Why Bitcoin Has Been All About Chinese Capital Flight

May 9, 5:00 pm EST

Yesterday we talked about the tool China will use to offset tariffs, if a deal does not materialize and the tariff penalty increases.

They will devalue their currency.

With a “no deal” potential outcome, there’s a lot of wealth in China looking for ways out.

In recent years, they have found a way out through Bitcoin.  And, no coincidence, Bitcoin is again on the move.

With that, let’s take a look at the timeline on Bitcoin…

The 2016-2017 ascent of Bitcoin coincided perfectly with the crackdown on capital flight in China.  In late 2016, with rapid expansion of credit in China, growing non-performing loans, a soft economy and the prospects of a Trump administration that could put pressure on China trade, capital was moving aggressively out of China.

That’s when the government stepped UP capital controls — restricting movement of capital out of China, from transfers to foreign investment.

Of course, resourceful Chinese still found ways to move money.  Among them, buying Bitcoin. And that’s when Bitcoin started to really move (from sub-$1,000 to over $19,000). China cryptocurrency exchanges were said to account for 90% of global bitcoin trading.

Chinese capital flows were confused for Silicon Valley genius.

But in late 2017, China cracked down on Bitcoin – with a total ban.  A few months later, Bitcoin futures launched, which gave hedge funds a liquid way to short the madness. Bitcoin topped the day the futures contract launched.

So, as Chinese officials visit the White House for a deal or no deal on trade, China has been moving their currency lower — and bitcoin has (again) been moving higher.  Perhaps the Chinese are finding new ways to buy Bitcoin.

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Watch The Yuan As A Proxy On A Trade Deal

May 8, 5:00 pm EST

We talked about China’s currency yesterday, as the key proxy on a U.S./China trade deal.

Let’s revisit some background and context on the whole trade negotiation.
China’s currency manipulation (i.e. weak currency policy) is at the core of the global trade imbalances that precipitated the global financial crisis.  With that, the currency is a key piece of the trade and structural reform demands from the Trump administration.

After using its currency to corner the world’s export markets for more than a decade, which led to China’s rise to a global economic power, you can see how China has been maneuvering to pacify currency tensions over the last decade:

 
(In the chart above, the falling line represents a strengthening yuan versus the U.S. dollar, and vice versa)
1) They slowly allowed the currency to climb (against the dollar) following threats of a big tariff on China from Graham and Schumer (yes, Schumer) back in 2005.
2) When the global economic crisis hit, they went back to a peg to protect their ability to export.
3) They went back to a slow crawl higher as tensions rose, and people began to believe the developed market economies might be passing the torch to China for economic leadership.
4) It became clear that China can’t grow fast enough in a world where developed market economies are struggling. So, they went back to weakening the currency to protect their ability to export.
5) They strengthened the yuan when Trump was elected to try to ward off a trade war.
6) Trump wasn’t placated and tariffs were launched. They weakened the currency with the idea that a threat of a big one-off devaluation in the currency might create some leverage.
7)  After trying to hold-out, it seemed clear earlier this year that they needed to get a deal done, as the economy continued to sink.  They walked the currency higher again – a signal that they are willing to make aggressive concessions to get a deal done.
But now, with a hard deadline and threat of a tariff escalation, the Chinese made one of the largest devaluations in the yuan in years (a warning shot).
Here’s a look at the chart going into the deadline …
If we get a no deal/ tariff escalation on Friday, we can expect the Chinese to continue weakening the yuan to offset some of the tariff burden.
So, tariffs have been a tool of retaliation for the U.S., to counter nearly three decades of currency manipulation by the Chinese.  If we don’t get reform, the Chinese will retaliate with … more currency manipulation.

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What China Has To Lose On A ‘No Deal’

May 7, 5:00 pm EST

As we get closer to the hard deadline on a U.S./China trade deal, markets are adjusting for the potential of a no deal/ tariff escalation.

What does that look like?  U.S. stocks are now off 2% from the highs of the year.  That still puts us up 15% year-to-date.

