Chaos vs Grand Design: Trump 2.0 for investors

00;04;08;28 - 00;04;38;11

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00;04;38;14 - 00;05;02;23

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00;05;02;25 - 00;05;36;23

Michael Cembalest

Good morning, everybody. This is Michael Cembalest. Thank you very much for joining our webcast. The topic today is chaos versus grand design. Trump 2.0 for investors. it's been a bumpy ride so far this year. I think the street in many ways has gotten it wrong. The perception was that with people like Scott Bezzant and Howard Neck and Chris Wright and the administration that the administration would carefully balance their pro-growth, productivity enhancing policies with their anti-growth inflationary policies.

00;05;36;26 - 00;06;00;27

Michael Cembalest

so far we've gotten a lot more of the latter than the former. it's interesting. A few months ago, Scott Bassett was quoted as saying, the tariff gun will always be loaded on the table, but rarely discharged. Charming metaphor. Scott should also remember that most gun accidents begin at the home. So, that's, that that gun has been fired a lot more than Scott thought it would be.

00;06;00;29 - 00;06;24;07

Michael Cembalest

So, I'm going to take the next hour to walk you through the grand design of this Trump administration. and the issues and challenges that it creates for investors. And I want to start by giving credit to the administration for the things that they're trying to address and that they're trying to solve them. I'm going to try to apply some kind of grand design to this, so that we can understand what the implications are.

00;06;24;09 - 00;06;50;29

Michael Cembalest

So let's get started. Let's see if this thing works. Okay. So remember when I wrote The outlook in the beginning of the year? I said, whatever the goals are, I'm taking these alchemists at their word that they're going to break something. I wasn't sure what it would be, but with valuations as high as they were, I thought that equity markets would end the year higher than they began, but I expected a 10 to 15% correction at some point.

00;06;51;01 - 00;07;13;07

Michael Cembalest

I didn't expect it necessarily to take place within the first 50 days. We had that 10% correction. There's been a little bit of a bounce since then. and I still think that there's there's more shoes to drop, but I don't think we're going to have a recession this year. So what is this administration? if you take them at their word, what are they trying to fix?

00;07;13;13 - 00;07;39;02

Michael Cembalest

And I've showed this chart before in a few presentations, and I think in the outlook, ever since China joined the World Trade Organization a couple of decades ago, U.S. consumer spending and GDP have done fine. But U.S. industrial production has been stagnating and that's been leading to all sorts of negative consequences, whether it's rising opioid addictions and suicide rates and falling manufacturing wages relative to service sector and things like that.

00;07;39;04 - 00;08;06;03

Michael Cembalest

And so they're trying to fix this stagnating industrial production, which is kind of stuck in neutral. And as part of that, the administration believes that that that the lack of tariff reciprocity is part of the problem. The chart here shows a reciprocity line. And as of 2016, when Trump took office, every single country on this chart applied a higher tariff to the United States than the United States charged in return.

00;08;06;05 - 00;08;30;26

Michael Cembalest

And while economists will tell you that this is perfectly normal, I think to a lot of people in practice it may not have been and entailed certain costs for manufacturing communities that were very painful. if you look back and try to think where did this lack of tariff reciprocity come from? It occurred during a period when the United States was negotiating favorable tariff deals for other countries.

00;08;30;26 - 00;08;59;16

Michael Cembalest

In exchange for their support at the UN. historically, the U.S. has received very low returns on investment for those geopolitical kind of justifications. Here's one analysis of U.S. aid recipient alignment on important U.N. votes. Aside from Israel, the Ukraine, the country of Georgia and Peru, all of the rest of the U.S. aid recipients, voted less than 50% of the time with the U.S., most of them less than a quarter of the time.

00;08;59;19 - 00;09;36;20

Michael Cembalest

So if you're trying to provide geopolitical justifications for those unfavorable tariff arrangements, it's hard to do. They're also trying to fix this chronic deficit in traded goods. it was bad in the 80s when people used to talk about twin deficits, but it's gotten a lot worse since then and again since China joined the World Trade Organization. we've basically had a, roughly 4 to 6% chronic deficit in traded goods and which has made its way into the most critical national defense systems.

00;09;36;23 - 00;10;04;07

Michael Cembalest

This complicated rubric, which you may see more of, shows on the right, all the different Chinese suppliers and the products they flow into, which eventually make their way into some of the most critical U.S. national defense systems. So the Chinese supply chain has even infiltrated the U.S. air launched armaments supply chains, which is the most one of the most important parts of national defense.

00;10;04;09 - 00;10;33;06

Michael Cembalest

So this is the kind of thing that they say they're trying to fix. They're also trying to to address what they refer to as the NATO free riding problem. I've written about this for over 15 years. I think it's a fair issue. NATO made an agreement in 2006 to spend 2% of GDP on defense spending, and it took the NATO countries ex the U.S. almost 20 years to reach that level.

00;10;33;11 - 00;11;03;22

Michael Cembalest

And you can see here that in 2024, they finally made it. So it took them 18 years to get there. And part of the issue is that the underlying driver of low NATO defense spending appears to be proximity to Russia. So what this chart is showing you is on the x axis, the farther away you are from the Russian border, the lower your defense spending was at least in 2024, and those of the Scandinavian countries at the upper left, or at least most of them in places like Poland.

