Trump's Theatrics Culminate in Inflationary Debt Relief Path

Hello everyone, I am Dolphin Research!

In last week's Strategy Weekly Report, Dolphin Research mentioned that with the tariff negotiation deadline of July 8th and 9th approaching, Trump is likely to make some noise and pull some strings. However, as we truly reach the deadline this week, there is a significant possibility that it will still be TACO (“Trump Always Chickens Out”).

Regardless of whether it ends up being TACO, the overall impact of the tariff issue on the market is diminishing. Even if TACO occurs again at this juncture, with market valuations already hovering at high levels, the key question remains: what will the fundamental economic outlook for the U.S. be next year? With less room for valuation expansion, what is the fundamental driver of U.S. stock growth—EPS growth?

I. Is it TACO Game Time Again?

As mentioned by Dolphin Research last week, with the tariff deadline of July 8th and 9th approaching, it is once again game time:

a. Bet on TACO (“Trump Always Chickens Out”), meaning that it is unlikely for tariffs to escalate further; if negotiations fail, they will be postponed rather than immediately implementing the tariffs announced on April 2nd;

b. Gamble on a short-term escalation of the situation, with the tariff deadline approaching, the risk of tariff escalation intensifying in the short term, while the market is currently priced too optimistically.

First, the judgment, Dolphin Research believes the probability of a TACO trade is high. Based on statements from Trump and others in the media, a possible scenario after the deadline on the 8th and 9th is that the U.S. government will issue a notice stating that the tariffs announced on Liberation Day will be implemented starting August 1st.

This is equivalent to extending the negotiation time by 20 days compared to the situation where the tariffs automatically revert to the April 2nd rates after the deadline.

Looking at the previously announced deal with Vietnam: a. A 20% tariff on all goods exported from Vietnam to the U.S.; b. A 40% tariff on goods transshipped through Vietnam; c. Vietnam exempts tariffs on all goods exported from the U.S.

Thus, with the two countries that have announced agreements so far— the UK and Vietnam, it seems to draw an invisible line to some extent:

a. Countries with a trade deficit with the U.S., represented by the UK, are subject to a 10% baseline tariff—understood as a “global governance fee,” which is likely unavoidable for every trade partner in the future;

b. Countries with a significant trade surplus with the U.S., represented by Vietnam, have a tax base of 20%; goods exported to the U.S. market are required to have zero tariffs.

c. China is singled out: A 40% tariff on re-export trade via Vietnam, which might imply that the future tariff rate on Chinese goods should be around 40%.

Considering that during Trump's first term, the weighted average tariff rate on Chinese goods was roughly 20%, this effectively adds another 20% or so this time.

Currently, the provisional tariff rates during negotiations, besides the 20% implemented during the first term, include: ①. A 10% reciprocal tariff, with an additional 24% suspended; ②. A 20% fentanyl tariff, making the current term's negotiations involve a 30% implemented tariff + 24% suspended tariff.

Currently, major countries like Europe, Japan, and China generally expect the negotiation target to align with the UK, paying only a 10% “global governance fee”; they also hope that country-specific taxes can be negotiated together with industry taxes.

Based on the current negotiations with Vietnam, the U.S. still has significant differences with major trade partners, making it difficult to lock in negotiation terms at this time, so it is unlikely that the 7th and 8th will be the deadline.

From the perspective of market expectation differences, even if the U.S. government increases its threats before the deadline, both the market and negotiation counterparts are psychologically prepared, significantly reducing the threat level.

In fact, the U.S. is currently negotiating with various countries simultaneously, making it unrealistic to quickly lock in negotiations with major trade partners in the short term.

Overall, Dolphin Research believes that compared to the last escalation, where the signal was to “beg for negotiations” from foreign governments, the significance of further escalation this time is not as great.

Whether it is a direct postponement or adopting different flexible strategies based on the negotiation progress with different countries, the overall likelihood of Trump TACO remains high.

II. Is U.S. Employment Really Good or Bad?

However, the market's overall pricing is already optimistic, and besides the TACO trade, the economic fundamentals themselves need to be considered. On the macroeconomic front, two key variables are rate cut expectations and new employment.

Since rate cut expectations largely depend on employment market trends, the changes in the U.S. labor market supply and demand, measured by non-farm payrolls and job vacancies, are the real focus.

June's 147,000 new non-farm jobs, is it really that impressive? At first glance, nearly 150,000 new jobs per month seems excellent.

However, upon closer inspection, government agencies contributed nearly half of the new jobs in June, with the federal government still in cost-cutting mode, and most new jobs coming from local and state governments—adding 80,000 people.

Further examining state and local governments, most new jobs are in education. Considering Biden's education subsidies are about to end early, is there a rush to hire before the subsidies end to lock in the subsidies? If so, the expansion of local personnel is not sustainable.

Therefore, the truly meaningful new jobs in June are mainly in the private sector, healthcare (healthcare, hospitals, nursing, social assistance), offline entertainment (events, entertainment, gambling), and construction. In contrast, most other industries have either stagnant or shrinking new employment.

This employment report appears strong but is actually weak, and another indicator showing weakening employment is the average weekly hours worked: non-farm employment hours have fallen to 34.2 hours, the level of April 2020 (when the pandemic broke out).