The bigger adjustment is coming in China.  As we discussed yesterday, China is in the position of weakness in these negotiations.  The U.S. economy is strong.  China’s economy has been very weak.  A more expensive and indefinite trade dispute puts downward pressure on both economies (and the global economy), but it puts the Chinese in dangerously slow economy — which becomes politically dangerous for the Chinese Communist Party.

As such, here’s what Chinese stocks have done in the past eight days …

 

And, perhaps as a warning shot, China is starting to move their currency.

As we’ve discussed, China has used their currency (a weak currency) as the primary tool to achieve their extraordinary economic ascent over the past two decades — cornering the world’s export market.

We should expect, when their backs are against the wall, with a dim economic outlook, they will go back to weakening the yuan.  That’s what they have been doing since Trump’s tariff threat on Sunday.  They adjusted down the yuan yesterday by almost 1%.  That doesn’t sound like much, within China’s currency regime, it’s a big move.  We saw a one-off move like that once last year.  The other time was August of 2015, which led to fears that China might devalue the yuan. That set off a global market rout.

With the above said, China is sending Hui for the meetings that are scheduled to run Thursday and Friday.  Hui has been the point-man on trade negotiations.  His presence, in light of the tariff threats, give some encouragement that China has intentions to get a deal done.

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Trump’s Win-Win Bet

May 6, 5:00 pm EST

Late last week, the White House floated the idea that a trade agreement with China could come by this coming Friday (May 10).

And then Trump did this yesterday …

 

Why would Trump risk complicating a deal, even more, by threatening China with a deadline/ tariff increase?  Because he has leverage.  He has a stock market near record highs, and a strong economy and the winds of ultra-easy global monetary policy at his back.

China, on the other hand, has an economy running in recession-like territory, with key data just (recently) bouncing from global financial crisis era levels.  And Chinese stocks, after soaring 34% since January 4th, have given back 12% from the highs, in just seven days.  And they’ve just fired a ton of fiscal and monetary policy bullets to stimulate the economy – which could be diluted by a more expensive and indefinite trade war.

So, Trump has a win-win going into the week.  If the threat works, he gets a deal done, and likely gives less to get it done.  If China backs off, stocks go down, and he gets the Fed’s rate cut he’s been looking for – stocks go back up.

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Positive Surprises In Productivity And Wage Growth, A Big Deal

May 3, 5:00 pm EST

If you are a regular reader of my daily notes, you’ll know we’ve been discussing the setup for positive surprises all year.

As we’re near the end of Q1 earnings season, clearly we’re getting it. With 78% of the companies in the S&P 500 now reported on Q1 earnings, 76% have beat earnings estimates.

And we’re getting positive surprises in the economic data.  We had a huge positive surprise for Q1 GDP this week.  And today we had a blow out jobs report.

There were 263k jobs added in April.  The market was expecting just 185k.  That gives us a 12-month average of 218k, well above pre-financial crisis average monthly job growth!  The unemployment number was 3.6% — the lowest since 1969.

Remember, we’ve been told all year long that we were headed for both earnings and economic recession.  It’s not happening.

Moreover, the two missing pieces of the economic recovery puzzle, have been productivity and wage growth.  And these pieces are emerging. Wage growth has been on the move for the past 18 months, now sustaining above 3%.   And we had a huge positive surprise in productivity this week.

With the above in mind, given the contrast of media narrative and reality, how are people getting it so wrong?   I suspect we are seeing plenty of people make the mistake of letting politics cloud their judgement on the economy and the outlook for stocks.

Can Stocks Force The Hand Of The Fed … Again

May 2, 5:00 pm EST

We talked about the technical reversal signal in stocks that developed yesterday, following the Fed press conference.

Stocks continued lower today.  We’ve now had a quick 2% decline from the top.

And now we have this technical breakdown in oil as well (the break of the yellow trendline from the Dec lows). 

 

In the post-financial crisis world we live in, oil prices going down is generally representing a gloomier outlook on global growth and global demand.  Oil prices going up is good news — representing a hotter demand/hotter growth outlook.  And as you can see below, oil prices and stock prices have tended to move together. 

The recovery in oil prices has been almost in lock-step with the recovery in stocks (aggressively bouncing).  Crude is up 57% in four months.