00;11;03;25 - 00;11;38;11

Michael Cembalest

So, I think there are fair criticisms that can be leveled and an alliance where the farther away you are of the problem, the less used there's, the less you care enough to spend on it. They're also trying to fix the fact that the Chinese Belt and Road Initiative is not just an economic alliance. what this chart is showing is the the orange countries are members of the Chinese Belt and Road Initiative, and the red countries are members where there have also been visitations by Chinese military transport aircraft.

00;11;38;13 - 00;12;05;15

Michael Cembalest

So I think there are a lot of questions that the United States is deservedly asking about what membership in the Chinese belt and Road Initiative entails. And as it relates to Panama, you know, why was Panama the first Latin American signatory to this initiative? you know, there have been a lot of examples of Chinese investment in infrastructure and logistics, electricity generation and construction.

00;12;05;23 - 00;12;36;01

Michael Cembalest

And so there are a lot of legitimate questions, I think, that can be asked about, Chinese infrastructure and Panama. They're also trying to address dwindling U.S. ammunition stockpiles. This chart shows the number of years that that would be required to replenish U.S. ammunition stockpiles for certain key, military items, based on the transfers that have taken place to Ukraine.

00;12;36;03 - 00;13;03;12

Michael Cembalest

And so, you can see here that some of these are as little as two years, but some of them are as long as six years, eight years and 18 years. And, you know this. If I'm doing my job right, everyone's going to have something to be upset about on this call. the, and the transfers to Ukraine have resurfaced a lot of ideas that are hotly debated about the history of conflict in that region.

00;13;03;14 - 00;13;33;28

Michael Cembalest

I'm just going to show you here briefly. You can read it on your own, but there was a June 1997 letter to President Clinton from Bill Bradley, Gary Hart, Sam Nunn, Paul Nitze, Stansfield Turner, Robert McNamara, and and a bunch of other signatories of the Foreign Policy establishment that believed that the NATO expansion was an error and that it would decrease regional security and unsettle European, European stability.

00;13;34;01 - 00;14;00;28

Michael Cembalest

and if you read the bullet points of what they said would happen, it looks like exactly what's happened. And that expansion would trigger an extended debate over NATO's cost. And we'll call into question the U.S. commitment to the alliance. That's exactly what's happened. And so, this isn't to question Russian against Russian aggression against Ukraine, but this is part of the ideological basis that the administration is using to revisit it.

00;14;01;01 - 00;14;26;01

Michael Cembalest

They're also say they're trying to fix federal debt sustainability. And many of our clients know that, I've been talking about this chart probably for 20 years. It's about the crossover point and the point at which federal government revenues are eclipsed only by interest. And on the federal debt and entitlements. It now looks like early in the 2030s that's going to happen.

00;14;26;03 - 00;14;48;02

Michael Cembalest

So, I personally don't believe that Doge is a serious effort at addressing this, and we'll talk about that in a few minutes. But this is the underlying issue that Doge was created to address, which is federal debt sustainability. and again, this issue that we have this crossover point coming in less than a decade at least at this point.

00;14;48;04 - 00;15;14;17

Michael Cembalest

And, the General Accounting Office does cite it's interesting that they can compute this. They estimate around two, 200 to $250 billion a year in, in improper federal government payments. So they can identify after the fact that 200 to $250 billion a year are spent improperly, but they don't have the systems in place to prevent those payments from being made in advance.

00;15;14;19 - 00;15;43;08

Michael Cembalest

and so these are the kinds of things that that, efforts to add on to the Obama administration, they worked on as well, that they're trying to solve. and then with respect to border security, I think this is helpful context to understand what the administration is doing. for the for for about 15 to 18 years, there was about a million people a year of authorized legal permanent residents coming in.

00;15;43;11 - 00;16;12;11

Michael Cembalest

And another 10% or so, 150,000 a year, of, undocumented workers and or whatever you want to call them, not getting into that debate. And then at in the Biden administration, those numbers surged where you had almost 3 million people a year of unauthorized entrance. And so part of what's happening is a response to that. And by the way, the public polling is 50 to 60% in favor of what the administration is doing on immigration and border security.

00;16;12;14 - 00;16;40;11

Michael Cembalest

And they also say they're trying to address the fentanyl flows from Mexico, which, which have been rising extremely rapidly, since around 2018. And then the last thing that I would mention that the administration is reacting to is an increased ideological conformity on college campuses. this is a chart from, professor at Sarah Lawrence College that it only goes through 2015.

00;16;40;12 - 00;17;07;12

Michael Cembalest

He's updating the numbers for me. But just look at this. The red line is the liberal to conservative ratio of the American public. There's a slightly higher line, which is the liberal to conservative ratio of first year university students. And then that skyrocketed in blue Line is the liberal to conservative ratio of university faculty. And I don't think that these numbers can inexorably separate from each other before you, before something happens.

