You Ain’t Seen Nothing Yet

By Peter Tchir of Academy Securities

You Ain’t Seen Nothing Yet

I’m not sure what it means that this song, by a Canadian band, is stuck in my head, but I think it sums up where we are. If we listen to President Trump or Treasury Secretary Bessent – “we ain’t seen nothing yet.” Both are openly discussing possible hardships that need to be endured to get to the endgame they are looking for. Increasingly the endgame is that President Trump wants to create a legacy of returning manufacturing to the U.S. and re-invigorating a middle-class lifestyle in the U.S.

That is a laudable goal and it would be awesome if it could be achieved.

Many of our investment themes such as National Security Equals National Production and Refine Baby Refine are based on the U.S. taking the steps to achieve those goals.

We are not averse to the application of tariffs and think that at least some of the inflation concerns are overdone. We provided Some Tariff Basics, analyzing our overall views on tariffs, at the beginning of February. We do stand by the argument that corporations spend time to optimize their supply chains, and disruptions take time to digest, which will be problematic for the economy and earnings.

We have long argued that both Russia and Ukraine will need to be brought to the negotiating table with a mixture of “carrot and stick” diplomacy.

All of this fits well into our theme for 2025 – Messy but Manageable. Increasingly, the question of whether it is manageable is coming up in conversations. The answer remains yes, but as we outlined on Friday, the number of concerns is growing. This is less about the “what” (though concerns about the “what” are also rising), and much more about the “how.” The “what” vs “how” issue came up a lot during Trump 1.0. It seems to be coming up more and more lately, with a twist – is the “how” now affecting the “what?” We were all expecting an avalanche of executive orders and initiatives and that is what we are getting and dealing with.

It was all the way back in November that we published 3D Chess or 52-Card Pickup. The only thing I know for certain is that those who see the administration as playing 3D Chess, still see it that way, and those that see the opposite continue to see the opposite. For the rest of us, we are still trying to figure it out.

What Risk Assets Need to Rebound

We could go into a laundry list of details, but to me, there are two clear paths to a rebound in risk assets:

1. A lot of meaningful wins occur quickly. We’ve seen things like TSMC’s U.S. investment plans. We’ve seen or heard of various DOGE victories (though many of the initial claims seem to be getting watered down). We have seen, certainly with Mexico, some steps on the “war on drugs” front. But there have been stumbles. China, so far, doesn’t appear to be coming to the table with their hat in their hand. The list of risks is possibly longer than the list of wins so far. If that changes rapidly, and it could, then risk assets should be off to the races!
2. Consensus shifts to a high degree of certainty that the economic policies will deliver over time. Markets are always pricing in the future. If the market suddenly agreed that all of the current policies would shift us to the economy that the administration envisions, risk assets would rally.

I find option 1 far more likely than option 2 to trigger a rally in risk any time in the next few weeks.

Shifting the Narrative from Tax Cuts to Avoiding Tax Hikes

I’d love for a slew of new tax cuts to be put on the table. Bringing back the SALT deduction would be nice. But the reality is that extending the tax cuts that are expiring would not act like a tax cut. Literally no one, not one single person, is changing their spending behavior today with the expectation that taxes will be higher next year, because the cuts will expire (and deductions like SALT won’t be reinstated).

If the tax cuts don’t get extended that is like a tax hike! Merely extending the tax cuts already in place will not act like a tax cut for the economy, because it won’t affect spending. Yes, for all the official deficit projections, the extension will look like a tax cut, but it won’t impact the economy, because that is already priced into existing behavior.

This is a bit of a detour in today’s report, but I couldn’t help myself as this could be very important in the coming months as we start to see governing through legislation rather than through executive order.

The Market Risk of Deglobalization

Last weekend we questioned Where is the Economy Headed? Nothing that has occurred in the past week changes my view that the risks remain to the downside (though option 1 above could occur at any time, causing a rapid rethink of this view).

But today, we are going to go down a slightly different path. We will even discuss a couple of things that we rarely mention in the T-Reports – P/E ratios and Warren Buffet.

There is a large body of academic and practical research on the relationship between trade flows and capital flows. Since I only play an economist on TV, I typically don’t place a lot of emphasis on things that are very difficult to measure or infer causality in real time, like capital vs trade flows (we discussed this on Bloomberg TV – flows that is, not playing the role of an economist ).

This administration is quite clearly adamant that trade balances need to be corrected. Will correcting trade balances have any negative consequences? The corollary is, did rising trade deficits accrue any benefits to the U.S.? Certainly, some portion of the academic literature would argue that it did, potentially through capital flows. But that is all “too highfalutin” for a T-Report, so let’s bring it down to our level.

Somewhere between 25% and over 40% of revenue for the S&P 500 companies comes from outside the U.S. AI came up with 28% and someone I know well (and trust more than AI), Torsten Slok, produced a slide published on February 5th, showing “41% of revenue in the S&P 500 companies comes from abroad” (link).

In any case a significant amount of revenue (and presumably earnings and/or sales, depending on how revenue is used) comes from outside of the U.S. for the companies in the S&P 500. We have argued over and over, especially from a geopolitical standpoint, that this is crucial. “China Inc.” is the concept that Chinese companies and the Chinese government are effectively one and the same. That is just not the case for the U.S. government and U.S. companies (companies in the S&P 500 in this case).

The U.S. government is here to serve its constituents – which are the citizens of the Unites States. Administrations may find that the best way to do that varies, but that is ultimately their goal. It is clear that this administration is currently taking a focused view on what their constituency needs – lower taxes and more manufacturing.

