Trump: This is going to hurt me more than it hurts you

The chart below depicts container traffic at the Port of Los Angeles, the largest volume US container port. Loaded inbound containers (blue), measured in twenty foot units or TEUs, have far exceeded loaded outbound units (red) for a number of years. What is noteworthy is that the ratio of loaded outbound to inbound containers has deteriorated from 48% to 38% over the last 6 years.

Port of Los Angeles Container Traffic

Imposition of tariffs has not reversed this. In fact the opposite. Stats for July 2019 show an 8.7% increase in inbound traffic and a 4.0% decrease in outbound traffic, while the ratio of inbound to outbound containers fell to a new low of 34%.

S&P 500: Flight to safety

10-Year Treasury yields are near record lows after Donald Trump’s announcement of further tariffs on China. The fall reflects the flight to safety, with rising demand for Treasuries as a safe haven.

10-Year Treasury Yield

Crude found support at $50/barrel. Breach would warn of a new down-trend, with a target of $40/barrel. Declining crude prices reflect a pessimistic outlook for the global economy.

10-Year 3-Month Treasury Spread

The S&P 500 found support at 2850. Rising volatility warns of increased market risk. A test of support at 2750 remains likely.

S&P 500

Declining Money Flow on the Nasdaq 100 reflects rising selling pressure. Expect a test of 7000.

Nasdaq 100

The Shanghai Composite Index broke support at 2850. A Trend Index peak at zero warns of strong selling pressure. Expect a test of support at 2500.

Shanghai Composite Index

India’s Nifty is testing support at 11,000. Breach would offer a target of 10,000.

Nifty Index

Dow Jones Euro Stoxx 600, reflecting large cap stocks in the European Union, is testing primary support at 368. Strong bearish divergence on the Trend Index warns of a double-top reversal, with a target of 330.

DJ Euro Stoxx 600

The Footsie is similarly testing support at 7150. Breach would offer a target of 6600.

FTSE 100

I have warned clients to cut exposure to the market. It’s a good time to be cautious.

“There is a time for all things, but I didn’t know it. And that is precisely what beats so many men in Wall Street who are very far from being in the main sucker class. There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time.”

~ Jesse Livermore

The Long Game: Why the West is losing

Autocracies like China, Russia and Iran are challenging the dominance of Western democracies. Much has changed in the last two decades, fueling this emerging threat to the free world.

China & Global Trade

China joined the WTO in 2001 and disrupted global trade. Subsidy of state-owned or state-sponsored industries tilted the playing field. Manipulation of exchange rates, amassing $4 trillion of foreign reserves, helped to depress the yuan, creating a further advantage for Chinese manufacturers.

Manufacturing employment in the US shrank by more than 5.5 million jobs between 2000 and 2010.

Manufacturing Jobs USA

Europe experienced similar losses.

Manufacturing Jobs UK, France & EU

Output recovered, but through a combination of automation and offshoring labor-intensive activities, manufacturing jobs were never restored. Losses of 4 million US manufacturing jobs (23.5% of total) and an equal 4 million (10%) in the European Union appear permanent.

Manufacturing US & EU

The Global Financial Crisis

The global financial crisis (GFC) in 2008 and the recession caused soaring unemployment and further alienated blue collar workers.

Unemployment US & EU

The $700 billion bailout of the banking system (Emergency Economic Stabilization Act of 2008), with no prosecutions of key actors, undermined trust in Federal government.

The Rise and Decline of Nations

Mancur Olson, in The Rise and Decline of Nations (1982), argues that interest groups — such as cotton-farmers, steel-producers, labor unions, and banks  — tend to unite into pressure groups to influence government policy in their favor. The resulting protectionist policies hurt economic growth but their costs go unnoticed, attracting little resistance, as they are diffused throughout the economy. The benefits, on the other hand, are concentrated in the hands of a few, incentivizing further action. As these pressure groups increase in strength and number, the costs accumulate, and nations burdened by them fall into economic decline.

Olson formulated his theory after studying the rapid rise in industrial power in Germany and Japan after World War II. He concluded that their economies had benefited from the almost complete destruction of interest groups and protectionist policies as a result of the war and were able to pursue optimal strategies to rebuild their economies. The result was that their economies, unfettered by pressure groups and special interests, far outstripped those of the victors, burdened by the same inefficient, protectionist policies as before the war.

