Italy’s face-off with the EU is ramping up, following their announcement last week of plans to increase their deficit spending.
Why does it matter?
This is another round of populist push-back against policies that have stifled economic recovery and threatened sovereignty over the past decade. We’ve seen it play out in Greece, in the UK, and in the U.S. 2016 election.
With risk rising of a shakeout in Europe, you can see in the chart above, money is moving out of Italian government bonds and into German government bonds. This sends Italian yields UP and German yields DOWN — on what is already a 300 basis points spread between the two 10 year borrowing rates. A continuation of this puts pressure on Italian solvency.
But this will all likely end favorably for Italy and for the broader European economy. Because as Italy pushes back on austerity, we’ll likely to see the EU make concessions on fiscal constraints, that will open the door for fiscal stimulus across Europe.
The policymakers know very well that the health of the “monetary union” is the lynchpin in Europe. If it’s pulled (by an exit of a constituent member), the European Union will crash and fracture. That’s why the ECB stepped in back in 2012 to prevent debt defaults in Italy and Spain. And that’s why EU officials have made concessions throughout, on aid to keep Greece alive.
Italy’s resistance will come with a lot of draconian threats and warnings (from EU officials, as we’ve already seen), but in the end Italy may be the catalyst to unlock growth in Europe.
Trump has laid out the playbook for economic stagnation. It’s aggressive fiscal stimulus. Europe should follow that lead.
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Given the global nature of business within the Dow constituents, the DJIA has been the place for pain, as uncertainty over trade has ebbed and flowed over the past year. So, with a new trade agreement with Mexico and Canada, we get a big rally in the Dow today. That puts the Dow up 7.8% on the year.
Still, we came into the year expecting something much bigger for stocks.
The big tax cuts that came near the end of last year, have indeed translated into big corporate earnings surprises, and a hotter than expected economy. This is something you would expect to be fuel for a much bigger than average year for broader stock markets. And you would expect it to be fuel for a big run in commodities markets. But the stock market performance is sitting right around long-term average gains. And broad commodities performance (if we look at the CRB index) is up just 2% on the year.
This has all been supressed by the uncertainties surrounding trade, and the resulting rising geopolitical tensions.
But with concessions from Europe on trade earlier in the summer, and now a new agreement on North American trade, Trump is clearly winning on trade.
What’s next? Infrastructure. This has been the next pillar of Trumponomics. Gary Cohn, the former White House economic advisor, said he thinks the White House will get it done ($1 trillion+) regardless of who controls the House after November.
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The Fed moved again today on rates, as the market expected. This is the eighth quarter point hike in this post-QE normalization on rates. And this now puts the Fed Funds rate at the range of 2%-2.25%.
Now, the markets will pick apart the statement and endlessly parse the Fed Chair’s words in the press conference. But let’s step back and take a look at the impact of these Fed hikes thus far.
We know the economy is running at the best pace since before the financial crisis. We know that the jobless rate is near record lows. We know that consumer credit worthiness is at record levels. This has all happened, despite the Fed’s rate hikes.
What about debt service coverage? As rates are moving higher, are consumers showing signs of getting squeezed?
If we look back at the height of the credit bubble in 2008 (just prior to its burst), 13.22% of household income was going to service debt–within that number, 7.2% of household income was going to service mortgage debt. What about now? Debt service is now 10.2% of household income. And the mortgage piece is down to just 4.4%. This is the result of six years of zero interest rates, a massive QE program (which included the Fed’s purchase of mortgage bonds), and a government program that subsidized banks to refi high interest rate mortgages.
So the big question is, how has the Fed’s exit of QE effected the consumers ability to service debt? Are higher rates hurting?
Well, they started hiking rates in the fourth quarter of 2015. Total debt service at that time was 10.1%. That’s virtually unchanged from today. And the mortgage piece was 4.5%. That’s actually a touch higher than today.
Bottom line: The Fed’s normalization on rates has not damaged the consumer, nor has it killed the housing market.
But that’s only because the yield curve has been flattening. That is, longer term market interest rates have been steady. That means the benchmark rate from which consumer and mortgage rates have been set, has been steady. And those longer term rates have been steady, in large part, because Europe and Japan have remained in QE mode (buying global assets, which includes our Treasurys).
With that, while most have been watching the Fed closely for how it’s delicately handling the exit of QE, the more important spot to watch will be how Europe and Japan manage their exits. Hopefully, the U.S. economy is hot enough, at that point, to withstand the move in longer term U.S. rates that will come with the end of global QE.
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Last Friday we talked about the technical breakout in rates. And we looked at this chart as the benchmark 10-year U.S. government bond yield hit 3%.
