Predictably, Trump extended the timeline on new tariffs in his meeting with China’s President Xi over the weekend.
This is kicking the trade war can down the road. That extends the timeline on the trade war and resets the opportunity to force the Fed’s hand this coming month–to get a rate cut at the July 30-31 Fed meeting.
As we’ve discussed, with a rate cut under his belt, this would clear the way for Trump to, then, claim victory on the China trade war by doing ‘a’ deal, giving himself enough runway into the 2020 elections to have a booming stock market and booming economy.
Since December, we’ve been talking about the parallels between the current period and the 1994-1995 period. It’s worth repeating again. The script continues to play out. 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 more than 4% growth. Stocks tripled over the five-year period.
Think about that, and then remove the overhang of a trade war with the two biggest economies of the world and you can see the path to some very good times ahead. Moreover, if the above scenario plays out, Trump would then likely turn back to Congress and green-light a $2 trillion infrastructure plan.
While many have been predicting economic bust, this is a formula for an economic boom!
We end the week, month and quarter today. Stocks are up 17% year-to-date.
With the big Trump/Xi meeting coming over the weekend, let’s talk about how Fed policy has flipped from a headwind (adding to the risks), to a tailwind (backstopping against the risks – an implicit “put”).
And that’s why the chart on the S&P 500 looks like this …
Of course we’ve had big geopolitical risks along the timeline of this chart, that include an historic trade war (which continues) and potential sanctions against Saudi Arabia (late last year).
The geopolitics have consumed the markets attention. But maybe it’s all about the Fed, and their ability to interpret (or lack thereof) the impact of trade disputes and structural reform in the global economy – and position correctly.
If we look back at the timeline, the tops and bottoms in these V-shaped moves in the chart above all align perfectly with Fed speak.
Stocks topped on October 3rd and proceeded to drop 20% through the end of December. What happened on October 3rd? The Fed chair, Jay Powell, did a sit down interview with PBS, where he said, after raising rates three times for the year, that they remain far away from the ‘neutral’ rate. And he said they may go past neutral. Why? He thought tariffs and the uptick in wage growth would feed into inflation. He was wrong.
With that view of tighter and tighter monetary policy into a low inflation and recovering economy, with hurdles of trade reform in the path, the markets started signaling the contra-viewpoint: the trade war weighs on global growth, and within that context, rising U.S. rates are a killer for emerging market economies, and for the slow recovering developed markets.
Powell’s comments started the decline, which ultimately led to a big decline. Yet, the tone-deaf Fed raised rates in December, again, right into a falling stock market. Moreover, following the December Fed meeting, the Fed made it clear that they were prepared to mechanically keep raise rates — another four times in 2019.
When did it turn? It turned the day (January 4th) the Fed marched out Powell, Bernanke and Yellen, (tails between their legs) to tell the world ‘no more rate hikes/ the Fed is done.’
Stocks bottomed, on that day, and did a perfect ‘V’ back to the record highs over the following months.
When did it top again? May 1. What happened on May 1? The Fed met and Jay Powell had his post-meeting press conference. After months of running Fed officials out in the media to tell us the Fed’s got your back, Powell fumbled.
The interest rate market (10-year yields) had fallen 75 basis points from the highs of just six months prior, giving a very clear message to the Fed that, at the very least, the December hike was a policy mistake. But Powell was unwilling to show any leaning toward a rate cut. In fact, he said the risks that precipitated their “pause” on the rate path (China and European growth, Brexit risks, and trade negotiations), have been largely improving. Again, the Fed was tone-deaf and unwilling to take a defensive stance against the unknowns of geopolitical risks. Stocks go down.
A few days later, U.S./China trade talks come to a standstill. Stocks continue on for a 7% decline.
When did stocks bottom? June 3rd. What happened? A voting Fed member, Jim Bullard said that a Fed cut may be “warranted soon” to “provide some insurance” in case of a sharper slowdown. That was a primer for a June 4th speech by Jay Powell. Powell came out of the gates, in a prepared speech that morning, telling us they “will act as appropriate to sustain the expansion.” That spurred the second “V-shaped recovery” on the above chart.
The conversation at the Fed has now, finally, turned to rate cuts. And the market is now expecting a 100% chance the Fed will cut at the July 31 meeting.
Perhaps now the Fed is in the right position, trade deal or no trade deal. And that should be very good for stocks.
Remember, the last time the Fed was in this position in 1994, they cut rates and that led to a huge year for stocks — and stocks and the economy boomed through the end of the nineties.
