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A few days ago, just as the bombs were hitting the Middle East, Scott Bessent, the US Treasury Secretary, held private meetings with top Wall Street financiers.
He had an important message, I was told: don’t sell assets, as markets will quickly recover from the slump – just as they did a year ago after the so-called “liberation day” rate shock.
Was he right? Yes, given Wednesday’s stunning relief rally. As investors analyze the recent dizzying events, the first lesson to note is that the ‘Taco trade’ is still alive and well. Trump (still) always goes out and changes policy when there is market or political opposition, to quote the acronym coined by my colleague Robert Armstrong.
That’s because Donald Trump sees stock prices as key – if not the key – barometer of his success, more so than any president before him. Bessent is also obsessed with bond yields. Hence the ‘peace talks’ with Iran.
And recent events offer two other lessons. One is that the financial system has recently shown more medium-term resilience than ever expected, partly due to extensive recent road testing.
Think about it: asset prices have fallen repeatedly after shocks like the Covid-19 pandemic, Russia’s invasion of Ukraine and those tariffs. But on each occasion they recovered without a systemic crash. That could change given the explosion of non-bank financing. But right now it supports a BTD – Buy The Dip – mantra.
A third point is that while Trump’s erratic actions have increased anti-American sentiment and distrust around the world, non-Americans continue to gobble up American assets.
This could also eventually change; Long-term risks to the dollar’s supremacy are increasing, not least due to America’s nearly $39 trillion debt burden. But as risk-off sentiment explodes now, investors are behaving as if U.S. capital markets are a more liquid and safer choice than most rivals. This is very ironic considering that Trump himself is a major source of risk.
But in addition to these three points, there are now three additional lessons for investors that are less reassuring. One of these is a theme that analysts like Jeff Currie of the Carlyle Group have emphasized: molecules matter – and so do they cannot be printed.
Because while services and cyber innovation drive 21st century growth, they are underpinned by chemical and physical processes that have (until recently) often been ignored.
It is therefore doubtful whether markets have really taken into account the consequences of the supply chain disruptions that have already occurred since the last month of war, not only in the energy sector but also in petrochemicals. Hence European leaders’ fear of stagflation.
Then: bottlenecks are more important than before and many of them are beyond Western control. Yes, Washington dominates the global financial centers, through the dollar. But it does not (currently) control the shipping bottleneck for energy and chemicals, namely the Strait of Hormuz; nor major pressure points around rare earths and pharmaceutical supply chains, as we learned last year.
These vulnerabilities must be priced in; Indeed, I have been told that a major reason for the decline in private dealmaking is the fear that this is not the case. But one big problem, as Gina Raimondoformer Secretary of Commerce recently told the Council on Foreign Relations that investors do not reward companies that invest in supply chain resilience because it is so difficult to measure in advance.
And while economists continually model macro and micro trends, they have paid less attention to them ‘meso-economics’, to quote the economist William Janeway – i.e. the factors in between, including supply chain networks. The war with Iran shows that this must change.
Then there’s the final lesson: Investors need to get better at imagining – and estimating – once unimaginable disasters. This is difficult. No business school teaches students how to model something like a presidential threat eradicate a civilization. And the success of the recent Taco trade will no doubt make many even more reluctant to do so.
But the grim reality is that even if a ceasefire is reached in Iran – a big “if” – peace appears elusive. “Because most people tend to have this short-term perspective, they now expect, and the markets are pricing in, that this war won’t last long and that when it ends we will go back to ‘normal’,” writes Ray Dalio, founder of the Bridgewater hedge fund. “[But] we are in the early stages of a world war that will not end anytime soon.”
Some are preparing for that. The financier Bill Ackman is reportedly developing a “complacency trading fund” to trade doomsday risks. But most investors simply still can’t imagine the disaster. And if you take the long-term historical view, we may now be “in a transitional phase… roughly analogous to the 1913-14 and 1938-39 periods,” Dalio says. Gulp.
So celebrate that Taco moment and Buy The Dip. But buying small disaster insurance is also a wise bet.
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