The measures currently expected from the new US government

Executive Summary:

The new US government wants to reduce the trade deficit, inflation and national debt with tariffs and the deportation of migrants. According to a fairly unanimous opinion among economists - including in the USA - this will not work. Mr. Trump's voters are also beginning to suspect this; in the first month of his new presidency, consumer confidence has already fallen far below the level that usually prevails in recessions.

If Trump chooses the more correct way to reduce the trade deficit, namely to weaken the dollar, the US equity market is likely to suffer, as it has always done for decades. US investors will also realize that Europe could possibly emerge from its current phase of economic weakness, supported by a sharp rise in defence spending, which it can afford due to its relatively low national debt. This would benefit the local stock markets, which are much cheaper than US companies. The price of gold could benefit from a weaker dollar, even if, for once, it has not fallen in the current phase of a strong dollar, but has actually risen sharply. Other commodities should also perform well in an environment of increased demand (armaments, reconstruction of Ukraine, etc.).

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It remains to be seen whether the new US president has goals that go beyond maintaining and expanding his power and private wealth - he has taken a lot of money from his supporters by issuing a meaningless cryptocurrency bearing his name. In addition to his current efforts to damage democracy in the US and also in Europe, some important developments for the global capital markets are already clearly emerging. Trump has already introduced tariffs in recent weeks, but these were immediately withdrawn (Canada, Mexico). Warnings from US industry may have played a role in this. Bob Farley, head of US car manufacturer Ford, had warned of high burdens for car production in the US if supplier parts from these countries were subject to 25% tariffs (source: Business Insider, February 6, 2025). In general, the tariffs have an inflation-increasing and anti-growth effect and tend to lead to a rising US dollar exchange rate (source: Austrian National Bank, January 20, 2025). However, this is exactly what the new US government does not need, in addition to the trouble with US industry. As is well known, Trump wants to reduce the US trade deficit in order to create more jobs in industry for his voters. This shows that he has understood the first lesson of the populist school. This lesson is: take a problem that is not particularly important and present a solution that is obvious even to the simple-minded, regardless of whether it is suitable or not. The trade balance alone, which shows the difference between imports and exports of goods, does not say much. More important is the current account balance, which also includes services such as tourism.

This currently stands at -3% of national income (chart 1); however, the deficit was already twice as high without the USA going under, especially as American consumers are not being forced to buy German or Japanese cars at gunpoint. In any case, tariffs and a rising exchange rate will not succeed in solving this not particularly important problem. For the past 30 years, the US current account balance has deteriorated if the US dollar exchange rate had risen five years previously (or the blue line in chart 2 had fallen), and vice versa. The correlation is very close; the correlation, which can lie between -1 (both values always move in the opposite direction) and +1 (both values always move in the same direction), is as high as +0.85 (chart 2). Tariffs are therefore not a suitable solution.

To make matters worse for "Tariff Man" Trump, global economic policy uncertainty has risen sharply due to the US's recent aggressive foreign policy and tariff announcements (chart 3), which has contributed to a falling exchange rate for many years. The correlation between the two values is -0.66; a falling exchange rate (which corresponds to a rising value of the dollar; it takes fewer US dollars to buy one euro, the blue line in chart 3 is shown inverted) is usually accompanied by rising uncertainty. Michael Hartnett, investment strategist at the renowned US bank Bank of America (BofA), says that inflation will force Trump to opt for the lowest possible trade tariffs (source: BofA, February 14, 2025). This is because rising inflation is likely to lead to a rising interest rate differential between two-year US government bonds and German Bunds (blue line in chart 5 falling), which has reliably led to a rising value of the dollar in recent years (orange line in chart 5 falling). If Donald Trump achieves calmer foreign policy waters in addition to largely abandoning tariffs, the overvalued US dollar (charts 6 and 7) could even fall and the US current account deficit could decrease as desired. Ultimately, the new US Treasury Secretary Bessent, a former hedge fund manager who is said to be highly competent, will explain these correlations to his boss. After US consumer confidence had initially risen to a (low) level of 74 following Trump's renewed election victory, the aggressive and chaotic measures taken by President Trump from January 20 onwards have unsettled consumers considerably; the figure has slumped to 64.7, well below the average level reached during historical recessions (chart 4, gray horizontal line). Weak consumer spending will also hurt the dollar, meaning that the dollar exchange rate against the euro is likely to fall in future.  

However, the euro is unlikely to rise if the eurozone economy remains significantly weaker than that of the US. One possible trigger for an upturn in Europe could be the increasingly recognized need for a sharp increase in military spending. After the first Russian attack on Ukraine in 2014, Europeans continued to rely entirely on the Americans and reacted surprisingly slowly even after the second attack in February 2022. Now Trump has finally woken up the Europeans by linking American support to significantly increased arms spending.

