gold is largely due to investors’ false perception of inflation cooling combined with anticipation of Bessent’s better management of Treasury issuance. Unfortunately, inflation isn’t dead—not by a long shot. We can expect the dollar to continue falling against gold, even if it rises against other currencies, which is the current trend. Don’t confuse “dollar strength” as measure against the pound, yen, or peso with actual purchasing power as measure by the price of gold.

Gold is an especially great play right now because of the quiet talks within the Trump inner circle about 50-year T-bonds with what is essentially a gold call option.

The government needs to refinance $7 trillion of debt next year, and a good chunk of that is T-bills that need to be shifted to longer-term securities, including bonds. But investors have been burned—badly—over the last 4 years from inflation. Between the rapid change in both inflation rates and interest rates, bonds have had their worst 3-and-a-half-year run in at least a century. That puts Bessent in a tough spot.

He needs to stretch out debt repayment over a long time horizon, but investors will demand much higher yields to assume the kind of risk associated with a 50-year T-bond. One way for the Treasury to have its cake and eat it too would be to provide inflation protection on those securities. But investors don’t have the appetite for TIPS and I-bonds like they used to. Enter the 50-year gold-option bond.

In her recent book, Good As Gold: How to Unleash the Power of Sound Money, Judy Shelton outlines how these bonds work. Upon maturity, bond holders have the option to take payment in either dollars or a specified weight of gold. That means the government can’t inflate away the value of the debt. This in turn gives investors confidence that they don’t have to worry about inflation since they have the ultimate inflation protection. Consequently, they’ll be willing to accept a lower nominal yield, reducing the cost of servicing the debt in next year’s budget.

There is an important spillover effect to consider. Investors will have increased confidence in not only bonds but notes and bills too. This will help push down yields across the entire yield curve, even though the regular-issue bills, notes, and bonds don’t have the same protection that the 50-year T-bonds do.

In addition to keeping a close eye on gold, we’ve also been tracking all of the regional Fed surveys, which are showing a massive surge in optimism and future business conditions, especially for manufacturing but the service sector too. Consumers and businesses alike are much more upbeat about what the future holds. It would be wise to consider slowly shifting from consumer defensive to consumer discretionary in the year ahead. The same goes for rebalancing the portfolio to include less healthcare and more tech along with basic materials. Just be careful not to do it too early as there are still troubled waters ahead before we enter the promised land of a new American Golden Age.

And there really are some troubled waters ahead—that’s not hyperbole. It isn’t all sunshine and rainbows for the economy broadly nor financial markets specifically. We’ve already highlighted how the Fed is running into problems as it tries to unwind its monetary manipulations, and things are going downhill fast with a repo crisis looming.

Bessent and Trump are going to have a helluva time trying to undo the sabotage from Yellen while limiting the collateral damage—but that’s a subject for the next post. For now, let’s show our gratitude this Thanksgiving and hopefully spend it with the ones we love.