The companies in the S&P 500 presumably have constituents across the globe that they need to pay attention to. Not just as customers, but also as suppliers. I haven’t spent much time on this because:

1. With some hiccups, we had been drifting towards more and more globalization where national boundaries seemed to make less of a difference. Since 2018 when Academy started focusing on China as a Strategic Competitor we could hone our analysis in on China (our view that China is shifting from Made in China to Made by China, went from being an outlying viewpoint, to pretty much consensus in the past year or so).
2. We have presumed companies have optimized their supply chains and distribution networks, and while from time to time, government policies (here and abroad) would create risks and opportunities, they have only impacted companies at the margins.

Right now, this isn’t at the margins and everyday there are indications of accelerating deglobalization (or at least dramatic changes in interconnectivity – like the potential for a reinvigorated trading relationship between Russia and the U.S.).

First chart ever looking at P/E ratios.

There have been a few periods when the average P/E ratio between the S&P 500 and the STOXX 600 has diverged. The times when the U.S. was significantly higher than Europe have been highlighted in orange. The recent divergence has lasted longer and is significantly higher than the other two periods of divergence since the early 2000s.

P/E ratios, especially for the U.S., but also for Europe (at least until 2022) have been drifting higher.

There are several reasons for this that have nothing to do with deglobalization:

• More wealth chasing fewer public investment options.
• A higher percentage of tech companies in the U.S. indices.

But what if globalization also allowed P/E ratios to rise? That the benefits and efficiencies of globalization helped investors get comfortable with paying more for stocks? That companies being able to optimize their businesses globally supported higher P/E ratios?

I’m not arguing that globalization was the biggest force behind higher P/E ratios, especially during the recent wave of AI valuations soaring, but it seems plausible that it was a part of it. Especially with somewhere around 1/3 of S&P 500 revenues coming from outside of the U.S.

Which brings us to Warren Buffet. The only time that I can recall mentioning him was in reference to his insurance companies selling massive amounts of first loss protection on the HY CDX Index first loss tranche. It was an incredibly efficient way to raise money at Libor flat to pay for Katrina damages (with low tail risk, unlike other things they underwrote). Pretty impressive for a person who is famous for claiming “derivatives are weapons of mass financial destruction.” But I digress.

I could be wrong (I really don’t pay attention to Buffet), but I think he is often linked to comparing the market capitalization of the S&P 500 with U.S. GDP. There are a number of bears out there who point out this disparity. Many seem to link it to 
Buffet holding record amounts of cash.

I’ve largely dismissed any comparison between U.S. GDP and the S&P 500 Market Cap because – you guessed it – about 1/3 of revenue comes from overseas!

Comparing global equity market cap to global GDP makes more sense, but it is nothing I spent much time thinking about, until recently.

I think it is more difficult to argue that globalization hasn’t played a role in this divergence! Again, lots of other factors are at work, but how much of that orange oval is linked to the benefits of globalization that may be getting disrupted?

Bottom Line

We are at the very early stages of a dramatic realignment of the global economy. The U.S. is the one setting it in motion, and the administration seems comfortable with creating bumps along the way. If the legacy is achieved, will it be great for domestic stocks? Unclear, but that is not today’s issue. Others are responding to the steps set in motion by this administration (we could also go back in time and figure out who did what to who, and when they did what to who, but tracing an “eye for an eye” back to the first eye, hardly ever accomplishes anything).

On risk assets, look for continued reversion to the mean. Own what is under-owned and shorted (globally). Be underweight what has been overbought and remains crowded longs. (Despite the recent domestic sell-off, despite the Nasdaq 100 closing below the 200-day moving average, I’m struggling to see signs of capitulation).

This is likely to bleed into credit spreads. The weakness that started a week or so ago, and accelerated last week, is likely to continue as this isn’t just reacting to shifts in data, it is the beginning of a reaction to a potential dramatic shift in global economics.

Rates are confusing to me. On the one hand, our outlook for the economy would indicate lower yields. I’m firmly in the 3 to 4 cuts camp, starting in May (I’d argue that we got into that camp before others starting joining us). But is that what will drive 10s and beyond? The 10-year yield rose 10 bps during a week in which the Nasdaq and S&P dropped over 3% (and no, the drop wasn’t tied to rate fears). Longer dated bonds have to contend with higher yields elsewhere. These are some of the same capital flow issues that foreigners may see, potentially making the U.S. seem like a less interesting place to allocate assets. DOGE (and the deficit) seemed to take off like a rocket ship, but lately, under more scrutiny, the work seems less impressive than initially publicized. No doubt it is finding fat and excess, but maybe not to the degree or ease that it felt like in the first days of rapid-fire announcements. I was worried that an aggressive effort to buy crypto would have hurt the bond market, but we seem to have avoided that, for now. So, with two hands balancing so much, I’d err to slight caution on rates, but think 4.2% to 4.4% is fair on 10s. We only get below that range on weak data (which may be coming, but it is a bit early). We could get higher on good data (which wouldn’t be bad) or we could break the range to the upside on yields because of a buyer strike, which would not be good for anyone!

I do think that crypto remains a leader on some days, and think that we could see further weakness next week as no new money was committed and this is a market that needs new money to flourish.

While it is difficult to be as bearish at levels around 10% below the highs, that is the direction I’m leaning as this isn’t your run-of-the-mill response to earnings and economic headlines. We are trying to price in a potentially massive change to the global economic and geopolitical landscape!

Despite the volatility that we’ve already experienced, I suspect that We Ain’t Seen Nothing Yet. On that happy note, the weather looks to be turning for the better for much of the country!