October 14, 2019
We have a quiet open to the week, with bond markets closed for the holiday in the U.S. This follows the big U.S./China trade deal that was announced in the Oval Office on Friday.
Big? Of course, people are picking apart the lack of detail, skeptical that an actual deal was made. Some are scrutinizing the heavy demands that aren't part of the deal. And of course, at the moment, it's a hand shake. And a hand shake with the Chinese Vice Premier, not President Xi.
With that, there is an overwhelmingly skeptical tone in the media about the prospects of seeing a formal deal, and, in the near term, the influence this "deal" will have on markets and the economy. Much of the skepticism is underscored by the view that Trump is forcing/manufacturing an end to this trade war (i.e. it's not a real deal).
But people are forgetting that Trump started the trade war. And he has maintained enough leverage so that he can finish it (when he sees fit). That appears to be the approach he has taken.
If he says its a deal, and ultimately removes tariffs. Then it's a deal.
And whether it looks great or not, or has big impactful consequences long-term, it clears the overhang of uncertainty, now, that has been weighing on markets and the global economy. With that, we'll get to see what the unfettered power of fiscal stimulus, structural reform and ultra-easy global monetary policy can do for a U.S. economy that already has very solid fundamentals (record low unemployment, record household net worth, record consumer credit-worthiness, a record low household debt-service ratio, well-capitalized banks, low inflation, affordable gas).
That should be plenty of tailwinds for a re-election. And Trump likely turns back to China for the big demands in a second term.
October 11, 2019
The catalysts have been lining up.
After forcing global central banks back into an ultra-accommodative stance, with the risk of an indefinite trade war hanging over the heads of central bankers, Trump has positioned himself, to make concessions at anytime (in this case, a "limited deal") and claim victory on the trade war.
After this week's U.S./China trade meetings, it sounds like that's what we're getting.
Trump has called it a "Phase 1" deal, which includes an agreement on "currency issues," which I suspect will result in weaker dollar, not just against the yuan ,but a broadly weaker dollar.
Most importantly, both parties stood in the oval office and ceremonially shook hands in an Phase 1 agreement (in principle). The intent was clearly to signal the end of the trade war (for the moment), to clear the overhang of uncertainty on markets, and move any further phases of negotiations to back burner issues for the global economy.
This probably keeps the Fed on hold this month, in a wait and see, posture. And I suspect we'll see global sentiment, which has waned over the past year, bounce back.
October 10, 2019
Indeed, as we awaited the high level U.S./China trade talks to begin this morning, it was reported overnight that a currency pact is in the works.
With that, let's revisit my May note for some background on why it makes sense, and what to expect …
Excerpt from Pro Perspectives, May 21, 2019
"With the stalemate on U.S./China trade talks, let's take a look today at how this may end.
A lot of attention has been given to trade quotas, intellectual property theft and the challenges U.S. companies have accessing Chinese markets. What hasn't been talked about as much is the currency issue. Yet China's currency is at the core of it all.
China has used a weak currency to leapfrog almost the entire world over the past 30+ years, capturing 15% of the global economic market share and rising to an economic power. They've gone from a $350 billion economy in the early 80s, to a $13 trillion economy today (the second largest economy in the world).
That's how they got here, and we've talked in recent weeks how they are attempting to stay here …. going back to what they know, weakening the currency, as a tool to fight the impact tariffs.
With that, the trade war has been manufactured by more than three-decades of China's currency war. It only makes sense that it can only be resolved with a primary focus on the currency. We may find that if/when the U.S./China stalemate ends, it will be with a grand and coordinated currency agreement.
With that, a lot of comparisons have made between the U.S/China standoff and that of U.S. and Japan in the 80s. That was ended with the 'Plaza Accord' — an agreement between the U.S., Japan, Germany, England and France. The Plaza Accord was a plan to balance global trade, through a 50% depreciation of the dollar (vs the yen and d-mark).
We may wake up one day and find a similar agreement has been made between the U.S. and major global trading partners (which may include China, or not)."
So, what happened to stocks, following the '85 currency agreement? Stocks rallied about 15% into the end of the year in 1985, following the deal. Stocks were up 16% in 1986, and rose as much as 40% year-to-date in 1087, prior to the October crash. Gold rose close to 60% of the next two years.
October 8, 2019
The Trump team blacklisted eight Chinese tech firms and restricted the visas on some Chinese officials, all of which they associated with human rights abuses on Muslim minorities in China.
Why now, just as they head into trade negotiations again?
Leverage. Trump has always had leverage over the Chinese on these negotiations, and has been in complete control (able to make concessions and pull the trigger on a deal at any time). But that leverage has eroded in recent months.
The Chinese Communist Party (CCP) has gained some leverage, as the U.S. economy has softened, and as the 2020 election draws closer. China has had the option of holding out, if they think the prospects are favorable for seeing a new U.S. President next year.