Federal government, choked by lobbyists and special interests, failed to prioritize issues facing blue collar workers: global trade, off-shoring jobs and fallout from the GFC. Formation of the Tea Party movement in 2009 created a rallying point for libertarians and conservatives — supporting small government and traditional Judeo-Christian values1 — but it also opened the door for populists like Donald Trump.

Polarization

Exponential growth of social media, combined with disinformation and fake news, has polarized communities.

In 2017, 93 percent of Americans surveyed said they receive news online, with news organization websites (36%) and social media (35%) the most common sources. Trust and confidence in mass media has declined from 53 percent in 1997 to 32 percent in 2016, according to Gallup Polls.

Politics are increasingly dominated by outrage and division, with populist candidates gaining handsomely.

Many Western governments are now formed of fragile coalitions. Greece, Italy, Germany, even the UK.  Others in Eastern Europe — Poland, Hungary, Austria, Turkey — are heading towards autocracy.

The Long Game

China has been quietly playing the long game. Massive investment in infrastructure, subsidy of key industries, controlled access to its markets, upgrading technology through forced partnerships with Western companies in exchange for access to Chinese markets, and industrial espionage have all been used to gain an advantage over competitors.

The CCP exploits divisions within and between Western governments while expanding their influence in universities, think tanks and the media. The stated aim of the CCP’s United Front Work Department is to influence Chinese diasporas in the West to accept CCP rule, endorse its legitimacy, and assist in achieving Party aims. This includes some 50 million who emigrated after 1979 or are PRC students studying abroad. Stepped up surveillance of PRC students, funding of Confucius Institutes on campuses and growing student activism has raised concerns in Australia over academic freedom and promotion of pro-Beijing views3.

Western governments seem unable to present a coordinated response. Absence of a cohesive, long-term strategy and weakened alliances make them an easy target.

Pressure Groups

Governments are also subjected to pressure from within. The latest example is pressure exerted, by US companies, on the White House to lift the ban on sales of US technology to Huawei. From the New York Times a few days ago:

Beijing has also pressured American companies. This month, the Chinese government said it would create an “unreliable entities list” to punish companies and individuals it perceived as damaging Chinese interests. The following week, China’s chief economic planning agency summoned foreign executives, including representatives from Microsoft, Dell and Apple. It warned them that cutting off sales to Chinese companies could lead to punishment and hinted that the companies should lobby the United States government to stop the bans. The stakes are high for some of the American companies, like Apple, which relies on China for many sales and for much of its production.

Short-term Outlook

The problem with most Western democracies is that they are stuck in a short-term election cycle, with special interest groups, lobbyists for hire, and populist policies targeted at winning votes in the next election. Frequent changes of government lead to a lack of continuity, ensuring that long-term vision and planning, needed to build a winning global strategy, are woefully neglected.

Autocrats like China, Russia and Iran are able to play the long game because they enjoy continuity of leadership. They do not have to concern themselves with elections and the media cycle. They own the media. And elections, if held, are a mere formality, with pre-selected candidates and pre-ordained results.

Western democracies will have to adapt if they want to remain competetive in the 21st century.

Focus on the Long-term

Switzerland is one of the few Western democracies that is capable of a long-term focus. Their unique, consensus-driven system ensures stability and continuity of government, with buy-in from all major political parties. The largest parties are all represented on the 7-member governing Federal Council. Elected by Federal Assembly (a bicameral parliament) for four-year terms on a proportional basis. There has been only one change in party representation on the Federal Council since 19592.

Cohesiveness and stability provide a huge advantage when it comes to long-term planning.

Conclusion

Regulating global trade, limiting the threat of social media, ensuring quality journalism, protecting academic freedom, guarding against influence operations by foreign powers, limiting the power of lobbyists and special interest groups — all of these require a long-term strategy. And buy-in from all sides of the political spectrum.

We need to adapt our current form of democracy, which has served us well for the last century, but is faltering under the challenges of the modern era, or risk losing it all together. Without bipartisan support for, and commitment to, long-term policies, there is little hope for building a winning strategy.

The choice is ours: a highly-regulated, autocratic system where rule of law is the first casualty; a stable form of democracy that ensures long-term continuity and planning; or continuation of the present melee, driven by emotion rather than forethought, populist leaders, frequent changes in government — and subservience to our new autocratic masters.

