Alternative Market Briefing

The Big Picture: What to expect in the U.S.

Monday, December 30, 2024

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Roy Niederhoffer Opalesque Geneva:

Roy Niederhoffer, founder of R.G. Niederhoffer Capital Management, a 30-year-old New York-based quantitative trading advisor, takes a wide look at U.S. equities, the U.S. economy and how the next administration might manage it.

The funny part about the Trump economy is that there are a lot of conflicting ideas that could be good or bad for the U.S. economy, he says during a recent Opalesque webinar with Michelle Makori and Matthias Knab.

Tackling massive debt

One of the biggest problems in the U.S. is the massive national debt, the total amount of outstanding borrowing by the Federal Government, currently at some $36tln. There are also unsustainable deficits because of the interest financing of the debt.

The upcoming Government Efficiency Commission is hoping to institute large-scale layoffs of federal employees, as part of a solution to reduce the debt. Getting rid of 90% of government employees could be a positive for the government spending problem, but that would lead to less demand when millions of government employees have lost their jobs. That would slow the economy and affect the stock market. "That's one example of the way Trump can be a mixed signal for equities," Niederhoffer notes.

A positive environment for businesses

However, one net positive for equities is Trump's clear emphasis on a pro-business, low-tax, deregulatory environment. Businesses suffer from the cost of regulation, especially the energy sector which is highly regulated and is coming against heavy competition from overseas. "We have to produce power as we have never done before," he says, and that means improving the grids and investing in solar and nuclear.

The threat of tariffs may be the cause of volatility

Trump has promised to impose a new slate of tariffs as soon as he enters office in January 2025, such as 25% tariffs on Canada and Mexico and an additional 10% tariff on goods from China. Tariffs are a fine way to get concessions out of other countries, says Niederhoffer. At the same time, it would be good for the U.S. to build back its manufacturing, especially in strategic industries such as robotics.

The president-elect has warned BRICS nations of 100% tariffs over plans for a new joint currency to challenge the US dollar, the world's reserve currency. Niederhoffer does not believe a competing currency is likely to happen, as the member countries do not have the greatest records of keeping their currency on a reasonable supply level and free of state control.

The threat of tariffs is certainly a potential cause of volatility, but a lot of Trump's ideas are based on negotiation - as is the case for many people in New York, he explains. "He has a very Manichean view (seeing things in black and white) of the world and a great tendency to negotiate in that way, to take the extreme position and then retreat from it to a more reasonable negotiation point. So when we see 100% tariffs, maybe we'll get a 5% tariff if we get a tariff at all, and no one will notice it because the dollar will rally. So I'm unsure as to whether the whole tariff thing is Trump trying to get some concessions. Obviously, if it happens, it is a cause of volatility."

The only way to solve this problem is to print

Concerning inflation, the Fed is not currently in an easing mode. The Producer Price Index (PPI) is coming back up again, and M2 is beginning to increase again after the last couple of years' drop (M2 is a measure of the money supply that includes cash, checking deposits, and other deposits). "Milton Friedman was pretty clear about this. When you increase the money supply, you can be sure you're going to have inflation."

The major problem is the country is heading toward the worst deficit, probably "south of $3.5tln". This entails higher interest expense for the U.S. government. It will spend about $1.2tln on interest payments in 2024 - a record amount that is set to increase. The average interest rate on all the debt is 3.35%.

This cannot be solved through higher taxes, especially since, historically, it is hard for the U.S. to collect more than about 17% of GDP in taxes, no matter what the actual rates. Meanwhile, the country spends a lot more than that. This is where the Department of Government Efficiency will come in.

Cutting spending and growing the economy may not be enough to solve the problem. "I mean, we need 5 or 6% growth for a long time to make this 44% of GDP spending go away," Niederhoffer says. "And we have to make sure that we don't spend even more if there's more economic growth."

"The only way for us to solve this problem is to print," he notes. However, while printing would be good for the equity markets, it would not be so for interest rates, "because selling all this, the debt is competing with corporate debt issuance and it makes interest rates higher."

The thing he is most concerned about is "a world in which stocks just start rising inexplicably," while profits and price-to-earnings ratio (P/E) are not. "And stocks just go up and up and up because the dollar is depreciating because there's just more of them." It may be good for equity investors, but they would have to keep up with the stock markets, as cash would lose real value. That is why he has been bullish on hard assets, such as collectables and gold, for years. And then there is Bitcoin, against which the dollar has momentously devalued, which he has held in his portfolio for years as well.

People are expecting one more rate cut, but that is not going to solve the deficit problem with interest financing costs. As there is more liquidity coming into the system, the country is spending it on the government and the deficit problem. "And so I'm not so sure that we're not going to have some inflationary pressures that will make another rate cut beyond that difficult."

He is optimistic about Trump's picks. For example, hedge fund manager Scott Bessent, who is expected to fill the role of Treasury secretary, is an advocate of deficit reduction. Like him, many of the other appointees are from the business world and will encourage innovation as opposed to regulation. "The SEC should balance protection and innovation," Niederhoffer says.

The case for digital currencies

He sees the crypto sector as one that will appreciate exponentially. "And so I'm suggesting that it become a global reserve currency. Now, we already have Trump talking about that. And other smaller countries are doing it." (Three countries have fully launched a Central Bank Digital Currency (CBDC)-the Bahamas, Jamaica and Nigeria.) However, U.S. corporations are still not putting their corporate treasury into digital currency. Eventually, some will do it.

Digital currencies have strong upsides. "Let's say that Bitcoin goes up 20 or 30 X, if you've 4 or 5% of your portfolio in Bitcoin, you're back to 100%. And it doesn't matter what the rest of your portfolio is," he says. Furthermore, the downside risk of Bitcoin is probably lower now than it's ever been, with the expected regulatory easing. "There is a tremendous bullish case to be made, and it's a tremendous safe haven asset."

The Trump administration may well set the Bitcoin it is holding as an official government strategic reserve asset. He believes lobbying will eventually cause that to happen, and that would be a good thing. Of course, it would have been even better if that had been done earlier. For example, Bitcoin's value in US$ went up 128% this year alone and by more than 1,200% in the last five years.

"Bitcoin, by the way, is not an inflation hedge. It's a money supply hedge," Niederhoffer notes. "So it's very important to remember that when the Fed starts fighting inflation. In times of inflation, Bitcoin hasn't done so well. It's when the money supply increases. Like right now, M2 has been rallying. That's why Bitcoin is going up. It's liquidity flowing into the system that drives the price of Bitcoin, not inflation."

Watch the rest of the interview here, where Roy discusses portfolio construction and more:
The Trump Portfolio Challenge: How to Balance Profit and Protection

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