The S&P 500 and Plan B

The S&P 500 penetrated its rising trendline, warning of a re-test of support at 3000. But selling pressure on the Trend Index appears to be secondary.

S&P 500

Transport bellwether Fedex retreated below long-term support at 150 on the monthly chart — on fears of a slow-down in international trade. Follow-through below 140 would strengthen the bear signal, offering a target of 100. The bear-trend warns that economic activity is contracting.

Fedex

Brent crude dropped below $60/barrel on fears of a global slow-down. Expect a test of primary support at 50.

Brent Crude

Dow Jones – UBS Commodity Index broke primary support at 76 on the monthly chart, also anticipating a global slow-down.

DJ-UBS Commodity Index

South Korea’s KOSPI Index is a good barometer for global trade. Expect a re-test of primary support at 250.

KOSPI

While Dr Copper, another useful barometer, warns that the patient (the global economy) is in need of medical assistance.

Copper (S1)

The Fed can keep pumping Dollars into financial markets but at some point, the patient is going to stop responding. In which case you had better have a Plan B.

Trump gets his Deal

Donald Trump signed the Phase One US-China trade deal with China’s Vice-Premier Liu He in Washington D.C. on Wednesday.

The deal is important for Trump politically as he needs to disrupt media focus on his impeachment playing out in the Senate.

China attempted to downplay the significance of the deal by sending their Vice-Premier rather than Xi Jinping for the signing ceremony. But the deal is no less important for them in order to halt/slow the relocation of manufacturing jobs by multinationals to avoid US tariffs.

Trivium China sum up the outcome:

  1. We are still in a trade war. Tariffs remain levied on hundreds of billions of USD worth of goods.
  2. A phase two deal looks dead in the water. US President Trump has already said that he might wait until after the November election to negotiate the next phase. More importantly, there is little appetite in China to make concessions on any of the remaining issues.
  3. Third countries are getting screwed. China’s overall import bill is unlikely to jump by USD 200 billion over the next two years, so increased purchases of US goods will come at the expense of producers in other countries.
  4. This deals another blow to the multilateral trading system. The world’s two largest economies just bypassed the multilateral rules-based system to negotiate a deal that undermines the principles of free trade.
  5. China is downplaying the deal. The fact that Liu He – not Xi Jinping – signed the deal sent a strong signal domestically that this is not a big deal. And Chinese officials have said that most of these measures would have happened irrespective of a deal.
  6. Finally, the deal is a positive for stability. This will serve to halt – or at least slow – economic decoupling. That’s a positive for the global economy and security.

Rhodium Group in The Good, The Bad and The Missing focus on what should have been in the deal but isn’t:

  1. Chapter 1 Pledges greater protection for a handful of specific products – pharmaceuticals, medicines and unlicensed software – and generally more enforcement against counterfeit products but the concerns of other industries are not addressed
  2. There are no robust enforcement mechanisms in Chapter 7. It provides a forum for discussion and consultation but not arbitration. If unable to resolve the issue, the aggrieved party can withdraw from the Agreement. This creates little incentive to resolve issues and may result in a logjam.
  3. The managed trade approach does not even start to remedy systemic concerns like the predominance of state enterprises, the prevalence of foreign investment limitations in the vast set of industries that did not get early attention in this deal, the lack of consistency in competition policy treatment and the general asymmetry of information and the playing field for private firms foreign and domestic.
  4. Phase One fails to address growing challenges at the intersection of economics and national security: Huawei and 5G telecommunications, detentions and pressure on expatriates and travelers from the other side, foreign investment screening and export controls, and the threat of financial decoupling.

Rhodium concludes:

The agreement is a limited one, primarily capping the potential for further escalation of protectionism on both sides rather than taking serious steps to address long-standing issues in Chinese trade practices. The managed trade outcomes in which China promises additional US imports are the most significant substantive commitments made, but China’s capacity and willingness to meet these targets remains in question. Significant tariffs remain in place on both sides, uncertainty about the future path of the US-China relationship will persist, and the broader decoupling trends in security-sensitive areas of the bilateral relationship will continue. Progress toward any Phase Two agreement is likely to be minimal in 2020. (The Chinese side immediately said after the January 15 signing that it wanted to go slow before any further talks.)

The deal attempts to head off further escalation but falls well short of addressing long-standing issues with Chinese trade practices. Trade tensions and decoupling are likely to continue.

Trade deal announced

Donald Trumps latest tweets on a trade deal with China:

Twitter

As Trish Nguyen predicted, Trump was never going to introduce the Dec15 tariffs as they directly impact on US consumers, not producers as in earlier rounds of tariffs.

