Selling the dip on Trump tariffs

Notes on DOGE

Late on Friday night, Donald Trump announced 25% tariffs on Canada and Mexico and 10% tariffs on China. The market, having just retested the year’s high in the S&P 500 and in BTC, was positioned complacently going into the announcement, with the view that Trump’s tariff threats were mostly a negotiating tactic. As it turns out, Trump was very serious about imposing tariffs, and wasn’t swayed by Treasury Secretary Bessent’s proposal of graduated tariffs that start small and increase every month. The prevailing view that Trump only wants to pump the markets higher turned out to be misguided. On the contrary, perhaps he has the long term plan of taking pain early in his administration (via tariffs and DOGE) with the view that the economy will gain later on (when tax cuts pass through Congress and yields compress from the efforts of DOGE).

We have officially exited the honeymoon phase of Trump’s election and are now entering a traditional risk off regime where tariffs, not economic data, become the main driver for the markets. In other words, we will be trading “tariff on, tariff off” for the next few months. The main questions for traders will be the direction of the size of tariffs going forward (Trump has threatened to increase them by 5% if trading partners retaliate), and how long they will be in place before they get ratcheted lower. My view is that they will remain in place for several months with the risk of increasing, as Canada has already pledged to retaliate and China is suing the US in the World Trade Organization, responses that only escalate the situation. The best the market can hope for is a partial rollback of tariffs once negotiations with trading partners conclude. Trump believes that tariffs are the key to reviving and reshoring US manufacturing, and this can only be achieved by making tariffs permanent. His public statements make it seem like the tariffs are about fentanyl entering the US, but what he really cares about is the trade deficit. It may take days to weeks for this reality to sink in with the market, and the price discovery process will be volatile and painful.

What did we learn from the market reaction to the last trade war on China in 2018? Over the course of March to August 2018, Trump imposed tariffs on a total of $184b in Chinese goods. The initial fear of a trade war sent the S&P 500 down 9% from its local high in March. Trump imposed 10% tariffs on another $200b of goods in September, but by then the market had become desensitized to tariff shocks and had shifted its worries to growth fears and tightening financial conditions.

S&P 500 Mar-Dec 2018

Today’s tariffs are on $1.3T worth of goods that the US imports from Canada, Mexico, and China - 7 times the value of good tariffed in the initial 2018 salvo. It would be reasonable to expect a deeper selloff in equities than 2018’s 9%, especially considering the elevated valuations we are seeing today. Despite the 100 pt gap lower on today’s open, SPX futures are still less than 3% lower from all time highs, which means that this is a dip to sell, not to buy.

Source: Bloomberg

This morning I alerted paid subscribers in the Substack chat about portfolio trades to manage my risk and profit from the volatility that I’m expecting. For those who trade single stocks, I found Citrini’s post today to be a good guide for which companies will win and lose from tariffs.

The growth and inflation impact of tariffs

Tariffs are essentially a tax paid by US importers of foreign goods. Some of the tax gets passed on to consumers and results in inflation, but importers also are forced to eat some of the tax in the form of lower margins. As a result, tariffs are contractionary for growth and inflationary for price on a one-time basis. Piper Sandler estimates a cumulative impact on prices of 0.9%.

Source: Piper Sandler

Joseph Wang did a great interview on the podcast Monetary Matters, where he discussed the high likelihood of tariffs and their economic impact. If you have 50 minutes of time, I highly recommend a listen. He believes that the growth contraction will outweigh the inflationary effect when it comes to Fed policy and the direction of yields. Long Treasuries is still a viable trade, but its performance relies on growth fears weighing on risk assets, as well as China not resuming its sales of Treasury assets.

Elon discussing DOGE on X Spaces

Elon Musk did a Spaces on X to discuss DOGE with Joni Ernst (Senator of Iowa and chair of the Senate DOGE caucus) and Vivek Ramaswamy. I think DOGE will be one of the most impactful aspects of Trump’s presidency, so I tuned in and took some notes. Here’s a chronological paraphrasing of the conversation. Anything in brackets is my own commentary.

[The Spaces started with Elon's son X in the background, which was kind of adorable. Elon told him he needs to speak to some people on the internet.]

Elon says several billion of cost savings have been locked in. [A lot of this was from DEI related spending]. He says this is good progress, but acknowledges that this is far from enough as the deficit is in the trillions.