This week yields traded as high as 3.09%. These 3%+ levels have proven to spook stock markets on all other occasions this year. But it hasn’t this time. In fact, the Dow closed the week on new record highs. The prospects that Fed normalization might be slowing, and that 10-year rates may be carving out a new/higher range, reduces the prospects of seeing the yield curve “invert.” That’s positive for stocks.
As we close the week, let’s take a look at Chinese stocks, which put in a double bottom earlier this week, and closed today threatening a technical break of the big downtrend of the year. Believe it or not, Chinese stocks could be the best buy in the world right now.
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Yesterday Trump made good on his promise by announcing another $200 billion in tariffs on China.
To the surprise of many, stocks went up. Why?
Perhaps it’s because reforming the way the world deals with China is a good thing. Remember, China’s currency manipulation over the past two decades led to the credit bubble, which ultimately led to the financial crisis. And as long as the rest of the world continues to allow China to maintain a trade advantage (dictated by their currency manipulation): 1) they will manufacture hot economic growth through exports, 2) the global cycle of booms and bust will continue, and 3) the wealth transfer from the rest of the world to China will continue.
With this in mind, as I’ve said, the trade dispute is all about China – everything else Trump has taken on (Canada, Mexico, Europe) has been to gain leverage on getting movement in China.
With Trump now making it very clear that he won’t back down until major structural change takes place in China, it’s no surprise that one of the biggest winners of the day (following the further economic sanctions on China) was Japan!
The Nikkei was up big today. And it was Japanese stocks that set the tone for global markets on the day. As a signal that China’s days of cornering the world’s export markets may be coming to an end, Japan is in position to be a big winner.
Remember, while much of the world has returned to new record highs following the global financial crisis, Japan remains 40% away from the record highs set nearly 30 years ago.
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Those that look for reasons to pick apart the bull case for the economy and markets were disappointed by the ECB this morning.
As we discussed earlier in the week, the improvements in the U.S. economy and the trajectory of U.S. rates has cleared the path for Europe to finally exit QE. And the ECB confirmed this morning that they remain on that path — to end QE into the year end.
The idea that Europe can exit QE is a huge positive for both the European economy and the global economy – a confidence signal.
With that, German stocks are a big buy here. As you can see in the chart below, while the S&P 500 is on record highs, the DAX has been well underwater on the year (down more than 6%).
The index also trades well under the 200 day moving average (the purple line). To close the performance gap in this chart, German stocks could be in the early stages of a 13%-15% run.
And stocks in Europe should be supported by a strengthening euro.
Remember, as the global economy improves, the dollar should get weaker. The growth and rate gap (between the U.S. and the rest of the world) will be narrowing from here, which will promote foreign capital to flow into currencies like the euro. But most importantly, the exit of QE means Europe has escaped the dangerous crisis era, which means money will flow “back home“ out of/from the world’s safe-haven asset (dollar-denominated U.S. Treasury market).
I suspect the euro will trade closer to 1.30 by this time next year, as the ECB will begin raising rates in 2019, and likely follow the U.S. lead on fiscal stimulus to drive growth.
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Yesterday we talked about the case for breaking up Amazon, on the day it crossed the trillion-dollar valuation threshold. Today the stock was down 2%.
Also today, Facebook and Twitter executives visited Capitol Hill for a Congressional grilling.
If you listened to Zuckerberg’s Congressional testimony in April, and today’s grilling of Jack Dorsey (Twitter) and Sheryl Sandberg (Facebook), it’s clear that they have created monsters that they can’t manage. These tech giants have gotten too big, too powerful, and too dangerous to the economy (and society).
All have emerged and dominated, thanks in large part to regulatory advantage – operating under the guise of an “internet business.” And it all went unchecked for too long. These are monopolies in the making. But, as we know, Trump is on it.
As we discussed yesterday, Amazon has to, and will be, broken up. As for Facebook, Google, Twitter, Uber: the regulatory screws are tightening. Those businesses won’t look the same when it’s over. But it’s complicated. The higher the cost of compliance, the smaller the chances that there will ever be another Facebook or challenger. That goes for many of the tech giants.
With that in mind, regulation actually strengthens the moat for these companies.
That would argue that they may ultimately go the way of public utilities (in the case of Facebook, Google and Twitter).
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The best investing advice over much of the past decade has been “don’t fight the Fed.” The Fed needed stocks higher (to restore confidence and wealth — at least paper wealth). And the Fed forced stocks higher.
They did it through ultra-low interest rates and through a committment to backstop against any shock risks. With that, despite the many threats along the path of the the global economic recovery, stocks went up.What’s the best investing advice of the post-election environment?
Don’t fight Trump.
Remember, we’ve talked about the “great handoff” on election night. Trump finally represented an end to an era, where the global economy was surviving on central bank life support. It was the handoff from a monetary policy-driven recovery, to a fiscal stimulus and structural reform-driven recovery. And that handoff gave us a chance to get to a sustainable recovery — to escape post-recession stall-speed growth.
So no wonder, the influence of Trump on markets and global stability, is much like the influence of the central banks of the past decade.
Trump wants a booming economy.
We need a booming economy to escape the stall-speed growth of the post-global recession world. So we have major economic and geopolitical undertakings in play to achieve a booming economy. And just as the central banks wouldn’t let shocks undo the trillions of dollar they had committed to the recovery, Trump won’t either. The central banks intervened often, either verbally, or through policy. And Trump has intervened often. Also, a lot of verbal, and plenty of policy responses.
The dollar and the Fed are the latest examples. And today, we saw the influence and the outcome. Trump has hand-selected the Fed Chair that is continuing the program of gradual rate hikes. But Trump he sees higher rates, uncessarily threatening to curtail the growth picture, he’s “intervening.”
Below is some of his jawboning against higher rates …
And today, we heard from the Fed Chair at Jackson Hole. People were looking for any indication that the Fed Chair might be influenced by Trump’s comments.
And here are the money headlines from his speech…
The Fed explicitly said under Yellen one time, that they opted against a rate hike because they were no signs that the economy was overheating. That makes the second comment above very interest, regarding the expectations on the Fed’s movees for the remainder of the year. And if they don’t see inflation accelerating above 2% (the first comment) then why raise rates again.
The market seemed to agree with that interpretation today. The prospects of steady rates is a recipe for higher stocks, higher commodities and a lower dollar. And that’s what we had today. I expect it will continue. And this may have finally been the catalyst to get commodities moving again.
Have a great weekend!
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It was two weeks ago when Elon Musk sent this tweet about taking Tesla private…
For a guy that has taken personal offense to the short sellers in the stock, this tweet only emboldened them — and may have been the catalyst that will ultimately prove the shorts right.
Why? If you liked shorting a company that’s lost $6 billion over the past five years, while making the CEO/ founder a billionaire more than 18 times over, you’ll love it when you have an absolute ceiling of $420 to sell against.
And that’s precisely what the shorts have done. They’ve leaned more heavily against the company, as Musk has created an asymmetric outcome for them. As you can see in the chart, it’s working.
As I’ve said in the past, Tesla is among the tech giants that benefited from the Obama administration’s distribution of the massive fiscal stimulus package that followed the global financial crisis. Not only did they get regulatory favor from the government, but they received outright funding — a $465 million loan, at a time the company was broke. And in that economic environment, the big pension funds were happy to follow government money in search of relative security (plowing money into government “sponsored” investments).
Fast forward 10 years and the company is still bleeding money, but Musk is a billionaire! But sentiment has finally begun turning against the company, which is it’s biggest risk. When the investors stop believing in the hype and start demanding real performance, the air can come out of the balloon very quickly.
So, to step out of the scrutiny of public markets, Musk has threatened to take the company private, with the help of Saudi funding. But there’s a new problem. If the Saudis are indeed willing to fund Tesla, Trump may block it. The administration is stepping up protections against allowing U.S. intellectual property to fall into the hands of foreigners. The government may giveth and the government may taketh away, in the case of Tesla.
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Yesterday we looked at this chart of the S&P 500 …
In discussing this chart, I made an error. The blue line, of course, represents what the S&P 500 would have looked like had it continued its long-run annualized growth rate of 8% from the 2007 (pre-crisis) peak. That gives us perspective on where we stand in this stock market recovery. Even though we’re up more than four-fold from the 2009 bottom, and people continue to talk about how long this bull market has run, we still have not recovered the lost growth of the past decade.
That is clearly displayed in the gap between the orange line (the actual S&P 500) and the blue line (where stocks would be had we continued along the 8% annualized path).
What can we attribute this gap to? Post-recession recoveries are typically driven by an aggressive bounce-back in growth. We didn’t get it. Instead, the post-recession growth environment of the past decade was dangerously shallow and slow.
Why? The Fed and other major central banks were the only game in town for the global economy over the past decade. They saved the world from a total collapse, staved off further shocks along the way, and they manufactured a recovery. But the “easy money” solution doesn’t work the same in the depths and aftermath of a global debt bust, as it does in normal recessions. The central banks could only muster stall-speed growth.
That’s why the election was so important. It has resulted in the great hand-off, from a global economy that was just surviving on the life-support of central banks, to a global economy that has the chance to thrive on the catalyst of fiscal stimulus, and become sustainable from structural reform.
With that, we should expect the gap in the chart above to close. That argues for much higher stock prices, and a continuation of this bull market.
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