Just two weeks ago, the Nasdaq was up 19% on the year, while the “blue-chip” heavy DJIA was up just 4%.
This is in a world where rates are low, corporate profits are growing at 20% and the economy is on pace to have above trend growth.
Great traders love when prices are detached from fundamentals, especially when it’s driven by fear or euphoria. This was a clear disconnect. And you could argue that there has been a bit of both fear and euphoria driving it (fear priced into the Dow about trade wars, and euphoria priced into the tech giants on the idea that the burgeoning monopolies would go unchecked forever until all competition is left for dead).
Both the fear and the euphoria were misguided for all of the reasons we discuss almost daily in my ProPerspectives note.
And now we’re seeing a convergence. In just two weeks, that performance gap between the Dow and Nasdaq has now closed from fifteen percentage points to nine percentage points. And the Dow still has a lot of room to run. It remains just under the highs from January.
Now, yesterday we talked about the opportunity for Japan to benefit from forced trade reform in China. Other big beneficiaries? Emerging market economies.
In short, all of the countries that have been short-changed on their global trade competitiveness because of China’s weak currency policies, should benefit in a world where China is held to a standard of fair trade.
That’s why Japanese stocks had a huge run yesterday (and expect it to continue). And that’s why EM stock markets were big movers today. The Frontier Markets ETF (FM) is still down 14% on the year. With the idea that these countries may get a better crack at global demand, I suspect these stock markets could be in for a big bounce.
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As we discussed on Friday, with China coming back to the negotiating table on trade, we have a signal that the trade dispute smoke will not end in fire.
That is unlocking this rotation we’ve been talking about for the past month or so, where the money that has been plowed into the stocks of the very hot tech giants, starts moving out and into the lagging blue chips.
With that, as we sit eight months into the year, with the winds of fiscal stimulus in our sails, the S&P 500 is just now close to recovering the losses from the January highs.
And the Dow remains, 3.2% off of the January highs (which were record highs). But I suspect we will now close that gap quickly.
Remember, we have two very hot earnings quarters under our belt, and building momentum in the economic data, as fuel for stocks. And I suspect the China news, to break the stalemate on trade negotiations, will also fuel the resumption of the young bull market in commodities, which should offer very attractive investing outcomes in the coming months.
Maybe the best signal for commodities is this chart on Chinese stocks, which looks like it may have bottomed TODAY into these 2016 lows (circled).
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Back in July, we talked about the significance of the President of the European Commission coming to Washington to make a deal on trade. That was a big day for Trump’s fight to level the playing field on global trade.
Why? Because concessions out of Europe paved the way to more concessions globally.
That’s what we’re getting. Fast forward a little less than a month and now we have China (the center of the global trade dispute universe) coming back to the table on trade negotiations with the U.S.
This is what happens when you negotiate from a position of strength. Trump has the leverage of a strong economy, and the credibility to act on tough threats. And that is bringing about progress. Trading partners risk being left behind in the global economic recovery if they don’t play ball.
So we should expect “movement” from China. And movement equals success.
With that, as I said, I suspect that will be the catalyst to get stocks back on the path toward double-digit gains by year-end.
On Tuesday, we looked at the similarities between the recent currency collapse in Turkey, and the 2014 collapse of the Russian ruble.
And we looked at this chart of how the S&P 500 behaved back in 2014.
The S&P 500 is the proxy on global market stability. And stocks were shaken on Russia back in 2014. When the ruble collapsed, U.S. stocks lost 5% of its value in just 7 days.
But the decline was fully recovered in just 3 days.
Given the similarities of these two currency crises (a currency attack on a bad behaving leader), I thought we might see the same behavior in stocks this time. And that’s what we appear to be getting – a shallower decline but a swift recovery.
So, why the quick recovery?
As we also discussed on Tuesday, while the Turkish lira has been the center of attention in the financial media, the real reason global markets were shaking had more to do with China.
If a currency crisis that started in Turkey ended in China, there would be big geopolitical fallout.