The Kiel Institute for the World Economy (IfWl) has shown in a new study that an increase in European defense spending from the current level of just under 2% of national income to 3.5% annually (the current level in the USA, blue arrow in chart 8) would cost around €300 billion p.a., but that "this sum could also generate a similar amount of additional private economic activity if it were invested specifically in the expansion of military capabilities" instead of sourcing 80% of purchased military equipment from companies outside the European Union, as is currently the case. According to the President of the IfW, Prof. Moritz Schularick, the economic effects could "go far beyond short-term fiscal multiplier effects and boost growth in the medium term". However, this expenditure should be financed by debt, not by tax increases, as these are likely to stifle growth again straight away.

Fortunately, the Germans' love of their debt brake is cooling off in good time, as chart 9 shows.

Incidentally, there is only something comparable in Germany. A debt brake is completely wrong for sensible investments - and I can't think of anything more sensible than securing Europe's freedom. There is even evidence that the debt brake is to a large extent to blame for Germany's misery (charts 12 and 13). There were certainly phases in the distant past when the German economy made considerable progress in terms of productivity and was able to clearly outperform the USA, which was already technologically superior at that time - the beginning of the internet era (chart 10). One possible reason for this may have been that the Germans expanded their debt significantly more than the USA or the eurozone from 1996 onwards, when productivity measurement for the eurozone began (chart 11). Germany is ahead in both charts, followed by the USA and finally the eurozone, which was particularly cautious in terms of debt during this period (the sharp fall in debt in the USA up to 2001 was a consequence of the unprecedented boom in technology, telecoms and internet stocks in those years, which brought the US government enormous tax revenues from the country's customary "capital gains tax").

After 2008, the trends in productivity and national debt were even more similar (charts 12 and 13). If Europe now invests heavily in defense technology, economic development in Europe could actually be better in the coming years than in the USA, which is facing a number of problems after its debt-financed boom. The current difficult outlook for Europe (chart 16) could improve.

The US Leading Economic Indicator (LEI) has been showing growing problems for the future development of the US economy since 2022 (chart 14), but these have so far been masked by the US government's high level of new borrowing (chart 17). The strong growth in foreign debt (chart 18) has also helped the US economy so far, as money borrowed abroad can be spent at home without Americans having to save. Foreigners who invest money in America must first buy US dollars. This causes the dollar exchange rate to rise. If the foreign investors withdraw, the dollar and the US economy will be weakened at the same time. In an article dated September 3, 2024 (source: www.project-syndicate.org), Nobel Prize-winning economist Stiglitz describes in detail the numerous risks that a President Trump will trigger for the US economy with his misguided economic and political goals. This could well cause a decline in foreign investor confidence, just as Trump has already damaged consumer confidence (chart 4). This is an important component of the LEI, as is new residential construction activity (chart 15).

Another component of the US LEI is the US equity market, which has lagged behind Europeans and emerging markets since Trump's election victory and the rise to power of the unelected Elon Musk.

It is highly likely that a longer-term phase of underperformance of US equities has begun. In the last 55 years, there has only been one case in which one of the major equity markets was heavily overvalued and the other equity markets were normally valued, namely Japan in the second half of the 1980s (chart 20). The Japanese Nikkei share index did not return to its price level until 35 years after its peak in December 1989, while all other major stock markets had multiplied since then. The striking parallels between the Japanese bubble back then and the current US bubble can be found in the November 2024 Capital Market Outlook, which you can find here. If we use the ratio of share prices to gross profits (chart 20) to make forecasts, the expected return for US equities, whose valuation is at a record high since 1973, is -4% p.a. until 2035 (chart 21), while Europe's equity markets can still achieve an average of just under +5% p.a. (chart 22).

An interesting example of the exaggerations on the US stock market is the valuation of Tesla. Tesla shares, which are extremely expensive due to the fanciful but rarely realized predictions of its CEO Elon Musk, only managed 7.5% earnings growth per year from 2021 to 2024, while the profits of the Chinese electric car manufacturer BYD grew by 120% annually in these three years, but with a price/earnings ratio of 20 is far cheaper than Tesla shares, which are valued at 141 times earnings (chart 23).

European car manufacturers are trading at single-digit price/earnings ratios (chart 24). Toyota is also cheap. Anyone who still believes that the genius Elon Musk will continue to perform miracles in the future is recommended to read the article in the latest issue of manager-magazin. The title is: "CRASHING TESLA. Sales decline, innovation crisis: Elon Musk jeopardizes the electric pioneer". Tesla shareholders do not seem to have noticed that Tesla, like VW, is no longer growing. However, zero growth is much cheaper at VW (price/earnings ratio 3.9). Incidentally, the valuation of "normal" car companies in the USA (General Motors, Ford) is about as low as in Europe. Only Ferrari as a high-margin luxury manufacturer is significantly more expensive. The price/earnings ratio has been between 39 and 54 in recent years, but there has also been solid earnings growth of 23.5% p.a., more than three times that of Tesla.

Questionable prophecies and statements can obviously work wonders on the stock market these days, just as they do in politics, but they don't last forever. The famous American president Abraham Lincoln, the victor of the US Civil War from 1861 to 1865, once remarked: "You can fool all the people for a time and some of the people for all the time, but you can't fool all the people for all the time." (Source: www.zitate7.de). What is particularly sad about the current political development in the USA is the deliberate fight against truth and science by the new US government and its special representative. America became great through science, the prerequisite for technology and progress. However, the country will have to suffer under the new administration if the new trend towards lies proves to be sustainable - another argument for a coming structural weakness of the US dollar and the stock market.