Footnotes:

  1. Wikipedia: Tea Party movement
  2. Current Federal Council representation is 2 Free Democratic Party (liberals), 2 Social Democratic Party (social democrats), 1 Christian Democratic People’s Party [CVP] (Christian conservatives) and 2 Swiss People’s Party [SVP] (national conservatives), reflecting 76.2% of the popular vote in 2015 Federal elections. The SVP gained one seat from the CVP in 2003.
  3. The Diplomat: China’s United Front work – Propaganda as Policy

S&P 500: Plan B

The S&P 500 is testing its all-time high at 2950. Bearish divergence on Twiggs Money Flow warns of secondary selling pressure. Respect of resistance is likely and would signal retracement to test support at 2750.

S&P 500

The 10-Year Treasury yield has fallen to 2.0%, indicating that the Fed is expected to cut interest rates in the second half of 2019.

10-Year Treasury yield

Stocks are still running on hope of a deal in the US-China trade dispute. Xi Jinping and Donald Trump will meet this weekend to discuss the way forward. Chinese preconditions for a trade agreement are likely to include the US lifting its ban on the sale of technology to telecommunications giant Huawei and removal of US tariffs on Chinese imports, according to The Wall St Journal. The US is unlikely to accede and chances of a deal are slim to nonexistent.

Trump doesn’t seem concerned: “My Plan B with China is to take in billions and billions of dollars a month and we’ll do less and less business with them……My plan B’s maybe my plan A.” (Bloomberg)

Plan B is the likely outcome, with a moderate impact on US corporate earnings and Fed rate cuts to keep the market on track. Risks rise while the potential upside declines. It’s a good time to be cautious.

We must recognize that as the dominant power in the world we have a special responsibility. In addition to protecting our national interests, we must take the leadership in protecting the common interests of humanity……There is no other country that can take the place of the United States in the foreseeable future. If the United States fails to provide the right kind of leadership our civilization may destroy itself. That is the unpleasant reality that confronts us.

~ George Soros: The Age of Fallibility

ASX 200: Don’t ignore the headwinds

The ASX 200 is advancing to test its all-time (2007) high at 6830, having respected its new support level at 6350.

ASX 200

Shane Oliver, AMP economist, argues that an Australian recession is unlikely as the economy has tailwinds as well as headwinds:

  • mining exports have surged on the back of strong iron ore prices, narrowing the current account deficit;
  • a falling Aussie Dollar will act as a shock absorber to stabilize the economy;
  • the Australian government has strong capacity to stimulate the economy, through tax cuts and infrastructure spending;
  • house prices may be falling but there is no panic selling; and
  • the RBA has further capacity to cut rates if necessary.

The tailwinds can be summed up in two words: iron ore. Without high ore prices, our current account deficit and fiscal deficit would be much larger, limiting the ability of government to stimulate the economy.

Australian headwinds, on the other hand, can be summed up by one words: jobs. High ore prices do not create many jobs.

Job growth is falling and unemployment is expected to rise.

Low jobs growth is eroding consumer confidence, flagged by falling spending on durables such as motor vehicles.

ASX 300 Autos & Components

And housing.

House Prices

The critical question is: will the iron ore tailwind last long enough to save the Australian economy from recession?

High iron ore prices are unlikely to last long. From Reuters on Thursday:

Mining giant Rio Tinto on Thursday lowered its guidance on volumes of iron ore it expects to ship from the key Pilbara producing region in Australia for the third time since April, citing operational problems.

The guidance cut came just hours after Brazilian miner Vale, the world’s No. 1 iron ore producer, said late on Wednesday that it will fully resume Brucutu operations within 72 hours, after a favourable ruling from an appeals court…..Brucutu, which has been operating at only a third of its capacity, was shuttered in February as Vale’s mine operations came under close scrutiny after a tailings dam collapsed in Brazilian town of Brumadinho, killing more than 240 people…..The full operation of Brucutu “should help alleviate concerns about tightness in the market,” said ANZ Research analysts in a note. “However, issues at Rio Tinto’s operations suggest the market still has some challenges ahead.”

Rio Tinto said it now expects shipments from Pilbara at between 320 million tonnes and 330 million tonnes, mostly lower-grade and lower-margin product. Its previous target was between 333 million tonnes and 343 million tonnes.

Vale at the same time reaffirmed its 2019 iron ore and pellets sales guidance of 307 million to 332 million tonnes, saying sales should be around the midpoint of that range, instead of the low end of the range as previously expected.

Chinese steel production is strong.

China Output

Housing construction is rising.

China Housing

But rising housing inventories warn that construction is running ahead of demand, which is likely to exert downward pressure on prices.

While Chinese automobile production is faltering. From WSJ:

Auto sales in China declined for an 11th straight month in May, with the slump in demand showing no sign of easing and the country’s automotive industry bracing for losses tied to new emissions standards.