Bitcoin has had another huge move over the past three months — more than tripling. And then late yesterday afternoon, it collapsed 15% in just minutes. It lost 25% in value on the day.
The first rise and fall in Bitcoin, from $1,000 to $19,000 and back to $3,000, took place from early 2017 to early 2018. Most of the move was over just four months.
Here’s a look at the chart. You can see the first run-up and this most recent run-up …
Remember, this first run-up had everything money moving out of China, and less to do with Silicon Valley genius/ global monetary system disruption.
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 — better policing movement of capital out of China, from transfers to foreign investment (individuals can move just $50,000 out of the country a year).
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). China cryptocurrency exchanges were said to account for 90% of global bitcoin trading. Capital flows were confused with Silicon Valley genius.
But in September of last year China crackdown 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. And a few months later it was worth 1/6th of its value at the top.
Is this time different? Is this real traction for Bitcoin, or is this just Chinese capital flows looking for a parking place, again? Likely, the latter. It’s probably no coincidence that as the prospects of a ‘no deal’ with China have elevated in recent months, Bitcoin has again been on the move. As we’ve discussed, if Trump holds firm on his demands, it seems impossible that China can do his deal. It’s political suicide for the Chinese Communist Party. With that, they fight tariffs with a devaluation of the yuan.
With those prospects, if you have money in China, you have been getting it out! While cryptocurrency exchanges have been banned in China, owning and buying Bitcoin in China is not banned. The Bitcoin futures market and off-exchange (peer-to-peer) trading are liquidity sources for Chinese citizens to respond to potential devaluation in the yuan.
With the above in mind, this round of Bitcoin bubble may not deflate until/unless Trump makes concessions to do a deal (which seems unlikely until, at least, we get past the July Fed meeting).
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This morning Mnuchin was interviewed by CNBC. He was the headline of the day, despite saying nothing new.
When trade talks broke down in early May, the Trump administration said they were 90% of the way to a deal. But China balked and reneged on concessions. Mnuchin said the same thing today (we were 90% there), and the media presented it as if he said progress was made this week, heading into the meetings. That’s not what he said.
Let’s talk about the backdrop heading into the weekend negotiations. Remember, Trump is in the driver’s seat in this negotiation. He can’t force a good deal, but he can claim victory on the trade front just by doing ‘a’deal.
With that in mind, as we’ve discussed over the past month, he seems to be attempting to surgically optimize the economy heading into next year’s election. He’s been fighting for a Fed rate cut, and through introducing heightened risks of a standstill on trade, he’s gotten what looks like Fed compliance coming down the pike (for a July cut).
The timeline set up perfectly for a June rate cut, and then for Trump to settle on a China deal at the G20 meeting. The economy would have launched like a rocket-ship. The Fed didn’t comply.
With that, at this weekends Trump/Xi meeting, let’s see if Trump extends the timeline on new tariffs, to get through the July Fed meeting (in hopes of getting his Fed fuel for the economy). At this point, the market has backed the Fed into the corner, with high expectations of not just 25 bps, but a 50 bps cut. Without an extension of trade uncertainty, those expectations will sustain if not grow.
Now, we’ve discussed over the past month, the prospects for this trade war with China ending with a grand and coordinated currency agreement — perhaps a big depreciation of the dollar, similar to the 80s “Plaza Accord.”
As I said a couple of weeks ago, 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). It might be a deal between the U.S. and China to “revalue” the yuan (i.e. strengthen it). Or it may exclude China (just G3 economies). An interesting takeaway from this morning’s interview with Mnuchin: Mnuchin did make a point to emphasize that they look forward to many bi-lateral meetings at the G-20 — not just with China.
How do you position for a dollar devaluation? Buy commodities. Is that what the move in gold is telling us (and Bitcoin)? Maybe.
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Remember, last year was the first year since 1994 that cash was the best producing asset class (among stocks, real estate, bonds, gold).
This year, as it did in 1995, the pendulum has swung.
Stocks are up 16% year-to-date. The Dow Jones Real Estate Index is up 19%. Gold is up 11%.
As you can see below, there is a lot of green on the year for global asset prices …
As we’ve discussed for much of the year, what else is similar between the current and 1994-1995 period? We had an overly aggressive Fed, that tightened into a low inflation, recovering economy. In 1995, they did an about face, cutting rates at their July meeting. And now we head into the July Fed meeting with expectations of a 50bps cut.