00;17;07;17 - 00;17;36;09

Michael Cembalest

Now, I'm not in favor of politically what's taking place right now, but I just wanted to show you the backdrop. So you might think that with all these slides, I came here to praise the administration. Rather to bury them. that's not quite the case for investors. there are some issues here and here. I'm going to go through some of the problems for investors with the way that this administration is trying to solve many of these issues that they've cited.

00;17;36;12 - 00;18;04;06

Michael Cembalest

The first one is globalization is really well entrenched after 40 years, and it's going to cost money to unwind this. and even even with the best of intentions and a scalpel like precision, it would be expensive to unwind this because this has been essentially a windfall for investors through higher profits. And it's been a windfall for consumers in the form of lower import prices.

00;18;04;09 - 00;18;34;15

Michael Cembalest

And it's been painful for manufacturing communities who suffered the brunt of that. So dismantling parts of this is going to be expensive for consumers, and it's going to take a hit on profits. The other thing that the administration has had to deal with is they they haven't said as much and they refused to say as much, but they inherited a stable economy with declining inflation expectations, plenty of liquidity and very high equity valuations.

00;18;34;20 - 00;19;07;22

Michael Cembalest

And this is a chart that shows the percentile of all the different cuts you could do on, different valuation metrics for, the US equity markets. And many of the valuation measures were between the 90th and 100 percentiles evaluation. So there wasn't room for error here. And on top of that, what's happening now is coming after a period of really exceptional US equity market outperformance, around 15 years, the US has been crushing Europe and Japan for many of our clients.

00;19;07;22 - 00;19;35;13

Michael Cembalest

That's been one of the mainstays of our asset allocation recommendation. And even with the minor underperformance that's taking place this year, you can see, the these gaps are incredibly wide. And so to upset the applecart at a time of very high valuations and extended US outperformance is going to be volatile for investors. And so now let's look at the tariff issue.

00;19;35;13 - 00;19;58;19

Michael Cembalest

Assuming they stick and they may not be gone tomorrow. But assuming these tariffs stick we're back to 1950 levels or pre 1950 levels. They're most likely to be inflationary, although not all of them with 100% certainty. And I thought it was notable that that lot neck has begun to say tariffs are worth it, even if they trigger a recession.

00;19;58;21 - 00;20;21;15

Michael Cembalest

Besson's been out saying that US consumers don't have an entitlement to cheap Chinese goods. It's an indication of the fact that the cabinet members are now accepting the permanence of some of these tariffs, and are trying to get the American public to accept them. Here you can see a chart on the average tariff rate on all U.S. imports going back to around the, you know, 1900.

00;20;21;17 - 00;20;47;02

Michael Cembalest

remember that those were the McKinley tariffs. And they the inflation that resulted from them ended up crushing the Republicans in the midterms. They lost 100 seats in the 1890 midterms. And it was a third largest loss ever. But here you can see various overlays of where we are now and what tariffs could go to. And I believe the the next shoe to drop in early April will be the reciprocal tariffs.

00;20;47;03 - 00;21;14;21

Michael Cembalest

I don't know exactly how they're going to compute it. I don't know whether there's going to be carve outs or offsets. We'll see. But between the reciprocal tariffs and their tariff retaliations, we're moving in to unprecedented territory, at least from a post war perspective. And the sectors that are most exposed to retaliation are things like aircraft, machinery and parts, semiconductor manufacturing equipment, oilseed farming, plastics, resins, inorganic chemicals.

00;21;14;24 - 00;21;43;15

Michael Cembalest

These are the things where, U.S. production is. At least 25% of U.S. production is dedicated to export, rather than domestic consumption. So. I understand why they want to do something about the crossover point on the debt. I just don't think that cutting non-defense discretionary programs like USAID and firing 100,000 federal workers is going to get you a lot of bang for the buck.

00;21;43;17 - 00;22;11;15

Michael Cembalest

It may get you a lot more chaos and disruption than it's worth. And those things are minor in the scheme of things relative to entitlement, spending and interest on the debt. And here is a chart that I've showed before. It starts in the beginning, at the end of the 1960s, when the entitlement system was created. At the time, entitlements had a 1 to 1 relationship with non-defense discretionary spending, which is all the stuff the government spends money on that helps generate growth and productivity.

00;22;11;18 - 00;22;35;21

Michael Cembalest

And ever since then, like clockwork, these numbers, the entitlement spending ratio has been rising relative to non-defense discretionary spending, of which there's just not that much left to cut. So I think DOJ's working on a lot of third derivative distractions, that aren't really worth it. And so here's the part I need everybody to just, you know, settle in.

00;22;35;23 - 00;22;56;12

Michael Cembalest

Here's the part of the discussion where I want to address the real critical issue for investors. And these are two different questions, which is and I'm referring to the people the administration implementing and coming up with these policies. Are these people serious and are these serious people? I think we know the answer to the first question is yes.

00;22;56;12 - 00;23;18;11

Michael Cembalest

These people are very serious. they've done their homework. They clearly understand the Administrative Procedures Act. The the approaches that they've take to do certain things are being challenged in court, but I expect them to win more often than they lose. even though there was a decision recently that, that, a lot of those probationary employees that were fired are going to be sent back to work, at least for now.