With that, as they come to Washington to resume negotiations, it appears that Trump has found an angle to dissuade the Chinese from turning their backs on a deal. By taking aim at the human rights abuses of the CCP, he telegraphs how the specter of the fight might change. He draws in the other half of America (the other party), and U.S. allies, that have been apathetic if not annoyed by the distraction of a fight (in their view) over a trade imbalance. Up to just a few months ago, the Democratic candidates had no interest in talking about China. If China chooses to hold out now, and Trump subsequently escalates the focus on China’s human rights record, then the "dealing with China" topic could easily become the biggest issue in the election.
With that, despite the criticisms of the moves yesterday, China has sent their A-team to Washington. We'll see if Trump opts for a cut-down deal, with the plan of going after the bigger demands after the election.
October 8, 2019
As we discussed yesterday, this was important to watch — to see if the Fed chair might bring up the balance sheet (i.e. signal another round of QE).
Remember, not only is the ECB is back in the QE business, with plans to restart QE in November, but the Fed has already quietly been expanding its balance sheet.
Here's another look at the about-face by the Fed …
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So, we were looking for some discussion on the balance sheet.
And we got it. In his prepared remarks today, Powell said that the "time is now upon us" to expand the balance sheet. Big news? Powell downplayed it, saying it's "not QE." Not QE? Let’s compare …
The Fed expanded the balance sheet for the better part of six years, as a primary tool in manufacturing an economic recovery. It promoted stability in the financial system, which promoted confidence, which promoted economic activity.
After spending eighteen months shrinking the balance sheet, the Fed choked off the hottest growth we've seen in a decade (producing the opposite outcome of QE).
Now they are now back to expanding the balance sheet — and it's aggressive. The Fed has injected nearly $200 billion dollars of liquidity into the financial system in the past five weeks. It’s probably safe to say, the Fed expects their new "balance sheet expansion" to produce the same outcomes as their multiple rounds of QE: promote stability in the financial system, which promotes confidence, which promotes economic activity.
October 7, 2019 We enter what could be a very important week for markets.
China trade negotiations resume this week. And we have a slew of Fed officials scheduled to speak, including a prepared speech tomorrow by Jerome Powell. Trump made sure he did his part today to remind the Fed they should be lower, given subdued inflation and the ultra-easy stance of its global central bank counterparts. With the softer manufacturing data last week, the interest rate market is already pricing in a 73% chance of another rate cut from the Fed at the October 30th meeting. Trump is looking for a "substantial cut." That said, whether he gets any Fed action this month, or not, will depend on the developments on the trade standstill (more in a moment). What should be closely watched this week, from the Fed commentary, is any discussion about the balance sheet. It was arguably the Fed's error in shrinking the balance sheet, especially in concert with the ECB's exit of QE, that sent global financial markets haywire (namely, the spiral of global interest rates deeply, and broadly, into negative yield territory). And, as we know, the ECB is now back in the QE business, with plans to restart QE in November. And as few know, the Fed has quietly been expanding its balance sheet again. Here's the latest look at the Fed's balance sheet. |
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With the atonement from global central banks, we may find global bond yields begin to recover.
On that note, we have a good bullish technical reversal signal today in the U.S. 10 year yield. |
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Now, as I said, the Fed's actions this month will depend on the developments on trade. With central banks now providing tail winds for the global economy and markets, we've talked about the prospects that Trump may (should) agree to a cut-down version on a U.S./China deal just to get it done — to remove the overhang of uncertainty on the global economy. Remember, there were White House "sources" saying as much early last month — that a "limited deal" was in the works.
October 3, 2019 On Tuesday the manufacturing data came in at 10-year lows. Today the reading on the services sector came in at 3-year lows.
While the services sector is still expanding. The manufacturing sector is in contraction. This is the impact of an indefinite trade war on confidence. Weaker confidence, ultimately leads to weaker economic activity. Until this year, the strategy from the Fed was to ignore it all. They assumed they could keep plugging away at normalizing interest rates and shrinking their balance sheet, all while riding the wave of fiscal stimulus. As long as the economic data was solid, their mistakes were hidden. But the markets called them out last December, and started pricing in a world where the central banks (led by the Fed) were asleep at the wheel during perhaps the most important step in the post-financial crisis global economic recovery: structural change (i.e. repairing global structural imbalances). So, as I said yesterday, finally the central banks have now positioned themselves to absorb potential shocks and economic weakness from an indefinite trade war.
With that, let's take a look at the expectations that are building for another move by the Fed at their end of the month meeting (October 30th). |
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Just a week ago, the market was pricing in a coin flips chance of another quarter point cut from the Fed. Following this week's ISM data, the probability of another rate cut has jumped to 88%.