As we’ve discussed over the past month, the biggest risk from China is a big one-off devaluation. That would stir up a response from other big trading partners (i.e. Europe and Japan), where they would likely coordinate to blocktrade from China all together. That’s where things would get very ugly and likely (ultimately) culminate in a military war.
But the probability of that outcome was reduced yesterday. We had news that a China delegation would travel to the U.S. to re-open trade negotiations. They’re coming back to the table.
So we should expect concessions from China. That’s good news for the globlal economy and for global stability. And that news drove the big bounce in stocks yesterday, which continued today. I suspect this will be the catalyst to get stocks back on the path toward a double-digit gains by year-end.
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We talked yesterday about the sharp currency devaluation in Turkey over the past few days. The Lira bounced aggressively today, which soothes some fears in global markets.
As I said, many have made comparisons to the Asian currency crisis of the late 90s, and have speculated on the potential for the events in Turkey to ultimately destabilize global markets. But as we discussed yesterday, this looks more like the 2014 currency attack on the Russian ruble — a geopolitically-driven crippling of an economy with bad behaving leadership.
With that in mind, here’s what happened to U.S. stocks back in 2014, when the ruble lost 5% of its value (vs the dollar) in just 7 days. But the decline was fully recovered in just 3 days.
U.S. stocks have been the proxy for global market stability throughout the past decade (the crisis and post-crisis era). So, for perspective on just how shaky the Turkey influence is being perceived, the S&P 500 sits just one percent off of all-time highs at today’s close.
Remember, the ECB stands ready to plug any holes necessary in European bank exposure to Turkish debt. That euro-denominated debt has been the risk people immediately homed in on.
The real question is, will this (currency crisis) ultimately end in China, with a revaluation of the yuan, or perhaps a free-floating yuan?
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Tomorrow we get the second quarter GDP number. We’ve gone from a consensus view that didn’t believe in the economic momentum, or in the value of fiscal stimulus, to a consensus view that is now looking for more than 4% annualized growth for the second quarter. The switch has flipped in just the past few months.
As a goal for the economy, we hear the 3% growth number thrown around quite a bit. That’s right around long-term trend growth (trend growth is a little higher). But the GDP report that gets the most attention is a quarterly annualized number, which is more of a reflection of what the economy would look like if we moved forward over the next few quarters with similar economic activity. That can be a very volatile number. And we can see big numbers, in good economies and in bad economies. This is where the politicians like to find ambiguity to argue over. The pro-Trumpers will say we’re growing at 3%, something Obama never achieved. And the Obama defenders will point to several 3%+ annualized quarters in the Obama era.
What’s more informative is the average annualized growth over the past four quarters. That’s where you can see smoother trends and considerable improvements in the Trumponomics world.
On that note, we may finally hit that 3% number tomorrow. If the GDP number comes in tomorrow at the Atlanta Fed’s expectations (4.5%), we will have the hottest growth since June 2006.
A 4.5% second quarter number would put the four-quarter average annualized growth at 3.175%–the highest since the pre-financial crisis days. You can also see in the chart, the steady improvement in growth since the election, first driven by the optimism of pro-growth policies, and now driven by policy execution, as deregulation and tax cuts are working through the system.
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Last week Larry Kudlow, the White House Chief Economic Advisor, hinted that Jean-Claude Juncker (head of European Commission) would be coming to Washington with some concessions on trade.
As I write, we’ve yet to hear the results of the Trump/Juncker meeting today, but this could be a major turning point in the perception of the U.S. trade offensive. Movement equals success. And in that case, concessions out of Europe may pave the way to more concessions globally. That signal could trigger a big rally in global markets.
One particular market to watch is copper. Copper is the first place you should look if you think the world is escaping the slugglish post-crisis growth period, and possibly entering an economic boom period. It has been sensitive to the global trade disputes. A clearing of that, would resume what should be a multi-year bull market in copper.
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We’ve been watching the Chinese currency very closely, as the Chinese central bank has been steadily marking down the value of its currency by the day, in efforts to offset U.S. trade tariffs.
Remember, in China, they control the value of their currency. And they’ve now devalued by 8% against the dollar since March. They moved it last night by the biggest amount in two years. That reduces the burden of the 25% tariff on $34 billion of Chinese goods that went into effect earlier this month.
