As Trump Invites Chaos, Here's How to Adjust Your Portfolio

As there is a lot of chatter about “chaos,” which fits our general themes of last few weeks, I recommend checking out the Sierpiński triangle as another way to help you digest and frame all the noise coming out of Washington, D.C.

Expect Some Chaos

OK, "chaos" is probably too strong a word, but I do think the market should be prepared for some setbacks as not every negotiation or appointment will go smoothly. It is the nature of President Trump’s style, from his old real estate days, to his first term as president: He will push, he will be aggressive and there will be some confusion.

Inflation

Inflation might be the trickiest variable to estimate right now. Over time, we could see the economy turn one way or the other, we could see the jobs situation change over time, but inflation, in my view, has the widest range of possible outcomes in the coming months:

• Tariffs, as discussed last week, could push inflation higher. That is not our base case (and is now consensus), but there is some risk here.
• Immigration issues could impact inflation quite dramatically. Again, we covered this last week, and our base case is that Trump will go after some high-profile wins and listen to some of his constituents, who don’t want wholesale deportations that would disrupt the labor force. Again, consensus seems to have moved in this direction as well, but our conviction on this base case is medium (at best) and there could be risk not being priced appropriately.
• The natural ebbs and flows of supply and demand. We were in the camp that inflation was under control, but not tamed (call it settling into a 1.75% to 2.75% range). As businesses are allegedly pulling forward purchase to avoid potential tariffs, as China continues to try and stimulate its economy and as we see policy to promote “on-shoring,” there are some risks of inflation moving back to the high end of our range, which would likely make the Fed (and bond markets) uncomfortable.
• Commodity prices should help the inflation story. If we really are going to see a "drill, baby drill" mentality or, as discussed in detail last weekend (yes, I’m referring to that fairly often, but it forms the building blocks for much of our current work), a pushback against "not in my backyard," commodity prices should remain under control (while commodity related companies can do very well with increased production).

Rates

Positioning has been and will continue to be a factor.

I’ve been pointed to the “Commitment of Traders” report, that there is a lot of short interest, by speculators, especially in the 10-year part of the curve. It apparently has been coming down, but if traders remain short, it will continue to help support bond prices. TLT, a 20-plus-year ETF has been seeing outflows even as yields went higher — another potential indicator that positioning remains “underweight” bonds.

The negative buzz around the deficit and bond yields seems to have dissipated. In a quick note on Friday to our capital markets team and via Bloomberg to the customers I’m in IBs with, we reduced our bullish outlook on bonds at 4.19% on 10s.

We actually saw buying right up the last minute on Friday’s trading, but think with the “index extension” trade over and back to full days to trade bonds, it will be difficult for the rally to continue (our target was 4.1% to 4.2%, and while we are at the high end of our range, the rally has been almost too ferocious of late to be truly believable). The fear around tariffs, immigration and deficit, which was overdone, has not been replaced with a degree of complacency that doesn’t seem deserved.

The Fed:

• One cut in the next two meetings, probably this next one.
• A terminal rate of 3.875% next year, a bit above the 3.45% priced in for December 2025 (according to the Bloomberg WIRP function).

Bond Yields:

• The 10-year to inch a touch higher, pushing back towards 4.3%, with a lot of difficulty getting back to 4%.

Should be a good “range trading” environment, with a much greater risk of 50 BPS higher than 50 BPS lower from here, for the long end.

Credit

While I remain very comfortable with credit, it is more difficult to sit here near the lows and continue to add credit. It might not take much to “upset” the apple cart here, at least a little? While the arguments for liking credit so much (at what already seemed like tight levels) back in June largely remain in place, they are all a bit worn here. Like that favorite shirt, that is still up there on your list, but you can tell it is getting dated.

I think credit (IG, HY and even munis) faces two main obstacles:

• Much lower treasury yields. That should be good, but I think the only way we get much lower yields from here, is if recession talk mounts, and spreads will widen rapidly, offsetting the benefit of treasury yields.
• Much higher treasury yields. This risk seems much greater than getting much lower yields (especially as the opposite view becomes consensus). It is extremely difficult for spreads to keep up with bond yields. It just becomes difficult for spreads to move even 10 BPS tighter, from these levels, if bond yields move 25 BPS higher. So, yes, higher treasury yields, will likely be accompanied by tighter spreads, but all-in yields will be higher.

Bottom Line

In your fixed income portfolio, you can switch to moderately underweight duration here. If you are a corporate bond manager, I think it is time to get back down to a normal, rather than overweight position. Maybe even inch towards underweight/short. While it is anathema for hedge funds to think about running IG credit without rate hedges, I think betting on overall yields going higher is the right move, as scenarios with significantly lower overall yields seem unlikely.

In your equity portfolio, nothing has really changed — be nimble, trade the ranges, be overweight sectors that are catching up. Seasonality should still be helpful, but since people have been talking about (and presumably positioning for) seasonality since September, I’m a bit skeptical it will be overwhelming strong, at least at the start of the month.

Be long risk that benefit from a push to extract and refine commodities, if not domestically, much closer to home (and further away from China). Be wary of big tech at these valuations and watch carefully for China’s attempts to push their brands globally, especially into emerging markets — that is a risk that still seems largely dismissed, even as it is occurring.

Everything that comes across my stream in terms of CRE scares me, which, the contrarian finds even more tempting. The exact opposite is occurring with crypto, but watch out for a rug pull there,

Hopefully you all had great Thanksgiving weekend and a fun holiday season, but I suspect the market will create multiple opportunities to adjust portfolios as D.C. will remain front and center.

At the time of publication, Tchir had no positions in any securities mentioned.