October 2, 2019 Global stocks took another slide today. Noticeably, European stocks have taken the biggest hit, not just today, but over the past two days.
On that note, the media's attention was given to the U.S. manufacturing data yesterday, to explain the shake up in global financial markets. But was there something more? It appears, maybe so. Today at 10pm EST, the headline hit that the World Trade Organization has sided against a longstanding United States complaint against the EU over subsidies that have been given to the European aircraft maker, AirBus, that have distorted global fair trade and competition — namely, anti-competitive to American aircraft maker, Boeing. The U.S. estimated that the economic benefit of those subsidies, overtime, at more than $200 billion. Now, this headline sounds like an aggressive ramp in Trump trade aggression. But this was a complaint dating back to 2006!
After more than a decade of hearings, and rounds of EU appeals, today, the final decision came down, and on the side of the complainant, the United States. This decision awards the U.S. the right to sanction the $7.5 billion of EU imports related to the case.
Bottom line: The threats of action against EU subsidies have been floated by the Trump administration many times. But now they have the WTO stamp of approval. Comments from a U.S. treasury official hit the wires at the close of the stock market today, saying the U.S. has readied tariffs to retaliate against EU subsidies. With the above in mind, remember, the central banks have now positioned themselves specifically to absorb potential shocks and economic weakness from an indefinite trade war. And this may prove to be the catalyst to move the ECB toward outright stock purchases.
October 1, 2019 Yesterday we talked about the overwhelming weight of positive surprises in the economic data over the past month. Today, we had a big negative surprise in manufacturing data (the September ISM Manufacturing index).
Here's a look at the chart … |
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As you can see, above the 50 level represents expansion in the manufacturing sector. Below 50 represents contraction. The September number was 47.8, the lowest number in ten years (since the global financial crisis).
Now, if we look back at the dips in 2012 and 2016, they both have commonalities with the present: Central banks responded. In 2012, the ECB pulled out the threat that they will do 'whatever it takes'. The Fed followed by launching its third round of QE (QE3). Later in the year, the ISM number bottomed and turned around. In 2016, following the crash in oil prices, and a contraction in global manufacturing activity, global central banks all responded with action. The BOJ intervened in the currency markets (and likely used the dollars it bought to buy oil, putting a floor under it). China eased reserve ratio requirements. The Fed took four projected rate hikes for the year off of the table. And the ECB ramped up its QE. What about this time? Central banks are responding. The Fed is cutting rates, and has stopped QT (quantitative tightening). China is firing every bullet they have. Global central banks around the world are cutting rates. And the ECB is restarting QE. To follow the stock picks of the world’s best billionaire investors, subscribe at Billionaire's Portfolio.
Bottom line: The central banks are acting! That should support global economic activity, and therefore put a floor under global manufacturing activity. So, within the context of a strong consumer, and ultra-accomodative central banks, positioned to keep the consumer strong and to neutralize the indefinite trade war, this manufacturing data point should not be taken as some Draconian signal that recession is here. With that in mind, after stocks took a hit today on the weak manufacturing number — as did global interest rates and almost all commodities — where do things go from here? We revisited the big 2940 level in the S&P 500 today. We talked about this big level back in August. Here's a look at an excerpt from the Aug 29 note … … we're approaching a big technical level in stocks. |
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If we get above this key 2,940 area in stocks (the yellow line in the chart above), we could see record highs again, soon.
Here's how the chart looks today …
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As you can see, that level was indeed an inflection point for stocks. Now we are revisiting it, which should make for a good spot to buy, not sell.
September 30, 2019 We end the quarter today. In the coming weeks, we'll see Q3 earnings. What should we expect?
As we discussed last week, estimates have already been ratcheted down. Wall Street is looking for earnings to contract of 3.8% from the same period a year ago. That seems to fit the recession narrative we've been hearing. But is it warranted, or is it Wall Street and corporate America taking advantage of the fear in the air, to set the bar low? Let's take a look at the third quarter. First, take a look at Citigroup's Economic Surprise Index. In the chart below, above the zero line is the degree to which the data is coming in above expectations. |
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You can see, the positive surprises have been coming in hot over the past month, and the index itself has been on the rise throughout the third quarter. This suprise index behavior typically drives multiple expansion (in stocks) and higher yields. That doesn't fit with the earnings expectations/ recession story.
And it doesn't fit with the Atlanta Fed's forecast for Q3 GDP, which has been on the rise too. |
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And don't forget, in the quarter, we had two Fed rate cuts, and the Fed's retreat from its Quantitative Tightening program. That has driven the benchmark 10-year yield down from 2.05% to 1.67% in the quarter (cheaper money), and it stabilized stocks near the record highs (fuel for consumer confidence).
Bottom line: The earnings bar has been set low, so that it can be beat. That's the way Wall Street works. So, positive earnings suprises should further underpin stocks as we head into Q4.
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