On that note, we heard from the Fed just days ago, signaling that they were ready to act if conditions deteriorated. And as I said following the meeting: “What is clear, from Powell’s press conference, is that this is all about the China trade deal. If it drags out, sentiment continues to erode. When sentiment erodes, the economic momentum will erode. If that’s the case, they will be reactive, with stimulus (rate cuts and/or slowing the runoff of Treasuries on the Fed balance sheet).”
Today, Jerome Powell was again on a stage talking about monetary policy, at a conference on the Economic Outlook and Monetary Policy at the Council on Foreign Relations. He had a prepared speech and did a Q&A. So what message was he trying to send to markets?
He did a lot of talking. But I suspect his posturing doesn’t matter at this point. This less about him, or the economy, and more about Trump. If Trump were to back off the hardline demands and signal a deal with China over the weekend, the Fed would be off the hook — no rate cut. If the meeting comes and goes, and it’s a clear kick the can down the road, or no deal –we get a cut by the Fed come July (whatever size and scope is necessary).
Let’s take a look at gold as we head into the Trump/Xi meeting scheduled to take place at the end of the week’s G20 meeting.
Gold has been sold all along as an “inflation hedge.” But unless you have Weimar Republic-like hyperinflation, you’re unlikely to get the inflation-hedge value out owning it.
Remember, gold went on a tear from sub-$700 to above $1,900 following the onset of global QE (led by the Fed). Gold ran up as high as 182%. That was pricing in 41% annualized inflation at one point (as a dollar for dollar hedge). Of course, inflation didn’t comply. Still, ten years after the Fed’s first round of QE and massive global responses, we’ve been able to muster just a little better than 1% annualized inflation.
If you bought gold at the top in 2011, the value of your “investment” was cut in half just four years later. That’s a lot of risk to take for the prospect of “hedging” against the loss of purchasing power in the paper money in your wallet.
So, gold isn’t a hedge against inflation, it’s a hedge against the worst-case scenario. It’s for sovereign wealth and anyone else that can take delivery, own and control the storage. For almost everyone else, it’s a speculative trade.
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As we end the week, any questions on whether or not the central banks have your back, have been answered.
Just as they have for the better part of a decade, they have no choice but to respond to any shocks that might knock the global economic recovery off path. And as I said yesterday, the major central banks of the world have lined up, because they are unable to predict what Trump will do on trade. To maintain market confidence, they have to posture as if they assume the trade war will go on indefinitely.
On that note, it seems to be priced into the global treasury markets and the gold market that China can’t accept Trump’s deal (or at least can’t deliver on the current demands of the deal). It’s politically unpalatable and an existential threat to the Chinese Communist Party. So, the question is, will Trump end the trade dispute with more bark than bite? Will he do a deal (not the deal) and remove the overhang of uncertainty from the global economy, and an election coming next year. Next week should be interesting, as we await the Trump/Xi meeting at the G20 (scheduled for Friday 6/28 and Saturday 6/29).
As we head into this weekend, markets hang around big levels: record highs in stocks, the big 1,400 level in gold, just above 2% on the 10-year, and closing in on 10k in Bitcoin (a haven for Chinese capital flight).
We’ve talked this week about the yield curve inversion.
In response, the market is now pricing in a better than 70% chance of a rate cut in June. And Trump’s new pick to join the Fed, Stephen Moore, has said the Fed should cut by 50 basis points immediately.We’ve talked about the comparisons between 2019 and 1995. In 1994 the Fed aggressively tightened into a low inflation, recovering economy (as they did in 2018). By the middle of 1995, they were cutting. Stocks finished the year up 36%.
Given the contrast of where the Fed has positioned themselves now, compared to just three months ago, they have effectively eased — and we can see it clearly manifested in the interest rate market. The 10-year U.S. government bond yield has gone from 3.25% to under 2.5% since just November. I would argue we already have a repeat of 1995.
Here’s a look, in the chart on the left, at what stocks did in 1994-1995, when the Fed transitioned fromovertightening (into a low inflation, recovering economy) to easing. And, on the right, this is how things look now, with similar context.
Within a few quarters of the ’95 rate cut, U.S. growth was printing above 4% and did so for 18 consecutive quarters. Stocks tripled over that period.
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Following the Fed yesterday, we heard from the Bank of Japan overnight, and the Bank of England this morning. As for Europe, we heard from the ECB last week.
Coming into this week we’ve had this ongoing dynamic, for quite some time, of the Fed going one way on rates (up) and everyone else going the other way (cutting rates, QE, etc.).
That’s been good for the dollar, as global capital tends to flow toward areas with rising interest rates and better growth prospects. That combination tends to mean a rising currency and rising investment values. What really determines those flows though, is the perception of how that policy spread, between countries, may change. Most recently, that perceived change in the spread has been in favor of it growing, i.e. Fed policy tighter or at least stable, while other spots of the world considering even easier on monetary policy.
