Markets seem to be caught in the grip of fear with Dow Jones, S&P 500 and the Nasdaq Composite down in the range of 8-12 per cent in three weeks. Volatility is very high in equities and bonds. Can you help us make sense of the chaos?

We have to rewind the clock back to the Covid period and understand first as to why the US economy and stocks have outperformed global economy and stocks over the last four years. The fiscal and monetary response of the US was, by far, the largest. The economy was supported by money printing. The fiscal spending that was monetised by bond purchases by the Federal Reserve (Fed). This spending became savings of others who looked for assets to buy, but the Fed had already bought those assets. This provided a very strong growth impulse and inflation impulse as well obviously (transitory elements notwithstanding), as this money chased other avenues for investing.

The big impact of all this was in nominal GDP growth (real GDP growth plus inflation). Despite recession predictions since mid-2022, the economy has kept moving along. This is because income growth, jobs and wealth have supported the economy in this cycle unlike past cycles where private sector credit growth supported growth and inflation. So, this is a very unique set of circumstances and requires a different set of response from fiscal and monetary policy makers to unwind an economy with the above trend growth and inflation. And both botched the response somewhat by easing financial conditions significantly in 2023 and 2024.

When the Fed cut interest rates last year, the US long-term bond yield started increasing significantly on fears that Fed was cutting too early. This increase in bond yields caused, what you can say, a tightening of financial conditions despite the Fed easing.

So, here we are. To cut demand to slow growth which will cause inflation to decline, the Fed needs to stay on pause, which they likely will.

So, we already have these tightening of financial conditions via the long-term bond yields, a pause by the Fed. Now add to this, the Trump administration agenda – the Reconciliation Bill, immigration, DOGE and tariffs. These combined are causing concerns on economic growth and impacting markets.

You have referred to tightening financial conditions. But over the last two months, the US 10-year bond yield premium to the two-year yield has declined. Doesn’t it reflect the easing of financial conditions since January?

Ten-year bond yields rose to recent highs in January and have come back a little bit. But this has happened at the expense of equity prices correcting. Equity price levels are also a measure of financial conditions. In aggregate, financial conditions have tightened meaningfully.

Can you decode this Trump administration agenda? You were among the first in the fin-twit universe to point out that Trump administration wants lower stock prices. What is the idea here?

First, they also are attempting through the Reconciliation Bill (primary spending and taxation action of the administration) to cut Medicaid, food stamps and income assistance which are all programmes that aid the least fortunate ones, in order to pass the corporate and other tax cuts that were implemented in 2017, but sun sets this year.

Now if done, this is not stimulative since it does not change the tax flows associated with the wealthy or corporates, but is very anti-growth where the bill consists of $1.5-2 trillion in reduced spending over the next 10 years.

Second is immigration. Part of the ability in the economy to grow in the last few years has been the very rapid increase in labour supply due to immigration. This allowed for a disinflationary pro-growth outcome. This is now reversing.

Third comes DOGE, which is focused on cutting expenditure. This policy is anti-growth

The last comes tariffs which is complicated. There is a lot of volatility around implementation of this, who they are targeting and how, the legalities of some of it given existing treaties etc. It’s a mess. In some cases, it has been like shooting first and aiming later! But if you look beyond these, it appears Trump is interested in reshaping global trade with the goal of more free trade (not less) and have it advantageous to US manufacturing. There is transition when that happens. The tariffs are designed to increase the share of domestic production at the direct cost of domestic consumption within the US GDP. Now given consumption (government and private) has been big driver of GDP, tariffs are anti-growth and pro-inflationary.

Now if you take all four components of the Trump agenda and add these up, it’s overall bad for stocks and the market has finally begun to move in that direction.

Why are they in a hurry to get things done? In his first term, Trump started implementing tariffs almost a year after taking over. Similarly, why can’t they wait for Fed to do its job, inflation to settle down and implement their agenda when economy will be better positioned to withstand it?

In my view, the Fed and Trump administration are together when it comes to policy to slay inflation. The Biden administration was not necessarily working well with Fed a number of times, like issuing a tonne of short-term bills instead of long-term bonds which eased financial conditions.