00;23;18;13 - 00;23;42;20

Michael Cembalest

But the second question is the one that's really important for investors, because it has to do with valuations and multiples and predictability. And the question is are these serious people? And I'm not sure that the answer is yes. And I want to show you why in about five slides. So are these serious people. Trump has said the Chips act is a horrible, horrible thing.

00;23;42;22 - 00;24;02;05

Michael Cembalest

Okay. Is that a serious statement? The US, as you can see, there's a chart here on the left that looks at US semiconductor reliance on Taiwan. You can cut it different ways. You can look at all chips. You could look at memory chips. You can look at logic chips. The last part looks at advanced logic chips including indirect flows.

00;24;02;08 - 00;24;25;05

Michael Cembalest

The US is 90% reliant on on Taiwan. And so the Chips bill, which was a bipartisan effort or at least partially bipartisan, was the first step in decades to try to repatriate some, semiconductor production back in US soil. And it's in Arizona, and it's taking a while to build. And labor costs are high, but you've got to start someplace.

00;24;25;07 - 00;24;46;08

Michael Cembalest

The chart on the right is the number in thousands of semiconductor Chinese semiconductors in U.S. critical military platforms. So when you look at the backdrop here, there may be things you want to change about the Chip act, but to simply come out and say it was a horrible, horrible thing flies in the face of this critical national security issue.

00;24;46;10 - 00;25;14;26

Michael Cembalest

Chip companies are reportedly already calling their lawyers to assess whether the administration can terminate signed contracts. And the Commerce Department has laid off around a third of the chief office employees. So if this is the direction this is going, I'm not sure serious people would do this. Next issue and this is on the issue of Canada, where Trump has said we're subsidizing Canada to the tune of $200 billion a year.

00;25;14;26 - 00;25;36;17

Michael Cembalest

This can't continue. The only thing that makes sense is for Canada to become our cherished 51st state. Okay, after I read that long tweet on Truth Social, I picked myself up off the floor. And then I started to look at the actual numbers and, Canada actually represents, as you can see on the left, one of the smallest components of the US trade deficit.

00;25;36;19 - 00;26;13;06

Michael Cembalest

And despite it being one of the largest trading partners with the US, the implication being that the terms of trade on a bilateral basis are fair and the US actually runs a trade surplus with Canada. Once you remove energy and look, the issue with energy is produce more of it as you can. But Canada sells us oil and critical minerals and zinc and solarium and nickel and vanadium, and energy and critical minerals purchased from Canada by the US is a deliberate strategy by the US to reduce reliance.

00;26;13;06 - 00;26;45;29

Michael Cembalest

And when we used to get those things, which is China and the Middle East, and so the notion that somehow bilateral energy deficits with Canada represents subsidies, it makes no sense economically, it makes no sense politically. And it doesn't even make any sense geologically. And so I'm not sure that serious people would say this, un doge. I mean, again, everybody I think that I've talked to understands the need for eliminating fraud, waste and cutting certain government programs.

00;26;46;02 - 00;27;07;26

Michael Cembalest

But, what's come out of Dodge recently? Massive amounts of misinformation on this whole Social Security payment. The dead people issue. We had a link in the prior I in the market to a, the Boston College Center for Retirement Research debunked all of those issues. there have been calls from Doge people to impeach judges when those actions were judicially reversed.

00;27;08;03 - 00;27;32;28

Michael Cembalest

I'm not sure that a serious person would do that. The Doge website reports of its savings are riddled with errors and constantly changing, and now the website is taking steps to make some of its errors harder to find. And just as an example, Doge fired and then rehired 350 people at the National Nuclear Security Administration, including people who assemble and reassemble nuclear warheads.

00;27;33;01 - 00;28;08;12

Michael Cembalest

Right? Not a serious thing. then is a strategic crypto reserve. Is that really what the country needs right now, given all the challenges that it's facing? Or is that simply or reward to the sector that contribute to the most of of across all the sectors to the president's reelection campaign? Citibank recently was instructed to freeze accounts for habitat for humanity, United Way and the New York Department of Taxation and Finance because they were recipients of green energy grants from the EPA, and they're now being investigated for possible fraud.

00;28;08;15 - 00;28;37;12

Michael Cembalest

There was a directive to Columbia University to put the Middle East and African Studies Department into receivership. And then recently, some European tourists, the United States, were detained by Ice, held for several weeks and then deported. I'm not sure that's great for, you know, tourism into the United States. and the Trump administration is also talking about, I read this morning all trading, altering the computation of GDP, in ways that it considers more favorable.

00;28;37;20 - 00;29;07;29

Michael Cembalest

So I'm not sure serious people would be doing these things. And then on science and medical leadership, some of the decisions to cut funding to the NIH, could have effects US science primacy for generations. When I first saw that indirect costs were, on average, 60% of direct costs. I asked the same questions the Trump administration did. Gee, those indirect costs seem kind of high.

00;29;08;01 - 00;29;48;05

Michael Cembalest

But the immediate response of cutting grants and funding, seems like an extreme and preliminary, you know, an overly cautious reaction to that. The NIH has already stopped issuing new awards and has begun withholding funds from grants that had already been awarded. And just as a reminder, the NIH has supported 99% of all the drugs approved by the FDA from 2020 to 2019, and nearly all major medical breakthroughs over the last few decades, including treatments for chronic pain, autoimmune diseases, GLP weight loss drugs, melanoma treatments, RNA vaccines, cervical cancer, you name it.