Assuming a future decline in the value of the US dollar against the euro, there should be a sustained phase of outperformance of European equities compared to US equities, as has been the case over the past 55 years. Chart 25 shows this very close correlation. When the red line falls, European equities underperform US equities (if the exchange rate and the relative performance of European equities move in the same direction, the correlation, which can be between -1 (always in the opposite direction) and +1 (always in the same direction), is positive). At the same time, the blue line usually falls (correlation averages +0.80), which means that fewer US dollars are needed to buy one euro. When the blue line last rose, namely from June 2001, when only USD 0.847 was needed to buy one euro, to March 2008, when the first major problems in the US real estate market became apparent and USD 1.585 had to be paid for one euro, European share prices outperformed American share prices by 51%. At the beginning of this outperformance, US equities were valued at 14.9 times gross earnings (cash flows), while European equities were valued at only 10.4 times gross earnings (cash flows). Cheap stock markets have outperformed expensive ones for decades (charts 21 and 22), so Europe's outperformance was not surprising at the time. Today, US equities are valued at 19.6 times cash flow and European equities at 10.4 times cash flow, i.e. even more overvalued than they were in June 2021 at the start of the last dollar decline. The probability of Europe outperforming the US over the next 10 years is therefore extremely high. This correlation also exists for emerging market equities (chart 26).                                                              

From 1969 to July 2017, the gold price also mostly rose when more US dollars were needed to buy one euro, i.e. when the exchange rate rose (hence the positive correlation) and the value of one dollar fell, and vice versa (chart 27). After 2017, the correlation changed and the gold price no longer reacted negatively to a rising value of the US dollar (falling exchange rate). This worked well from the end of 1979 to the end of 1984 and then from March 1995 to June 2001. For several years now (April 2019), commodities other than gold have also stopped reacting negatively to a rising US dollar or falling exchange rate (chart 28).  

The reason for the change in these correlations, which have existed for decades, is not in the newspaper; it can only be guessed at. One possible explanation begins with the rapid rise in US government debt over the years, also in comparison to the eurozone (chart 17). Then, over 10 years ago under President Obama, the logic of taking on government debt also changed. For decades, the US government had increased government deficits when the unemployment rate rose and vice versa (chart 29); now the deficits were increased even when unemployment was falling, meaning that they continued to step on the gas even though the engine was already running at high revs. The supposedly conservative Trump, who was president from the beginning of 2017, also doped the economy despite further falling unemployment until the coronavirus crisis resurrected the old logic at the beginning of 2020 - the unemployment rate shot up and the government helped with high government deficits. However, these remained conspicuously high under President Biden (from the beginning of 2021) despite a sharp fall in unemployment, which is likely to have contributed to even more nervousness among many investors. Then came Russia's attack on Ukraine in February 2022. After a brief hesitation, the gold price began to rise sharply, even though yields on inflation-linked US government bonds - a good substitute for gold until then - rose from -1% to over 2% (chart 30). A long-standing and economically logical relationship between the gold price and the yield on inflation-linked government bonds broke down completely. There is no reasonable explanation for this other than investors' growing mistrust of US government bonds, as the already financially strained US government now has to spend even more on armaments. In the case of other commodities, supply problems during the coronavirus crisis and after the start of the war are also likely to have played a role. War, rearmament and the subsequent reconstruction of the devastation further increased the demand for raw materials.

Conclusion

With his preference for tariffs and the deportation of migrants, Trump has the wrong recipes for the problems of the US economy. Perhaps he knows this and is merely using tariffs as a threatening backdrop for "deals". If he implements little to none of his planned measures, the dollar, which will be weakened by the weakening economy in the future anyway, and then the trade deficit will also fall significantly, especially as the European economy could catch up with the US economy, which has been doped up by high government debt, through higher arms spending and a subsequent reconstruction of Ukraine. After many years of outperformance, the heavily overvalued stock market is likely to perform significantly worse than the stock markets of Europe or the emerging markets in this environment for a number of reasons. The massive use of lies by the new US leadership will reinforce this development.

Consequences for the portfolio

• Equities: We remain underweight and prefer Europe to the USA.
• Bonds: We remain underweight, seeing bonds primarily as diversification in uncertain times.
• Gold: We remain overweight in times of global crises.
• Liquidity: We remain overweight in order to be able to react flexibly.

Finally, our key statements from the capital market outlook from February 2022, which you can find here here:

Three years ago, we examined the question of whether the weak demographic development in both industrialized and emerging countries can be offset by productivity gains in the workforce. The result was that there are many factors that weaken productivity, but also some positive trends. The use of robots is particularly high in countries with particularly low birth rates (South Korea, Singapore) and vice versa. On the other hand, the waste of capital by governments, which can be seen in the rising national debt in relation to national income, is just as negative as the low level of mathematical and scientific education in western industrialized countries, the extremely inefficient welfare state, particularly in Germany, excessive regulation and the increasing formation of monopolies.

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You can also download the capital market outlook here.