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Wednesday, 1st March 2017

The Fantasy Continues  

Well, that was fun. Trump made his first address to Congress last night and said nothing of substance. But because he didn't go off script and say something crazy, the stock market is happy and green, proving once again that the extraordinary performance of financial markets since November 8 is due to Trumpomanian policy expectations, not economic performance.

Trump promised more spending on the Pentagon, infrastructure, border control, education, veterans, crime, child care and medical tax credits. He also promised "big, big" corporate tax cuts and a "massive tax reduction for the middle class".

There was not one mention of how to pay for all this. Not one reference to the $20 trillion deficit now in place or the estimated $10 trillion in additional deficits that will accumulate over the next 10 years just maintaining existing programs, without including any of his new promises.

In Silicon Valley, they call uneconomic companies with big valuations unicorns. This is far more fantastic. The moratorium of the debt ceiling expires on March 15. Congress will have to debate and pass a multi-trillion dollar hike in the debt ceiling. There is no way that Trump's promises are going to survive the reality of a budget process and a debt ceiling debate. His own party will kill them before the Democrats get a chance to do so.

Beginning on March 15 — slowly at first and with accelerating intensity — markets will, we expect, become transfixed by the fact that the Treasury is running out of cash and that there is no conceivable path to a Congressional majority to raise the nation's $20 trillion debt ceiling on a timely basis much less to approve a Trump stimulus plan. The current euphoric risk-on mood will shift, in our view, and the bubble in financial markets will begin to collapse. 

It is difficult to know where to assign the blame for what we think is about to happen. Should we blame the President for promising what cannot possibly be delivered? Or should we blame the markets for believing what they want to hear? 

In our view, we are headed into a risk-off world, the sort of environment where gold outperforms other assets. There is risk to the stability of Europe as France and Germany move towards critical elections and the negotiations on Brexit begin. There is the risk of late cycle debt dynamics, where too much unproductive high yield corporate debt meets a slowing economy and rising interest rates. But most of all, there is the risk that markets have vastly miscalculated the potential for a Trump stimulus plan. With stock market sentiment and valuations at all-time highs, there is very little margin for error.