How the Markets Are Reacting to Harris vs. Trump — ft. Robert Armstrong | Prof G Markets

Pleasure.

Me too.

Yes, it is having an effect on the markets and it's dominating the news. How are the markets reacting to this news? Well, in fact, markets have been pretty calm. The first reason for that is that if you look at, for example, the betting markets, Biden leaving was pretty well expected by the time he left. So there wasn't a big change in the probability. The kind of betting market probability that Trump will win was around 60% and it stayed around 60%. So there wasn't a massive reshuffling of the electoral deck yet. One thing that makes this question very subtle and tricky is that the bad debate was at the end of June. And on the 7th and the 11th of July, we had this wonderful June CPI report which showed the Fed is clear to cut rates, inflation very near target. So the market has been digesting that fact at the same time as it digests the political facts. So it's hard to sort out what is what. I'll give you an example: one thing that happened a week or so ago was that small American stocks went completely bananas for about a week. Small American stocks have been performing very poorly compared to big American tech. Trump and Vance are not very enthusiastic about big American tech companies. So the idea was, 'We want to own companies that have most of their supply chains and most of their customers in the United States. Let's own small-cap stocks which have those characteristics.' That's one way to read the news. The other way to read the news is that small-cap stocks are very, very rate-sensitive. If you think rates are going to come down because of the good inflation report, who is going to benefit most? Companies with more debt, which are small-cap stocks, and companies that are more economically sensitive, which are small-cap stocks. So you can have a kind of political reading of this remarkable doings in one corner of the market. But the 'Trump trade' in capital letters is a curve steepener trade. Long-term rates are going to go up more than short-term rates do. That is Wall Street consensus. You ask your average Wall Street strategist what's going to happen, and they say Trump is a steepener. The reason they think that is that Trump is inflationary. He likes tax cuts, which if they're not funded are inflationary. He likes low rates, he likes spending, and he likes tariffs. He doesn't talk about reducing the deficit. So there is a reasonable case that he would be somewhat inflationary. But for all of the political turbulence, the sort of probability that Trump will be the next president doesn't seem to have changed that much. So that has kept the market moves from being anything like cataclysmic or violent. Implicit in that statement is the notion that if what looks like the coronation of Vice President Harris as the nominee, if she were to win, that somehow the markets might perceive that negatively. My sense is that the Biden economy... I think they've done a terrible job messaging, but I think it's hard to be anything but fairly impressed with this economy over the last three and a half years. I would argue corporate profits have gone bananas. We've got the lowest unemployment in years, low inflation. So a continuation or 'steady as she goes' is not bad. A lot of people remember how strongly stocks went up in the early months of the first Trump administration. They had a great rally. A lot of that had to do with the fact that Trump promised and then delivered pretty significant corporate tax cuts. Mechanically, if the corporate tax rate goes down, corporate earnings go up, all else being equal, stocks go up. The problem is that things are very different right now. Stocks are much more expensive now than they were in 2016. Risk premiums are much more compressed. So Trump cannot do the same trick he did last time, which is cutting that corporate rate. So I think your instinct is correct, actually. Just assuming that there will be a Trump rally because he is a businessman and says businessman things is probably a mistake.

On the growth side, it feels like a spring that's been wound with non-performance for the better part of the last decade. I think the same is true for markets like the UK. There's a huge gap between the US and the rest of the world in terms of how much assets cost. Is there a trade there? What are your thoughts?

It's the easiest and most exciting thing in the headlines. I think that is true. Particularly true in the case of Trump, his superpower is that he gets people excited, negatively or positively. He is an emotion pump in this incredible way. You just think about Trump and you start thinking about extreme outcomes, big ups and big downs, disaster, whatever. I think if you look at his first four years, his rhetoric is extremely strong, but the reality might be a bit milder. I'll give you an example. Trump loves to talk about how the dollar is too strong, and he wants to devalue it. The thing is, Trump also likes to think of the stock market as a measure of his performance. If he starts fiddling around with the US dollar, he's going to start getting extremely strong messages from the stock market and from the Treasury market. So there's a kind of natural guardrails around him, just as it would around any other president, if he continues to believe that he is the man who causes the stock market to go up and wants to continue to be that man. So I tend to think that the idea Trump will be hugely disruptive and the reality will have an effect, and we'll be right back.

Well, the futures markets tell you that the chance of a rate cut at this meeting is very, very low, and the chance of a rate cut in September is very, very high. Why? Because of that June CPI report. If you look at core inflation, meaning inflation minus food and energy, and annualize it for the month of June, it's at target. We've done it. On a year-over-year basis, it's about 2%. We're there. The most important thing was that housing, which is the kind of inflation that was refusing to go down, finally showed signs that rent and owner's equivalent rent are going down. Housing inflation was the last holdout, and it's coming down now. So it looks like it's happening. The Fed will probably not cut this month because they want to see a couple more reports like the June one. But if they do cut, I think they have good reason to, partly because in the most rate-sensitive markets like housing, these high rates are already causing trouble. If we keep these rates too high for too long, that's going to spread, and that's the classic Fed mistake. We don't want to do that. Now, this podcast began with a discussion of politics, so there's an extremely interesting question about whether you cut ahead of an election and whether that looks partisan. I'd like to think of this in terms of incentives. The incentives of the members of the monetary policy committee are to get the call right. The damage they will suffer, especially the Chair, Jay Powell, if they allow inflation to reignite or stay tight too long and put the country into a recession, is extremely bad. People call you Arthur Burns for the rest of your life. Arthur Burns was a Fed chair who screwed it up in the 70s. You don't want to be Arthur Burns. So their lifelong reputation is based on them getting the rate cycle correct. I don't think consciously, at least, they're going to think, 'Oh, we would cut now, but that would be too political.' Now, unconsciously, we all have our biases. We do things for reasons we don't understand. We all have strong political opinions. Could that influence the committee? I guess, but when they are thinking to themselves, I just think all the incentives are for them to just think about the economy, think about inflation, think about employment, and make the right call.

It matters when Treasury investors say it matters. We're playing dice with them because if you want me to buy paper from the United States, you've got to pay me 6%. No, make it 7.5%. When you and I were kids, what was it? 15% you had to pay. That happens, and suddenly it's the issue. This is exactly the one we talked about earlier: global and domestic treasury investors are very patient with the United States because where are you going to go? Where is all the global savings going to go other than by far the biggest market in the world, which is the US Treasury market? It's a question of hydraulics. Money's got to go somewhere.

Great question. I think it always turns out badly when you start writing sentences and working your way towards declarative grammatical structures. I try to articulate as simply as possible what I want to say in bullet points. A 500 or 1000-word piece might be five or eight bullet points. You use the term 'boil down.' That's what journalism is. Reduce. It's like making sauce. As Marcella Hazan said about making pasta sauce, 'Reduce, reduce, reduce.' It's the same principle. What helps you do that is not pretending to be a genius. People get in a lot of trouble trying to make the story they're telling neat. It saves you a lot of bad prose to just sometimes be able to say, 'And this is the part I don't really understand.' It's refreshing. I'm confused about this. You're making a big mistake if you think you have all the answers. Markets are bigger than us.

It's fun to talk to you guys. Thank you.