That divergence in policy has been bad for currencies like the euro, the pound and the yen. But that hit to the currency is part of the recipe. It promotes higher asset prices, better exports and growth. And as Bernanke says, QE tends to make stocks go up, which helps.
Still, those stocks have lagged the strength in U.S. stocks. With that, over the past six months or so, I’ve talked about the opportunities in European and Japanese stocks for a catch up trade.
While U.S. stocks have continued to set new record highs, stocks in Europe and Japan have yet to regain the highs of 2015 — when the global economy was knocked off course, first by slowing China and a surprise currency devaluation, and later by a crash in oil prices.
With that, if you think Trumponomics marked the end of the decade long deleveraging period (post-financial crisis), and that the Fed is signaling that by ending emergency level monetary policy, then the rest of the world should follow. That means the next move in Europe, Japan, the UK will be toward normalization, not toward more emergency policies.
That means the expectations on the policy gap narrows. With that, we may have seen the bottom in the euro. If negative interest rates and an election cycle that has parties that are outright promising to destroy the euro can’t push it to parity, what can? If it can’t go lower, it will go higher.
And if the euro has bottomed and the next move for the central bank in Europe is tapering, the first step toward ending emergency policies, then this stock market in Europe looks the most intriguing for a big catch up trade – still about 20% off of the 2015 highs and well below the pre-crisis all time highs.
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Remember, this (animal spirits) is the element that economists and analysts can’t predict, and can’t quantify. It’s not in the forecasts. This is what has been destroyed over the past decade, driven primarily by the fear of indebtedness (which is typical of a debt crisis) and mistrust of the system. All along the way, throughout the recovery period, and throughout a tripling of the stock market off of the bottom, people have continually been waiting for another shoe to drop. The breaking of this emotional mindsethas been underway since the night of the election. And that gives way to a return of animal spirits.
Higher stock prices tend to beget higher stock prices. Trust me, individual investors that haven’t been believers will be calling their financial advisors and logging in to their online brokerage accounts over the coming days. Institutional investors that haven’t been believers, that have been underweight stocks, will be beefing up exposure if they want to compete with their peers (and keep their jobs).
And not only do higher stock prices lead to higher stock prices, but higher stock prices tend to make people feel more confident about the economy, which begets a better economy.
Add to this, the psychological value of Dow 20,000 could finally be a turning point in the divergence of sentiment toward the Trump Presidency. It may serve as a validation marker for those that have been on the fence. And for those in opposition, as I’ve said before, growth solves a lot of problems! When the college grad that’s been relegated to a 10-year career as a barista begins to see signs of opportunity for a better career and a better future, in a stronger economy, the sands of Trump sentiment can shift quickly.
Cleary, Trump entered with a game plan that can pop economic growth. And he’s going 100 miles an hour at executing on that plan. For markets, what he’s doing is creating a sense of certainty for investors. They know what he’s promised, and now they know that he appears to intend on delivering on those promises. And the coordination of growth policies, along with ultra-easy monetary policy (even with tightening in view) serves as risk mitigators for markets. It should limit downside risk, which is what investors care most about. How?
Remember, even at Dow 20,000, stocks are still extremely cheap.
Here’s a review on why …
Reason #1: To return to the long-term trajectory of 8% annualized returns for the S&P 500, the broad stock market would still need to recovery another 48% by the middle of this year. We’re still making up for the lost growth of the past decade. And there’s a lot of ground to make up.
Reason #2: In low-rate environments, the valuation on the broad market tends to run north of 20 times earnings. Adjusting for that multiple, we can see a reasonable path to a 16% return for the year. That’s an S&P 500 earnings estimate of $133.64 times a P/E of 20 equals 2,672 on the S&P 500.
Reason #3: The proposed corporate tax rate cut from 35% to 15% is estimated to drive S&P 500 earnings UP from an estimated $132 per share for next year, to as high as $157. Apply $157 to a 20x P/E and you get 3,140 in the S&P 500. That’s 37% higher.
With this in mind, we are likely entering an incredible era for investing, which will be an opportunity for average investors to make up ground on the meager wealth creation and retirement savings opportunities of the past decade. For help building a high potential portfolio for 2017, follow me in our Billionaire’s Portfolio, where you look over my shoulder as I follow the world’s best investors into their best stocks. Our portfolio more than doubled the return of the S&P 500 in 2016. You can join me here and get positioned for a big 2017.