To the question as to why now, on implementing all the agenda, who knows, but if I were in Trump’s shoes, I would rather take the pain early in my term rather than later.

The way these are being implemented, can the equity markets take it?

We must put some perspective with regard to markets. They are down around 10 per cent. That’s nothing relative to where we have come from. Markets are still in spectacular shape relative to where they were pre-Covid. Corporate earnings growth remains good. It’s better to implement your agenda in a strong economy, and you don’t want to cause pain when the economy is on its heels. When the economy is gangbusters, that’s when policy-makers should respond and so they are.

While you say earnings growth is good, is there a possibility that due to deficit reduction earnings growth can be hit significantly and disappoint investors? There are theories from fund managers, John Hussman and GMO, explaining the correlation between government deficits and corporate earnings.

I agree with that relationship between corporate profits and deficits. What we are seeing is not necessarily going to cut the deficits much. Going by items in the Reconciliation Bill, the current and proposed tax reliefs are likely to offset the benefits to government budget from DOGE, tariff revenue and others. The important factor is the expenditure cut, not the deficit. Even if conservative DOGE estimates are taken, you are looking at around $500 billion in cuts. That’s a 14 per cent cut in government expenditure of around $7 trillion. A 14 per cent hit on government spending, which is roughly 20 per cent of the economy will be major drag on GDP and also on stock prices. That is, if these cuts happen.

Expenditure cuts impacting demand which, in turn, impact earnings and stocks. The markets are beginning to factor this now.

How should investors approach markets in these circumstances?

I can’t predict future growth or inflation. Generally, I look for an all-weather portfolio. One that does well whether growth does well or disappoints, or whichever way inflation trends. What are the conditions required for this type of portfolio to do well — you want your country to have lower asset prices than the rest of the world, a central bank that is either accommodative or likely to become accommodative and a fiscal policy that is expansionary. This may not be great for bonds, but they will still do well because of the monetary easing. The US has none of these conditions now and hence is not an attractive place to own assets.

On the other hand, Europe has just recently decided to embark on debt-financed expenditures on defence and infrastructure. That’s very bad for bonds initially, but provides an opportunity once the repricing is complete. This higher spending is excellent for their economy and assets in the region.

In China, equities are very cheap and there is fair amount of fiscal and monetary easing being implemented.

And in Japan, while fiscal policy is neutral, monetary authority is slowly getting less easy, but the economy is very strong. Bond prices, too, have corrected.

So, asset prices in Europe, China and Japan look much more attractive than they have and certainly more relative to the US. Hence, what you will see is global flows out of the US into rest of the world.

With regard to the US, the way things stand now with anti-growth policies for the time being amid very high expectations, I favour short equities and I think every rally should be sold.

Investors can take their cues here.

So, does this imply the USD will weaken relative to other major global currencies?

Yes, and it has been happening recently.

With the outlook for US assets not positive, is there a Trump or Fed put for the markets? After what kind of correction do you think the government or Fed could panic and intervene to support markets?

I am not a believer in this concept. If there is a financial crisis, yes, the central bank and the fiscal side will act, like in 2023 during the banking crisis. I would expect that to happen again if there is another crisis like that. But the price level does not matter at all. It could be right here if a bunch of banks blow up or 40 per cent lower if not a single bank blows up. Who knows! Such a put doesn’t exist is my point.

Do you think the slowdown in the US economy can end in a recession this year?

I don’t set targets. I don’t look for destinations, I look for paths. The current pressures indicate weaker nominal GDP relative to expectations. The economy is in a slowdown with an unknown destination.

There’s lots of people who would tell you the world is going to end! I am not one of them. I am telling you the world is going to slow down. You don’t need a destination. In fact, the destination is one of the worst things to have stuck in your head.

Given your long and storied career in Wall Street, would you like to share any words of advice with our readers who are interested in trading or investing?

My highest level of advice generally for people is, if you are trying to manage your own personal money, you can’t beat the market. Hence, you invest in a broadly diversified way.