Sales for the latest month fell 16% from a year earlier, to 1.91 million vehicles….

I am not sure how long the iron ore shortfall will last but I wouldn’t bet on high prices by the end of the year. Nor would I bet on the G20 meeting between Donald Trump and Xi Jinping resolving US-China trade differences.

That leaves uncertain tailwinds and far more certain headwinds.

No US-China trade deal

“On Monday, US President Trump told reporters that he would impose tariffs on an additional USD 300 billion of Chinese goods if Xi Jinping doesn’t meet with him in Japan.” ~ Trivium China, June 12, 2019

Trump is doing his best to kill any chance of a trade deal. He is making it impossible for Xi to turn up for a G20 meeting. To do so would be admitting defeat. Kow-towing to Trump would totally undermine Xi’s standing in China.

If earnings undershoot, stocks will fall

Annual employment growth is falling while average hourly earnings growth remains high. This is typical. Ahead of the last two recessions (gray bars below), average hourly earnings growth (green) held steady while employment growth (blue) declined.

Employment Growth & Average Hourly Wage Rate

If annual employment growth (blue line on the above chart) falls below 1.0% then a Fed rate cut is almost guaranteed. Not something to celebrate though, as the gray bars and further job losses illustrate.

Declining growth in hours worked points to lower GDP growth in the second quarter.

Real GDP & Hours Worked

From Bob Doll at Nuveen:

“China is taking a tough stance toward the U.S. on trade. Chinese officials appear open to ongoing negotiations, but a recently released statement denies the country’s role in intellectual property theft, blames the U.S. for negotiation breakdowns and calls out the damage done to the American economy as a result of the dispute. All of this suggests that trade issues will persist for some time.”

The CCP is upset that they are now being called out for bad behavior when this should have been addressed years ago. Conflict can no longer be avoided and is likely to last for a generation or more.

“On Monday, US President Trump told reporters that he would impose tariffs on an additional USD 300 billion of Chinese goods if Xi Jinping doesn’t meet with him in Japan.” ~ Trivium China, June 12, 2019

Trump is doing his best to kill any chance of a trade deal. He is making it impossible for Xi to turn up for a G20 meeting. Kow-towing to Trump would totally undermine Xi’s standing in China.

Xi wants a trade deal that is a handful of empty promises, so the CCP can continue on their present course. The US wants an enforceable undertaking, so that the CPP is forced to change course. Chances of both achieving what they want are negligible.

Both sides need to guard against economic war (time to call it what it is) slipping into a full-scale conflict. All it takes is a spark that sets off tit-for-tat escalation where neither side will back down.

Proxies such as North Korea, Syria and Pakistan are especially dangerous as they are capable of dragging great powers into direct confrontation (think Serbia before WWI, Korea after WWII).

Wannabe great powers like Russia will also do their best to foment conflict between their larger rivals. Stalin achieved this with the Korean War in the 1950s and Vladimir Putin is more than capable of attempting the same. The world is a dangerous place.

Upside potential for stocks is declining while downside risks are growing. Investors are flowing out of equities and into Treasuries despite minimal yield (10-year yield is negative after inflation and tax).

Stocks are being supported by buybacks but that can only continue for as long as cash flows (from earnings) hold up. Buybacks plus dividends for the S&P 500 exceeded reported earnings by more than $100 billion in Q4 2018.

S&P 500 Buybacks, Dividends & Reported Earnings

That is unsustainable. If earnings undershoot, stocks will fall.

Trade war reality sinks in

Realization that we are slipping into a trade war is starting to sink in.

The S&P 500 broke medium-term support at 2800, warning of a correction. The target is primary support at 2400. Volatility is flashing an amber warning, above 1.0%.

S&P 500

Nymex crude is plunging as anticipated global demand falls.

Crude Oil

Long-term Treasury yields are falling, with the 10-Year headed for a test of support at 2.0%. The Yield Differential (purple line) is back below zero, warning of a recession.

Yield Differential: 10-Year and 3-Month Treasuries

As I have mentioned earlier, a negative yield curve is a reliable early indicator of recession but trouble is imminent when it recovers above zero. Normally caused by the Fed cutting interest rates in response to falling employment growth. The critical indicator to watch is non-farm payroll growth. When that falls below 1.0% (right-hand scale), watch out!