Now, yesterday I asked the question:  Can stocks force the hand of the Fed, again (i.e. can lower stocks force a rate cut from the Fed)?

If oil prices were to fall hard from here, then maybe.  Why?  The Fed is afraid of deflationary pressures.  And while they like to talk about their assessment of inflation, excluding the effects of volatile oil prices, they have a record of acting on monetary policy when oil prices are falling quickly — especially in this post-crisis environment where deflation has been a persistent threat throughout.  They acted in 2016, and they’ve acted in early 2019 — in both cases taking projected interest rate hikes off of the table.

But the case for another crash in oil prices isn’t there.  We continue to have supply cuts outside of the U.S. (OPEC and non-OPEC countries).  Trump has recently stepped up sanctions against Iran, with the goal of taking Iranian oil exports to zero.  That takes supply out of the market.  And the political crisis in Venezuela has created supply disruptions for the oil market.

The shale industry is expected to plug the supply gap.  As it stands, the shale industry may or may not be able to.  But keep in mind, oil demand has been estimated on what is (and has been) low expectations for the global economy.  If we’ve seen a bottom in China, it would set up for positive surprises in the global economy. And that means the supply necessary to meet global oil demand, would be underestimated.  With that, higher (if not much higher) oil prices  from here remain the higher probability scenario.

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Stocks Flashing A Technical Reversal Warning

May 1, 5:00 pm EST

As we discussed yesterday, the interest rate market has been signaling that the Fed made a mistake in December, when it hiked rates one last time, into a stock market that was in a steep decline.

In today’s post-Fed meeting press conference with the Fed Chairman, markets were expecting signals from Jay Powell that they might be looking to take that hike back, if the current subdued inflation levels persisted.  But Powell was reluctant to give much of a leaning toward a cut.  In fact, he said the risks that precipitated their “pause” on the rate path (China and European growth, Brexit risks, and trade negoations), have been largely improving.  He’s right.  He said the economy was solid.  He’s right.

Still, stocks came off sharply into the close.

After today, you have to ask the question:  Can stocks force the hand of the Fed, again?  Remember, stocks fell 8% in just four trading days after the Fed’s December hike – penalizing a tone deaf Fed.  In a market that was already down 9% on the month, the slide was exacerbated by the further Fed tightening. 

That stock fallout soon led to a response from the U.S. Treasury, as Mnuchin called out to major banks and the President’s Working Group on Financial Markets (which includes the Fed) to “assure normal market operations.”  That put a bottom in stocks.  And within days of that, the three most powerful central bankers of the past ten years (Bernanke, Yellen and Powell) were backtracking on the Fed’s rate path — signaling a pause.  The Fed’s pivot has fueled a V-shaped recovery in stocks.

So, we’ve just come off of a four-month run in stocks that gave us a full recovery of the late 2018 losses — and a new record high in the S&P 500.  That was the best four month gain since 2010.  Now we enter May with this chart …

 
As you can see, with the decline this afternoon, the S&P 500 put in a key reversal signal — a bearish outside day.  That’s tough to ignore, given that we’ve had a 16% gain in stocks to open the first four months of the year. This signal may be enough to stop the momentum, for now, as we wait for the word on a China deal — which is now said to ‘possibly’ come by next Friday.

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Why A Fed Rate Cut Would Steepen The Yield Curve

April 30, 5:00 pm EST

As we head into a Fed decision tomorrow, we’ve talked about the prospects of a Fed rate cut.  It’s highly unlikely.

It’s even more unlikely today, after Trump pushed for, not just a cut, but a full point cut …

 

Unfortunately, the influence Trump tried to wield late last year, is probably why the Fed hiked in December — just to prove to the world that they (the Fed) wouldn’t be politically influenced.

With that, we now have an economy growing at 3%+, stocks near record highs and subdued inflation.  And yet we have a ten-year yield at 2.5%.  It doesn’t fit.  The interest rate market is still sending the message that the December rate hike was a mistake.

With that, if we did get a cut by this summer, I suspect the interest rate market would adjust to reflect a more optimistic economic outlook.  By that, I mean, with a cut in the Fed funds rate, the long end of the yield curve (specifically, 10-year yields) would probably go UP not down –steepening the yield curve.