00;29;48;07 - 00;30;11;05

Michael Cembalest

And then as it relates to RFK Jr, a lot of you know how I feel about that, he said. Studies have found that vitamin A can dramatically reduce measles, measles mortality. Here's the thing about RFK that where I question if he's a serious person, most of his factoids have kernels of truth in them, which then aren't applicable to the thing that's being discussed.

00;30;11;08 - 00;30;33;21

Michael Cembalest

And this is a perfect example, because vitamin A supplements can reduce the mortality risk of measles, but mostly in Low Countries where a lot of people have vitamin deficiencies in the first place. In the US, only 0.3% of all people are vitamin deficient, which is why studies have OECD countries show no benefit for vitamin A in measles outbreaks.

00;30;33;24 - 00;30;57;29

Michael Cembalest

So, you know, I am, I'm one of those people. That was I was born in 1962. So I'm one of those people where the MMR vaccine may have fading efficacy, but I have a certain condition where I can't take live vaccines. So I'm actually at risk of having a fading efficacy of my initial MMR vaccine. But I'm unable to get a new one.

00;30;58;07 - 00;31;22;01

Michael Cembalest

And so if there's a measles outbreak and I get sick, I know exactly who to blame. So, here's another one. A lot of people are upset about the chart on the left, and I understand why these are the seven largest pharma companies. And, what you can see is the US taxes they paid versus the foreign taxes they paid.

00;31;22;03 - 00;31;47;17

Michael Cembalest

And so this is one of the things where people say, that's why we need tariffs. Because U.S. companies are gaming the system. Are US pharma companies gaming the system by shifting profits offshore? Yes. But when did they start doing that? As you can see on the right, they started doing it after Trump's own tax bill was passed based on a low, highly favorable tax, on international intangible income.

00;31;47;19 - 00;32;19;04

Michael Cembalest

And so the US pharma trade deficit didn't start skyrocketing out of control until the 2017 tax bill, solving it by just putting tariffs on the entire pharmaceutical industry is not a serious way of trying to fix this problem. And then, you know, over the last 72 hours, we've had this executive order with respect to law firms whose partners participated in Trump prosecutions or investigations Perkins Coie, Paul Weiss Covington and Burling.

00;32;19;06 - 00;32;53;04

Michael Cembalest

And what I've listed here is a bunch of the components within those executive orders. So far, five of them have been challenged, and a judge has granted a temporary restraining order. but when you read some of the things in these executive orders, limiting access of these law firms, personnel to enter government buildings or speak to government employees, or investigating third party contractors to see if they have business with some of these law firms unrelated to their government work.

00;32;53;06 - 00;33;22;16

Michael Cembalest

I this is not this is not a serious way of dealing with the Justice Department, in my opinion. And the reason this matters for investors, you might be saying, why does any of this matter for investors? Here's why. The rule of law is an integral part of the global primacy of U.S. commerce. And this charts one of the most important charts that I'm always showing investors who are panicked about the dollar as the world's reserve currency.

00;33;22;18 - 00;34;05;02

Michael Cembalest

The most important number to look at here is the second bar. The US represents around a quarter of world trade. the US represents a much higher share of cross-border loans, international debt securities, FX transactions, foreign exchange, reserve investments by other central banks, trade invoicing, Swift payments, you name it. The United States. It has a as a primacy role in global commerce because if it's adherence to rule of law, and if that's if the perception of that starts to change, there can be an impact on all of these things multiples, portfolio flows, foreign direct investment, and a lot of things that the administration says that they care about.

00;34;05;04 - 00;34;32;23

Michael Cembalest

So that's what matters for investors. All right. Now, for the remainder of the presentation, I want to talk about how the markets are. By the way, nobody wanted to do this, present this webcast with me. And now I think you can see why, we're going to review how the economy's responding, how the markets are responding, and what are some of the pro-growth, productivity enhancing policies that the administration may pursue that are still to come that will offset some of the negative stuff they've been doing so far?

00;34;32;26 - 00;34;59;28

Michael Cembalest

Well, first, it's really important to point out that A, that this is my preferred high frequency indicator of the economy. it comes from the Dallas Fed and it's got retail sales, fuel sales, electricity output, unemployment claims. And it's very stable. As if anything, it's actually kind of ticking up. So contemporaneous real time measures of U.S growth still look good.

00;35;00;02 - 00;35;24;13

Michael Cembalest

What's changing is a rapid shift in some of the leading indicators, some of which are surveys and could reverse. But I just want to show you what they are. I think the first and the first leading indicator we need to talk about is inflation expectations, because this is what puts the fed in a box, which is if growth weakens at the same time that inflation expectations are going up, that's difficult.

00;35;24;13 - 00;35;53;18

Michael Cembalest

If you're if you're in charge of monetary policy on the left, you can see surveys of prices paid in both the manufacturing and services sector. Again, to be clear, nowhere near the surge that took place, during the Biden inflation period of 2021 2022. But those numbers starting to rise again. And then on the right, some of the University of Michigan and New York fed surveys of of medium term and long term inflation expectations, the short term ones are rising.