Elon highlights a "fourth branch of the government", referring to the government bureaucracy that controls the spending decisions of the government. He believes that government should be ruled by elected officials, not the unelected fourth branch of bureaucrats.

Joni Ernst highlighted USAID (U.S. Agency for International Development, which allocates and distributes foreign aid) as a source of wasteful spending. Supposedly USAID obstructed DOGE's and Joni's efforts to dig into the data containing their expenses. It took 4-6 months just for Joni's staff to be allowed to access a limited amount of data. She estimated that 50-60% of funds going to global NGOs doesn't even directly go towards the aid or work [the funds probably went towards other expenses such as administration, mgmt salaries, and fundraising].

[USAID has a $22.5b budget which is 0.2% of the total US federal budget - a small slice of the pie].

Ernst - 6% of federal workforce shows up to office every day. US has a lot of government buildings and leases that are not being utilized.

Elon called USAID a ball of worms that can't be untangled and therefore must be deleted. He recommended to Trump that they should shut down USAID, and Trump agreed.

Ernst proposed that the programs worth keeping should be moved to State Dept.

Elon - "If you're shorting bonds, you are on the wrong side of the bet. As we stop wasting money, there will be fewer bonds needed." [Sounds like global macro alpha]

Elon made fun of a $50m USAID expense line item that was condoms shipped to Gaza.

Elon on inflation - Checks don't bounce at the government. They can always make more money. Government spending creates inflation. Inflation has nothing to do with supermarkets taking advantage of customers, it's government overspending. If money supply grows at the same rate of the growth in goods and services, there will be no inflation.

Elon on interest rates - when the government is borrowing a lot of money, they compete with other borrowers and drive interest rates up. If they spend less, that drives inflation down and interest rates down, which is a win-win. [Elon knows what he’s talking about when it comes to global macro].

Senator Mike Lee of Utah (guest speaker) - We have misconstrued the purpose of the federal government. We've put the wrong branch in charge of the wrong responsibilities. Best way to start is to pass the REINS act and attach it to the debt ceiling [REINS act is a bill that would stop government agencies from making new regulations without approval from Congress]. Elon agreed.

Elon - When he lived in LA, the amount of regulations one had to clear just to build a kitchen was staggering. Despite the fact that many people need to rebuild in LA, the amount of laws one needs to comply with makes it practically illegal to build a house.

Elon blurted "I love Donald Trump. He is great!" [A positive sign for the relationship between Elon and Trump]

Ernst - Trump is moving fast and aggressive. First 100 days is not fast enough. We have a tough mid cycle election and they cannot lose the House or Senate or else Trump will be dead in the water.

Elon - If Republicans succeed in their goals and bring down inflation and interest rates, then they will win the midterms

Vivek - When in doubt about a regulation, push it to the states. Federalism is the answer. Let the states bear the load of enforcing and policing the regulations.

Senator Mike Lee - People are upset because the government has managed things poorly. The government has been doing things that they are not supposed to be doing (referring to regulation). Federal government wasn't built to do a lot of these things

Elon - Categorizes spending cuts by waste, fraud, and abuse. They will make significant gains in FY 2025 which ends in Oct. Thinks they can take $1T out of the deficit near year (out of $2T and a total $7T in spending), but it will require support from Trump, Congress, and judiciary. [It’s typical for Elon to set outrageous goals to reach for, and this is no different. If they can achieve even half of that, it would have a large market and economic impact.]

What about entitlement spending? There was a huge amount of fraud and waste in entitlements - bogus payments to SS and Medicare. There was also estimates of $100-200b/year in foreign fraud rates - fraudulent payments going to foreign entities. [Trump promised no cuts to Social Security and Medicare, but it would be hard to argue against eliminating fraud and abuse in entitlement payments. The fact that they are looking at this is a good sign].

Ernst - saw a video of Chinese scammers trying to scam the US government and collect entitlements

Mike Lee - The goal would be to get deficit back to 2019 levels, which doesn’t sound so painful.

Elon - Lesson learned from Paypal days was that fraudsters were the customers that complained the loudest with righteous indignation. Suggests that the most ferocious defenders of regulations and government spending are the worst abusers and fraudsters

Ernst - Over 100 members of House have joined the DOGE caucus and over 18 in Senate [Sounds like a lot of Congress is behind the DOGE effort, which is hopeful].

Elon’s closing comments - They will hold a DOGE space on X every week. The Space then ended abruptly, cutting him off.

---

How I’m trading tariff volatility (for paid subscribers)