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A Rational View Of S&P 3,500+

April 29, 5:00 pm EST

We ended last week with a positive surprise for Q1 GDP.  Today, we had more soft inflation data.

The Fed’s favored inflation gauge, core PCE, continues to fall away from it’s target of 2%.

Here’s a look at the chart …

 

With a Fed meeting this week, they remain in the sweet spot.  They have trend economic growth, subdued inflation and a 10-year yield at 2.5%.  They can sit and watch. They could cut!   That’s highly unlikely, but less unlikely by the summer, if current conditions persist.

The market is pricing in about a 60% chance that we’ll see a rate cut by year-end.  It doesn’t sound so crazy, if you consider that it would underpin/if not ensure the continuation of the economic expansion — perhaps even fueling an economic boom period.

Remember, we’ve talked about the 1994-1995 parallels. In 1994, an overly aggressive Fed raised rates into a recovering, low inflation economy.  By 1995, they were cutting.  That led to a 36% rise in stocks in 1995.  And it led to 4% growth in the economy through late 2000 — 18 consecutive quarters of 4%+ growth.  Stocks tripled over the five-year period.

This, as the S&P 500 is already sitting on new record highs?  As I said earlier this year, with yields back (well) under 3%, we should see multiples on stocks expand back toward 20x in this environment.

The forward 12-month P/E on the S&P 500 is currently 16.8.  If we multiply Wall Street’s earnings estimate on the S&P 500 ($175) times a P/E of 20, we get 3,500 in the S&P 500. That’s 19% higher than current levels.

But keep in mind, the earnings estimate bar has been set low.  And already 77% of companies are beating estimates on Q1 earnings.  I suspect, we’ll see higher earnings over the next twelve months than Wall Street has estimated, AND a higher multiple paid on those earnings (i.e. an outlook for an S&P 500 > 3,500).

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Bar Has Been Set Low To Manufacture Positive Surprises … And They Are Rolling In

April 26, 5:00 pm EST

The first reading on first quarter U.S. GDP came in this morning at 3.2%— much better than expected.  This is a huge positive surprise, for what many expected to be a terrible quarter.

Just a month ago, the consensus view was something closer to 1%.  Goldman was looking for 0.7% going into the end of the quarter.

With that, we’ve been talking about this set-up for positive surprises all year.

Remember, the economy added on average 173,000 jobs a month in Q1.  Both manufacturing and services PMIs expanded in the quarter, and stocks fully recovered the losses from December.  Add to that, just days into the first quarter, the Fed told us they were done raising rates.  Whatever headwinds the Fed was stirring up, quickly became tailwinds.
Yet we’ve been told an economic recession was coming and an earnings recession upon us.  The above is a recipe for growth, not contraction.

Still, as we’ve discussed, never underestimate the appetite of Wall Street and corporate America to dial down expectations when given the opportunity.  That sets the table for positive surprises.  And positive surprises are fuel for stocks.   Stocks are fuel for confidence.  Confidence is fuel for the economy.

Last week we looked at the early signals on Q1 economic activity.  The positive surprises started with what looks like the bottom in Chinese industrial output and retail sales (two key indicators of economic health). This is important because the global slowdown fears have been centered around the weak Chinese economy.

Then both UK retail sales and the U.S. retail sales came in better.  And yesterday, we had a hot durable goods orders number in the U.S for March.

So, despite the negative picture that has been painted, the trajectory of U.S. economic growth seems to be well intact.

This is just the first reading on the Q1 number, but it gives us an average annualized growth rate of three percent even.  The average annualized growth coming out of the Great Recession (pre-Trumponomics) was just 2.2%.

And keep in mind, the next big pillar of Trumponomics is a trillion-dollar-plus infrastructure spend (with bipartisan support).

Just as expectations have been dialed down, this is where we could see a real economic boom kick in, especially if we get a deal on China (clearing that drag on sentiment).  As we’ve discussed, we are well overdue for an economic boom period.  We’ve yet to have the bounce-back in growth that is typical of a post-recession, if not post-depression environment.  You can see in the table below, the six years that followed the Great Depression, relative to the growth coming out of the Great Recession …

 

Have a great weekend!

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