00;35;53;18 - 00;36;24;23

Michael Cembalest

But now some of the medium term inflation expectations are rising too. And some important actual measures of inflation are starting to tick up. This one looks at the producer price report and digs in, and looks at what's called stage three producers who buy intermediate inputs that are affected by tariffs. And maybe some of this is just people buying in advance of tariff imposition.

00;36;24;29 - 00;36;40;24

Michael Cembalest

But these stage three goods are plastic bottles, rubber hoses, tires, concrete, structural steel, motor vehicle parts wiring devices. So you can see that these stage three input costs are beginning to go up again.

00;36;40;26 - 00;37;05;27

Michael Cembalest

How are consumers responding? I tend to not get too carried away with this kind of stuff, because they tend not to be great leading indicators of what happens to, equity markets and credit markets. But I did want to show you that consumer sentiment is rolled over. And then on the right one of the questions in the University of Michigan Sentiment survey is, what do you expect to happen in the unemployment rate over the next year?

00;37;05;27 - 00;37;38;09

Michael Cembalest

And that number has imploded, to one of the worst observed nations on record since 1990. So, people are the consumers. Households are expecting a real implosion in the job market. so we'll see. So far, the job markets are pretty stable. My favorite leading indicator, and it's my favorite because it's the one that has the closest relationship with what equity markets do next, was rising recently and then just rolled over.

00;37;38;09 - 00;37;56;06

Michael Cembalest

And it's the new orders less inventories component to the ESM. And so for people that follow this kind of stuff, it makes sense. What are companies doing in terms of their order books for the the orders that they're getting for new equipment and the orders they're putting in for purchasing new equipment, less the inventory accumulation that they're doing.

00;37;56;12 - 00;38;24;28

Michael Cembalest

So and that number is rolled over. And then, as you can see on the right, the small business, the NFB Small Business Survey, perception of capital, future capital spending plans surged after the election. But then that optimism has cratered again to one of the lowest levels on record. And then what's been happening in the actual equity markets? Well, we've had a relief rally since last Friday.

00;38;25;00 - 00;38;49;24

Michael Cembalest

the S&P corrected by around 10% recovered, 2 or 3%. The US has been underperforming, the rest of the global equity markets. And then there's been a much bigger correction in, in the mag seven stocks. And just to touch on that a little bit, here is a valuation chart. And so this for for investors this is actually interesting right.

00;38;49;24 - 00;39;15;06

Michael Cembalest

Because if you look at that gold line the Mag seven PE ratios have gone way down. So for people deploying money at least since 2018 this is one of the lowest valuation environments. If you believe the forward earnings projections and then the S&P ex the Mag seven you know has has corrected modestly compared to where we've been. some I think there's more to come here obviously.

00;39;15;06 - 00;39;40;16

Michael Cembalest

But Trump's Department of Justice filed a brief arguing that Google should be forced to divest of of Chrome. and also no longer be able to make their default search engine payments to Apple and things like that. That may be negatively affecting sentiment, but one of the biggest issues facing the Mag seven stocks is what's happening with Tesla.

00;39;40;19 - 00;40;09;29

Michael Cembalest

the JP Morgan investment Bank is forecasting another 50% decline in the stock to just $120 a share. That was a report that they issued last week. And then I've shown here on the page there are some ferocious sales declines outside the United States for Tesla. looking at January, February sales down 70% in Australia, 70 something percent in Germany, 50% in China, 40 to 50% in Scandinavia, 25% in France.

00;40;10;02 - 00;40;38;06

Michael Cembalest

This is kind of a global schadenfreude, a reaction to what Musk has been up to. and so, and then down 11% in the US. So, that's been an issue for, for Tesla as well. The a lot of the questions we get obviously is about what's happening with policy rates and then what's happening with ten year interest rates.

00;40;38;09 - 00;41;03;04

Michael Cembalest

This chart is important to understand it. There's only been about seven cycles in which the fed has eased like over the last 30 years. And almost every time the fed eases, you start the clock and then the ten year either stays flat or goes down. This time the ten year started to rise and it started rising. Around the time that it became clear that Trump was likely to win the election.

00;41;03;07 - 00;41;31;20

Michael Cembalest

This was a barometer, in my opinion, that, the markets were expecting inflationary policies out of the administration. and I still think that's the case. We still have a ten year that's around 1% higher than it was, since the Fed's first cut. we may end up with lower rates on the ten year, but in the beginning of the year, the market perception was that you could get a growth and productivity surge that would allow rates to go down.

00;41;31;23 - 00;41;52;27

Michael Cembalest

in a strong environment. I no longer think that's the case. We're going to we're going to have rates of four and a half to 5%. And the only reason that rates go below four is if you have a growth collapse. so that kind of benign decline in rates I think is off the table right now. And, high yield spreads are starting to rise, but from very low levels.