But Trump is now officially on currency watch. Yesterday in a CNBC interview he said the Chinese currency is “dropping like a rock.” And he took the opportunity to talk down the dollar.
The Treasury Secretary is typically from whom you hear commentary about the dollar. And historically, the Treasury’s position has been “a strong dollar” is in the countries best interest. But Trump clearly doesn’t play by the Washington rule book. So he promoted his view on the dollar (at least his view for the moment)–and it may indeed swing market sentiment.
The dollar was broadly lower today. We’ll see if that continues. If so, it may neutralize the moves of China in the near term. Nonetheless, the U.S./China spat is reaching a fever pitch. Someone will have to blink soon. Trump has already threatened to tax all Chinese imports. The biggest risk from China would be a big surprise one-off devaluation. As we discussed yesterday, that would stir up a response from other big trading partners (i.e. Europe and Japan). And they may coordinate, in that scenario, a threat to block trade from China all together.
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Yesterday CNBC hosted their Delivering Alpha conference. This conference is primarily an opportunity for investors to hear views and ideas from some of Wall Street’s best.
However, the bigger picture geopolitical environment is far more important for the market at the moment, than what a big hedge fund manager thinks about valuation (for example).
On that note, there were some interesting takeaways from yesterday’s event. As we discussed yesterday, we heard from Larry Kudlow, the White House Chief Economic Advisor. And we also heard from Steve Bannon, the former White House Chief Strategist.
Bannon has been given plenty of unappealing labels by the media in recent years, but his perspective on the White House game plan and how it’s executing is invaluable. I think everyone would agree that the communication on the economy and foreign policy could be handled better by the White House.
And Bannon articulates the issues in the Trump plan, maybe better than anyone. It’s an interview everyone should watch (here’s a link).
As we’ve discussed here in my ProPerspectives piece since I started writing this nearly three years ago, the trade war is nothing new. And it’s all about China. As Bannon said, China has been waging an economic and cyber war with the U.S. for the better part of the past 25 years. Now they’ve run into a wrecking ball in Trump: someone with the leverage and the credibility to act on threats to end the gutting of global economies (including the U.S. and other major developed market economies). Bannonsays we’re in the early stages of a “reorientation of the supply-chain around freedom loving countries.”
As we’ve discussed, the best reflection of China’s strategic response to Trump’s pressure is their currency. What are they doing with it? They continue to walk it lower every day. This is a signal that they have no options–playing by the rules and getting slower economic growth isn’t an option for the ruling regime in China. They can only fight back by offsetting tariffs with a weaker currency. And that may ultimately lead to blocking China trade completely.
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The jobs report this morning continued to show an improving economy, operating with the luxury of low inflation.
I say improving because as the unemployment rate ticked higher, it represents people coming back into the work force. Those people that have been discouraged along the way, through the economic crisis and recovery, and have dropped out of the work force, are coming back, looking for work.
Remember, the missing piece of the recovery puzzle over the past decade has been wage growth. That has been the telltale sign of the job market, despite the low headline number. With little leverage in the job market to maximize potential, much less command higher wages, consumers tend not to chase prices in goods and services higher–and they tend not to take much risk. This tells you something about robustness of the economy. And that’s precisely why we’ve needed fiscal stimulus and structural reform. And it’s just in the early stages of feeding through the economy.
The other big news of the day was trade. The U.S. started implementing duties on $34 billion of Chinese imports today. On that note, the media has been focused on one specific sentence in the Fed’s minutes yesterday. After weeding through the long conversation on how well the economy was doing, they picked out this sentence to build stories around “contacts in some Districts indicated that plans for capital spending had been scaled back or postponed as a result of uncertainty over trade policy.” Plucking this one out and using it to support their scenarios of trade wars and economic implosion has to be good for reeling in readers.
But keep in mind capital goods orders (the chart below) are nearing record highs again.
Add to this: An ISM survey back in December showed that businesses were forecasting just 2.7% growth in capitalspending for 2018. But when they were asked again in May, they had revised that number UP to 10.1% growth.
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