Sunday, May 19, 2019

Tariff Man vs. Dow Man

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Bullish*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.

Trump's two personas
Trump's two personas are on a collision course with each other. On one hand, he likes to style himself as Tariff Man, because he believes the US has had a raw deal from its trading partners. The list of offenders starts with China, but it is numerous. Tariffs are the best tool to address that imbalance. On the other hand, Trump the Dow Man loves a booming stock market, which he tracks obsessively, and views it as a form of validation of the success of his administration.

As trade jitters rose, the stock market has become nervous and sold off. Markets hate trade wars, and they hate uncertainty. While Tariff Man and Dow Man can coexist when trade tensions are low, we will reach some tipping point where Trump has to choose.

Jason Furman raised a number of insightful points in a recent Twitter thread.
It would be rational to escalate the trade war with China if the short-run cost for the U.S. economy are outweighed by the long-run benefits of a more favorable trade agreement.

This is not a priori bad economics, it is a numerical cost-benefit question.

I have seen many quantification of the SR [short run] cost (usually something like 0.5pp hit to GDP growth if the tariffs are expanded and sustained).

But I have seen no quantification of the benefit of plausible or best-case Chinese concessions relative to what they have already conceded.

The LR [long run] benefits conditional on a favorable resolution is just one input into a view on the strategy, you would also need to know how the trade war changes the probability of a favorable resolution. But we should be able to take a stab at quantifying the LR benefits.

In theory equity markets are doing this sort of present value calculation—we lose upfront but this strategy raises the chances we get more IP protections, soybean sales, etc. And they seem to be saying that the potential LR benefits don’t outweigh the SR costs.

This is consistent with my hunch that there would be only a very small macro difference for the U.S. economy between China’s last offer and our latest demand. But I wish I had more than a hunch. Anyone seen anything better?
In other words, would the price of a trade war be worthwhile? We have a reasonable idea of what the costs are, but has anyone calculated the net benefits under varying assumptions and scenarios? In particular, has anyone in the Trump administration done a cost-benefit analysis?

If not, will Trump the Tariff Man or Trump the Dow Man gain the upper hand in the crunch? What are the bull and bear cases?

The full post can be found here.

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