Considering that many companies will first consider reducing employees' working hours before layoffs, a reduction in working hours is essentially a leading indicator of layoffs, and there is indeed a need to pay attention to the risk of employment decline here.

So, overall, while the June U.S. employment data looks impressive, in Dolphin Research's view, the employment structure issues reflected in this data actually indicate that the U.S. employment situation is relatively poor.

III. Is Trump's Final Call Just Inflationary Debt?

From market trading, after the release of June's new employment data, the market postponed rate cut expectations to September, with the probability of a July rate cut dropping to nearly zero. Following the passage of the Great Beautiful Act, the issuance of U.S. Treasury bonds will resume.

It is reasonable to estimate that the upcoming macroeconomic combination will be: high interest rates + slow employment + slow consumption + Treasury bond absorption. Even if Trump TACO's again this time, after a small rise, looking forward in the short term, it is still difficult to find upward driving factors for U.S. stocks.

However, if we look further ahead, if we stand a year from now and look at the current key contradictions, the answer is very clear:

a. Trump's Policy Combination? Fiscal Deficit Uncontainable

From DOGE+ tariffs + tax cuts, with DOGE failing, the policy combination will effectively evolve into fiscal stimulus (Great Beautiful Act) + tariffs. Due to the front-loaded spending/tax cuts and back-loaded spending cuts in the Great Beautiful Act, there is no hope of narrowing the fiscal deficit by 2026, and it will further widen.

b. A New Obedient Federal Reserve? Rate Cut Inevitable

The Federal Reserve, controlled by the Republican establishment, has caused Trump significant losses. After Powell steps down in May next year, Trump is likely to choose a loyal and obedient Federal Reserve chair, at least one who is willing to cut rates.

By then, regardless of how the Federal Reserve sells its independence, a year later, the U.S. benchmark interest rate should drop from 4.25%-4.5% to 3.25%-3.5%, with a 100 basis point rate cut being highly probable.

Therefore, a year from now, the U.S. macroeconomic combination is likely to be—fiscal stimulus + monetary easing, with rate cuts not only reducing Treasury interest payments but also lowering the financing costs of newly issued short-term debt.

And the simultaneous fiscal and monetary easing policy combination is a hotbed for price inflation, with an additional tariff boost, the probability of re-inflation next year will also be greatly increased.

The new Federal Reserve will cut the policy rate to 3.25%-3.5%, but under high inflation + Treasury bond glut, long-term bond rates are likely to be around 4.5%-5%, steepening the yield curve.

At this point, the Trump administration's governing philosophy becomes completely clear, regardless of how he claims not to engage in inflationary economic growth, the result of his economic policies is still inflationary economics.

And the essence of this economic model is inflationary debt, using a nationwide buy-in approach to resolve the soaring U.S. debt since the pandemic, with the constraint being to keep high inflation within a tolerable range for the public. If inflation is too high, elections are at risk, and he will be voted out.

And this economic outlook corresponds to an investment portfolio strategy that remains: strong U.S. stocks, strong gold, strong virtual assets + diversified investments under a weak dollar.

Looking back at current valuations, since the end of last year, the Nasdaq has stopped pulling valuations and started relying on EPS growth to drive it. If there is no further push from AI technology, EPS will be under pressure in the short term due to high interest rates, and U.S. stocks will face significant correction pressure in the third quarter.

And if we combine the short-term contradictions with the medium-term certainty, an easily constructed investment strategy is: in the short term, pay attention to the correction risk of U.S. stocks, but after the correction, facing next year's inflation outlook, it is instead a good opportunity, after all, whether holding stocks, gold, or virtual assets, facing next year's inflation expectations, having resources in hand provides peace of mind.

IV. Portfolio Returns

Last week, Dolphin Research's virtual portfolio Alpha Dolphin did not adjust its positions, rising 0.3% for the week, underperforming the observed markets—S&P 500 (+1.7%) and CSI 300 (+1.5%), but outperforming MSCI China (-1.2%) and Hang Seng Tech (-2.3%).

Since the portfolio began testing (March 25, 2022) until last weekend, the portfolio's absolute return is 91.7%, with an excess return of 89.5% compared to MSCI China. From an asset net value perspective, Dolphin Research's initial virtual asset of $100 million has exceeded $195 million as of last weekend.

V. Individual Stock Profit and Loss Contribution

Last week, the Alpha Dolphin portfolio underperformed the U.S. stock index mainly due to the overall pullback of Chinese concept stocks, especially the e-commerce sector such as Alibaba, which saw significant declines; while the current low holdings in U.S. tech stocks affected performance. However, it outperformed the Hong Kong stock and Chinese concept indices, mainly due to the recovery in gold returns last week.

VI. Asset Portfolio Distribution

The Alpha Dolphin virtual portfolio holds a total of 18 stocks and equity ETFs, with 7 standard allocations and the rest underweight. Assets outside of equities are mainly distributed in gold, U.S. Treasuries, and U.S. dollar cash, with the current equity assets to gold/Treasuries/cash defensive assets ratio approximately 53:47.

As of last weekend, the Alpha Dolphin asset allocation distribution and equity asset holding weights are as follows: