China remains the hold-out on making a deal with Trump on trade. And itlooks likely that they are holding out to see what the November elections look like.
Will Trump retain a Republican led Congress? I suspect we may see China do what they can to influence that outcome.
As we know, the Republicans will be promoting the economy as we get closer to voting day.
What can China do to rock that boat?
They can sell Treasuries, in an attempt to ignite a sharper climb in rates. And a fast move in rates (at these levels) has a way of shaking confidence in equity markets – which has a way of shaking confidence in the economy.
As we’ve discussed, the economy can withstand a 10-year yield in the low 3s. But what has spooked market this year (namely stocks) is the fear that a 3% 10-year could quickly turn into a 4% 10-year.
We may have seen a taste of it today. We had a run from 3.08% to 3.18%. That’s the highest level since 2011. And stocks came off of the highs.
If China was the culprit, or if China chooses to dump some Treasuries over the next month, in attempt to stir up some instability in markets, we should see them move that money elsewhere. The likely recipient of that capital would be gold.
It wasn’t evident with the behavior gold today. Gold had a big dayyesterday, but backed off today, even as rates ran. But as you can see in the chart below, the set up for a bounce in gold here looks ripe. The level to watch will be 1214.
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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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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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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 talked about the case for a shakeout in Amazon. It was up big today on news that it would be buying a big online pharmacy.
That worked to curtail the slide in the stock (for now). But it only exacerbates the building regulatory scrutiny and the President’s wrath against Amazon’s developing monopoly and power (much of which has been garnered overtime from the unfair advantages Amazon has enjoyed from operating as an internet company).
If there’s one thing we know about Trump as a President, he’s done what he says he’s going to do. And he’s had plenty of verbal threats directed squarely at Amazon. We can only assume that he will carry out the offensive he’s been promising — against a company that has crushed industries by price wars.
On a similar note, let’s talk about China. As we’ve discussed quite a bit, China’s rapid economic ascent in the world came through currency manipulation. They held their currency down, to underprice the world on exports. And as the world stood by and watched (and bought lots of stuff from them), they became the world’s second largest economy, and the accumulated the largest war chest of foreign currency reserves.
China is to the world, as Amazon is to corporate America. And Trump is attempting to deal with them both head on.
Interestingly, China is quietly fighting back, via the currency. The go to tool in China is currency devaluation.
That’s what they’ve been doing over the past three months. And that has accelerated in just the past 10 days – they’ve devalued by almost 4% against the dollar. This is something to watch closely. A big one-off devaluation out of China would be a geopolitical cage rattling.
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Last week we stepped through all of the components of economic output and talked about the setup for positive surprises. Keep in mind, the economy is running at near a 3% pace already. And if Trumponomics is just in the early stages of materializing in the data on consumption, investment, government spending and exports, then we may be in for a big growth number.
On Friday we talked about the exports (i.e. the trade) component. On that note, the media was stirring over the combative tone from G7 events over the weekend. What I heard was the potential for big movement (i.e. gains on U.S. exports, which will drive gains in GDP). Trump went in and proposed taking down all trade barriers. That’s negotiating from an extreme. And that typically brings about movement. Quickly, trade partners were discussing “reducing” barriers.
With hotter than expected growth coming, how will that effect Fed policy?
We will soon see. The Fed meets this week. They continue their path of normalizing rates. They’ve hiked once in 2015, once in 2016, three times in 2017 and once, thus far, this year. The market is nearly fully pricing in a second hike for the year on Wednesday. And expectations are for another hike in September. We’ll see this week if they’re adjusting uptheir growth forecasts.
As for the rate path: Remember, Powell is a Trump appointee, and from what we’ve heard from him thus far, he sounds like someone that’s not going to risk chipping away at the recovery by jumping ahead with overly aggressive rate hikes. Unlike the last regime, he will likely take a “whites of inflation’s eyes” approach.
We’ve talked the past couple of days about economic growth and the likelihood that we’re just beginning to see the positive surprises from Trumponomics materialize in the economic data.
The formula for GDP is consumption + investment + government spending + net exports. So you can see in these components, the direct targeting of economic stimulus in the Trump economic plan to drive growth: tax cuts, deregulation, repatriation, infrastructure and trade negotiations.
Now, consumption makes up about two-thirds of GDP. Let’s look at consumption today, and we’ll step through the other contributors to GDP over the next few days.
First, what is the key long-term driver of economic growth over time? Credit creation. When credit is used to buy productive resources, wealth goes up. And when wealth goes up consumption tends to go up. With that in mind, in the chart below you can see the sharp recovery in consumer credit (in orange) since the depths of the economic crisis (this excludes mortgages). And you can see how closely GDP (the purple line, economic output) tracks creditgrowth.
And we have well recovered and surpassed pre-crisis levels in householdnetworth — sitting at record highs now (up another $2 trillion since we last looked at it) …
A large contributor to the state of consumption is the recovery and stability in housing. We are now back to new highs on the broad housing index …
When we consider this solid backdrop, remember, we’ve yet to have a return of ‘animal spirits’ — a level of trust and confidence in the economy that fuels more aggressive hiring, spending and investing.
And with that, as we discussed yesterday, while we are in the second longest post-War economic expansion, we’ve yet to have the aggressive bounce back in growth that is characteristic of post-recession recoveries.
But we now have the pieces in place to see the return of animal spirits and a big pop in economic growth. And that should continue to fuel for much higher stock prices. And there are stocks that will do multiples of what the broader stock market does.
There has been a lot of attention over the past couple of days on China and trade relations.
China has moved down tariffs on auto and auto parts imports. And a source today said the government has “encouraged” China’s largest oil refiner to buy more U.S. crude oil. Based on the reports, China is now taking about 8 times the daily volume of U.S. crude imports, compared to averages a few months ago.
These are concessions! This is a distinct power shift. Not long ago, the world was afraid to rattle the cage of China. They (global trading partners) tiptoed around touchy matters like Chinese currency manipulation prior to the global financial crisis a decade ago, and even more so after the crisis.
But now, you can see the leverage that has been created by Trump. This is exactly what we talked about the day after the election.
Here’s an excerpt from my November 9, 2016 ProPerspectives note, back when the experts were predicting Draconian outcomes for poking the China giant: “As we’ve seen with Grexit and Brexit, the votes came with dire warnings, but have resulted in creating leverage. Trump’s complaints about China are right. And a threat of slapping a tariff on Chinese goods creates leverage from which to negotiate.”
Now, we have an economy that is leading the global economic recovery. China wants and needs to be part of it. And we have a President that has a loud bark, and the credibility to bite. And that is creating movement. Let’s revisit, also from one of my 2016 notes, why this China negotiation is so important …
TUESDAY, SEPTEMBER 27, 2016
China’s biggest and most effective tool is and always has been its currency. China ascended to the second largest economy in the world over the past two decades by massively devaluing its currency, and then pegging it at ultra-cheap levels.
Take a look at this chart …
In this chart, the rising line represents a weaker Chinese yuan and a stronger U.S. dollar. You can see from the early 1980s to the mid-1990s, the value of the yuan declined dramatically, an 82% decline against the dollar. China trashed its currency for economic advantage—and it worked, big time. And it worked because the rest of the world stood by and let it happen.
For the next decade, the Chinese pegged its currency against the dollar at 8.29 yuan per dollar (a dollar buys 8.29 yuan).
With the massive devaluation of the 1980s into the early 1990s, and then the peg through 2005, the Chinese economy exploded in size. It enabled China to corner the world’s export market, and suck jobs and foreign currency out of the developed world. This is precisely what Donald Trumpis alluding to when he says ‘China is stealing from us.’
China’s economy went from $350 billion to $3.5 trillion through 2005, making it the third largest economy in the world.
This next chart is U.S. GDP during the same period. You can see the incredible ground gained by the Chinese on the U.S. through this period of mass currency manipulation.
And because they’ve undercut the world on price, they’ve become the world’s Wal-Mart (sellers to everyone) and have accumulated a mountain for foreign currency as a result. China is the holder of the largest foreign currency reserves in the world, at more than $3 trillion dollars (mostly U.S. dollars). What do they do with those dollars? They buy U.S. Treasurys, keeping rates low, so that U.S. consumers can borrow cheap and buy more of their goods—adding to their mountain of currency reserves, adding to their wealth and depleting the U.S. of wealth (and the cycle continues).
This is the recipe for big trade imbalances — lopsided economies too dependent upon either exports or imports. And it’s the recipe for more cycles of booms and busts … and with greater frequency.”
Again, China has to be dealt with. And we’re starting to see signs of progress on that front. Good news.