Employment Growth and Fed Funds Rate

War is an evil thing; but to submit to the dictation of other states is worse…. Freedom, if we hold fast to it, will ultimately restore our losses, but submission will mean permanent loss of all that we value…. To you who call yourselves men of peace, I say: You are not safe unless you have men of action on your side.

~ Thucydides (circa 400 BC)

Market uncertainty is likely to persist as US-China negotiations stall | Bob Doll

From Bob Doll at Nuveen:

“There have been several risk-off phases this decade, triggered by economic threats due to politically induced setbacks. However, the current sluggish global economy and weak trade, coupled with escalating trade tariffs and non-tariff barriers, is a worrisome combination. This is especially true because once protectionism has gained momentum, it may prove difficult to stop or reverse. While many risk asset prices are only off modestly from April highs, there’s an ominous undercurrent in global financial markets.

We have assumed that the pro-growth bias of both the U.S. and China would lead to a trade truce. That premise looks increasingly questionable, although a deal is always possible. Given that financial markets have not reacted more significantly, investors are still generally expecting the global economic expansion to persist.

Despite the longer-term power struggle, the constructive case for a trade deal between the U. S. and China was predicated on President Trump focusing on the short-term win, while the Chinese look to the longer-term. This difference in political time horizons made a deal possible. Now, the focus for both parties has shifted to long-term strategic objectives, resulting in a stalemate. A financial market downturn may be needed to break the impasse. An extended period of churning could develop if trade talks resume, but without signs of a resolution.

The current market weakness differs from prior periods of economic uncertainty during this decade. There has always been a path to a positive outcome for growth and risk assets, primarily via additional policy stimulus. However, the economic and market outcome this time has become more uncertain, and time will not work towards a positive outcome unless trade negotiations improve. Business sentiment will erode if mounting trade roadblocks and uncertainty do not diminish. Protectionism tops the list of recession catalysts, and a permanent deterioration in U.S./China trade relations could have adverse long-term revenue ramifications for global trade and growth.”

My thoughts:

  • A trade deal was never going to happen. Long-term objectives of the CCP and the US are in direct conflict and headed for a collision.
  • Trump deserves credit for confronting the issues rather than kicking the can down the road as Obama did (Paul Krugman highlighted the problem in 2010).
  • Trump is the least likely President to negotiate a peaceful resolution to this hegemonic struggle. Diplomacy and building trust are not his forte.
  • Trust is low, eroding any chance of a face-saving public accord.
  • An agreement would simply be a band-aid, not a long-term solution (see my first point).
  • The impact on business will not be catastrophic but earnings growth will slow.
  • The market is unsure how to react. Yet. If it does make up it’s mind that this is bad for business, there won’t be enough room in the lifeboats. A down-turn could be sharp and hard.
  • Sell down to the sleeping point.

” I am carrying so much cotton that I can’t sleep thinking about it. It is wearing me out. What can I do?”
“Sell down to the sleeping point,” answered the friend.

~ Edwin Lefevre: Reminiscences of a Stock Operator (1923)

The eye of the storm

“On Wednesday, the US Department of Commerce added Huawei – and 70 other companies – to its “Entity List.” …. Huawei cannot buy parts or components from US companies without the explicit approval of the US government.” (Trivium China)

We are sliding towards a fully-fledged trade war. Following straight after the imposition of tariffs by both the US and China, US action against Huawei will be taken as a direct attack on Chinese industry.

The CCP is already stoking nationalist sentiment to bolster public support.

“Last night and today, CCTV replaced regularly scheduled programming with two films about the Chinese army fighting the US in the Korean War.” (Trivium China)

Market response is so far muted. On the daily chart, the S&P 500 correction is modest. Expect another test of 2800. Breach would offer a target of 2600.

S&P 500

The Nasdaq 100 retreated below its new support level at 7700 but Money Flow remains strong.

Nasdaq 100

China’s Shanghai Composite found support at 2900.

Shanghai Composite Index

Japan’s Nikkei 225 is ranging between 20000 and 24000. Expect another test of primary support at 20000.

Nikkei 225

India’s Nifty is testing support at 11000. Respect would confirm the primary up-trend.

Nifty Index

In Europe, The DJ Euro Stoxx 600 is undergoing a correction that is likely to test support at 365. But Trend Index above zero continues to signal buying support.

DJ Euro Stoxx 600

The Footsie found support at 7200, with Trend Index again signaling buying support.

FTSE 100

10-Year Treasury yields are testing support at 2.40%. One of the few clear signs that markets are growing increasingly risk averse, as demand for bonds drives down yields.

10-Year Treasury Yields