00;41;52;27 - 00;42;23;03

Michael Cembalest

And, and I wouldn't describe the, the increase in high yield spreads as, as particularly problematic right now, they have risen to just 300 basis points for double B in single B spreads, which I don't think is is anywhere near fair value. But as a as a response to what's going on, this is a rather tepid response. And one of the reasons is that default rates in high yield and leveraged loans and private credit are still running at very low rates of around 2%.

00;42;23;05 - 00;42;46;22

Michael Cembalest

and the Europe's been outperforming the US so far this year, but not by more than it has in recent years, where kind of every once in a while Europe will outperform the US by 10% or so and then roll over again. Now what's happening here this time around is a little more interesting. You're seeing a move towards more European stimulus and things like that.

00;42;46;24 - 00;43;17;25

Michael Cembalest

But, I don't know. I would rather take my chances outside the US. in, in, in places like Japan, where there are some interesting corporate governance changes going on than, than in Europe. But that said, there the US, this chart is on the PE discount of Europe versus the US and Europe, even after it's outperformed this year, is still trading at a 35% PE discount to the US, which is kind of remarkable.

00;43;17;27 - 00;43;46;16

Michael Cembalest

So let me close with what are so what are the pro-growth productivity policies of the administration that everyone thought were going to be rolled out contemporaneously with the tariffs? that would eventually kind of make investors and profits and multiples, react positively. So let's talk through those. One of them is the pace of government regulation. And that takes time.

00;43;46;18 - 00;44;18;14

Michael Cembalest

And the impacts are long dated. the pace of government regulation obviously should slow. This is a chart on economically significant rules by presidency. Trump was on a low GOP like path until Covid hit. And then in the beginning of 2020, obviously, all of a sudden there were all sorts of Covid related regulations that took place. But Trump during his first administration, was on track to be a low regulation president.

00;44;18;16 - 00;44;41;11

Michael Cembalest

And I, I fully expect that to be the case here as well. Why wouldn't it be? They're dismantling a lot of the entities that that do regulating in the first place. I on this one, I do want to mention there was a study that came out from Yale's budget lab yesterday, about how the Trump administration might want to cut, headcount at the IRS.

00;44;41;14 - 00;45;05;19

Michael Cembalest

So if the IRS shrinks by 50%, which is a workforce decrease of about 50,000 people, Yale Budget Lab estimates that this could result in a $400 billion forgone revenue, over the next ten year budget window. And if the lack of IRS resources leads to a substantial increase in noncompliance, which is tax evasion, the numbers could be much higher than that.

00;45;05;21 - 00;45;37;25

Michael Cembalest

So, something to keep an eye on. Basel the Basel three project will probably be abandoned. certainly. I don't think this administration has mentioned anything they want to do to support it that could boost the credit supply as banks reduce accumulated capital. So if I can just explain for a minute the Basel three proposal would have required the big banks, the category 1 or 2 banks to increase, their capital by about $2 trillion.

00;45;37;27 - 00;46;08;07

Michael Cembalest

And in advance of Basel three being implemented, a lot of banks began to accumulate the necessary capital to do that. If Basel three is now dead, presumably that capital would flow back out into the economy and terms and conditions on credit would loosen, which could help growth. I think they'll be. I think Trump will continue to negotiate deals with other countries where to avoid tariffs if they make sufficient foreign direct investments in the US.

00;46;08;10 - 00;46;29;27

Michael Cembalest

that would be helpful. In other words, more examples of the of the deal that was struck with TSMC to start investing in US semiconductor production. you can see in Trump's first term, there was a surge in the inward share of global foreign direct investment in the United States. And then again during the period of the post-Covid focus on domestic resiliency.

00;46;29;29 - 00;46;34;18

Michael Cembalest

So more of those deals would help.

00;46;34;20 - 00;46;58;25

Michael Cembalest

There is a lot of discussion now about European rearmament, which is being imposed on them essentially by the United States, that if it happens, that would be an indirect benefit to U.S. defense contractors, at least so far as we can tell. If you look at European weapons spending, since 2022, more than half of it went to U.S. defense contractors.

00;46;58;28 - 00;47;21;05

Michael Cembalest

So, if they continue to rearm as much as they may try to spend a lot of that money domestically, they I think, would be required to spend some of that money with U.S. defense contractors simply because they don't always have all the products and services and procurement equipment that would be needed. I think a lot of people are familiar with the administration's view on oil and gas production.

00;47;21;08 - 00;47;45;06

Michael Cembalest

Although if you if you look at, crude oil, natural gas and NGL production, it went to an all time high under the Biden administration. The Biden administration was not about sticks against the oil and gas industry. They were focused on incentives for the renewable industry to the tune of anywhere from 1 to 2 trillion, depending upon how you compute them.

00;47;45;09 - 00;48;14;06

Michael Cembalest

but they weren't as restrictive in terms of actual oil and gas production as people sometimes think, which is why Besson's target is only a 5 to 7% increase. in overall fossil fuel production compared to current levels. And since some of that is going to end up exported, through LNG relationships, I don't see how much benefit that's going to have in terms of reducing, energy costs.

00;48;14;08 - 00;48;38;11

Michael Cembalest

Now, this will be interesting. If they can do this, I would really kind of tip my hat to the administration over the last few years, it's gotten close to impossible to build transmission for renewable projects or pipelines for oil and gas projects. And the Trump administration says they're focused on permitting reform. If they can get that done, that would be impressive.

00;48;38;14 - 00;48;56;02

Michael Cembalest

I'm going to watch this chart, on on, pipeline growth and transmission line growth and we'll see what happens. That's a kind of a long dated benefit. But these are the kind of things the administration says they're going to focus on, which would be growth enhancing if they could get them done.

00;48;56;04 - 00;49;27;25

Michael Cembalest

And as it relates to the stimulus bill, this is a brutally complicated chart. So I'm not going to walk through it. I'm simply going to say that even if they can get this reconciliation bill passed, extending tax cuts is not stimulus. And that's all they're really trying to do, is pass a reconciliation bill, which will extend the personal and corporate tax cuts that were embedded in the 2017 bill and everything else outside of that is reshuffling the deck there.

00;49;27;25 - 00;50;03;22

Michael Cembalest

And this is one iteration, right? The bill hasn't passed, but this is one iteration that we've written about recently. And what's going on in this chart is, they're they would aim to cut, about 800 billion for Medicaid, get rid of the Biden student loan forgiveness, and increase the, at the same time that they would increase the salt cap, they would claw back about 500 billion from Biden's energy bill, mostly EV charging other EV projects and a little bit of a clawback on the wind and solar, ITC, PTC incentives.

00;50;03;25 - 00;50;20;14

Michael Cembalest

They would want to have no income tax on tips. So manufacturing incentives mean maybe no taxes on overtime, an increase in homeland security. But most of this is just deck shuffling with a modest increase in the deficit compared to the CBO baseline.

00;50;20;16 - 00;50;47;11

Michael Cembalest

So wrapping up. I think we titled this presentation chaos versus Grand Design. I think chaos is part of the grand design. There's a deliberate amount of chaos in this grand design that investors are going to have to get used to, and which credit spreads and p multiples and valuations of real estate and cross-border capital flows will eventually start to reflect as well.

00;50;47;14 - 00;51;08;03

Michael Cembalest

So what do we have here? I think we have a growth slowdown. JP morgan's investment banking economists have already started to publish on that. I think we get a growth slowdown but no recession. the economic consequences of some of this chaos are hard to predict. Remember, the tariff rates are now going back to before all or most of us on this call were born.

00;51;08;05 - 00;51;29;15

Michael Cembalest

I do think there's another shoe to drop with the imposition of some kind of reciprocal tariff. A big issue was whether or not the administration includes that taxes in Europe as part of that reciprocity. And but just to be clear, corrections like we've had are not uncommon over the last hundred years. A 10% correction like the one we've had happened more than half the time.

00;51;29;15 - 00;52;00;17

Michael Cembalest

It happened at 60% of all years. And a 15% correction happened 40% of the time. And in years with those 10 to 20% corrections, full stock market returns have still averaged 15%. So the fact that a correction is taking place doesn't necessarily tell you that the full year returns are problematic, or there's more bad news to come. I personally think a 15% decline from the peak levels, which is about 5200 on the S&P, would be a clearer sign of capitulation.

00;52;00;20 - 00;52;31;23

Michael Cembalest

I'd also like to see high yield spread credit spreads go above 400 basis points. Those are the kind of things that would make me personally feel more comfortable advising investors to take some of their spare liquidity and put it to work. And the other thing is, as I have been a stronger advocate for a US centric portfolio than almost anybody in the on the buy side in the industry, but the US is 60, around 63% of a global diversified equity portfolio.

00;52;31;23 - 00;53;08;17

Michael Cembalest

If you believe the MSCI weights, if you're 85% plus, I would consider some rebalancing at this point because I think that the administration, oddly enough, with its American America First agenda that may not translate into American first outperformance in the equity markets. And then one last comment. you know, I we've written a lot about how the hyperscalers may have overspent in the near term relative to demand for compute infrastructure, but the productivity benefits for the corporate sector from AI adoption should gradually start to show up in earnings.

00;53;08;19 - 00;53;32;19

Michael Cembalest

I do believe there's more substance to that than the last round of stuff we had with hydrogen and the metaverse and things like that. I do think that there are some real productivity and earnings benefits to come from AI adoption. and that that could partially offset some of the costs related to a higher tariff world. the next project that we're all going to work on, on my team is health care.

00;53;32;21 - 00;54;01;26

Michael Cembalest

And as you can see in this very messy chart, this looks at, consensus forward return on equity on the x axis relative to price to book ratios on the y axis. Bottom line is that most of these things tend to move together. Valuations tend to go up as you make more money. but the cheapest sectors on this chart are health care providers, the overall health care sector, large cap pharma and biotech.

00;54;01;29 - 00;54;26;03

Michael Cembalest

And, it's going to require us to do some deciphering of how this administration is going to deal with, its ability to have Medicaid and Medicare CMS re negotiate the price of, of non generic drugs. So anyway, that's our next project. Thank you all very much for dialing in. I hope there was something that was triggering and offensive to just about everybody.

00;54;26;05 - 00;54;37;05

Michael Cembalest

And, I appreciate your continued. following of our investment research. That's all for today. Bye.

00;54;37;07 - 00;54;48;22

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