Prof Aaron Friedberg (Princeton) gives an interesting summary of the impact this deal will have. The bottom line is that China will not change its ways:

 

  • CCP-ruled China has long exploited advanced industrial economies – by pursuing a variety of predatory and market-distorting policies

  • The CCP is exceptionally unlikely to offer any fundamental concessions on these policies – they are deeply embedded in China’s economic system and the CCP views them as essential to its hold on power

  • Even if CCP-ruled China were to modify some of its more objectionable economic practices, so long as its domestic political regime remains unchanged, it will continue to pose a serious geopolitical and ideological challenge to the U.S.

  • In light of these realities, the U.S. should pursue a four-part strategy for defending U.S. prosperity and security, by moving toward a posture of partial economic disengagement from China.

De-coupling will continue.

S&P 500 and Europe: New deal or a false dawn?

Donald Trump and is making noises about an interim trade deal with the CCP, while Boris Johnson appears to be making progress on a Brexit deal with Ireland premier Leo Varadkar.

Trump’s announcement is little more than a sham, intended to goose financial markets, with nothing yet committed to writing:

“Trump said the deal would take three to five weeks to write and could possibly be wrapped up and signed by the middle of November….”

…what could possibly go wrong?

The economy continues to tick along steadily, with unemployment and initial jobless claims near record lows.

Unemployment & Initial Jobless Claims

But high levels of uncertainty are likely to create a drag on consumer spending and stock earnings.

At the outset of Donal Trump’s presidency, value investor Seth Klarman, who runs the $30 billion Baupost Group hedge fund, predicted the impact that Trump would have on financial markets:

“The erratic tendencies and overconfidence in his own wisdom and judgment that Donald Trump has demonstrated to date are inconsistent with strong leadership and sound decision-making…..

The big picture for investors is this: Trump is high volatility, and investors generally abhor volatility and shun uncertainty…. Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan.”

In his letter, Mr Klarman warned: “If things go wrong, we could find ourselves at the beginning of a lengthy decline in dollar hegemony, a rapid rise in interest rates and inflation, and global angst.”

While not entirely prescient — we have low interest rates and low inflation — Klarman was right about the decline in dollar hegemony and the rise in global angst.

Markets are clearly in risk-off mode.

US Equity ETFs recorded a net outflow of $824m this week, compared to a net inflow of $2,104m into US Fixed Income. Year-to-date flows present a similar picture, with a 3.3% inflow into US Equity compared to 13.9% into US Fixed Income (Source: ETF.com).

ETF Flows YTD

Long tails on the S&P 500 candles indicate buying support. Expect another test of our long-term target at 3000. Volatility remains above 1%, however, indicating elevated risk. Breach of 2800 is unlikely at present but would offer a target of 2400.

S&P 500

According to Factset, the S&P 500 is likely to report a third quarter this year with a year-on-year decline in earnings.

S&P 500 Earnings

The Nasdaq 100 paints a similar picture, with another test of 8000 likely.

Nasdaq 100

It is becoming impossible to justify current heady earnings multiples when reported earnings are declining.

Europe

If Johnson’s “free trade zone” for Northern Ireland can break the Brexit impasse, then there may be room for optimism over the future UK – EU relationship.

Europe seems to be stirring. Trailing a distant third, to North America and Asia in terms of investment performance, there are some early encouraging signs. A higher trough indicates buying pressure and breakout above 400 on DJ Stoxx Euro 600 would signal a primary advance.

DJ Euro Stoxx 600

The Footsie shows similar early signs of a potential recovery. A higher trough on the trend Index indicates buying pressure. Breakout above 7600 would signal a primary advance.

FTSE 100

Let us hope that this is not a false dawn and the UK and EU are able to resolve their differences.

For the present, our outlook for the global economy remains bearish and equity exposure for International Growth is a low 34% of portfolio value.

Trade talks: ‘Extend and pretend’

Donald Trump

Donald Trump has been weakened by the impeachment process, with more than half the respondents in a recent Fox News poll wanting the troubled President impeached:

“A new high of 51 percent wants Trump impeached and removed from office, another 4 percent want him impeached but not removed, and 40 percent oppose impeachment altogether.”

Criticism in the right-wing press is growing, with Judge Andrew Napolitano on Fox News:

“A CIA agent formerly assigned to the White House – and presently referred to as the “whistleblower” – reported a July 25, 2019 telephone conversation that Trump had with Ukraine’s President Volodymyr Zelensky. That conversation manifested both criminal and impeachable behavior.

The criminal behavior to which Trump has admitted is much more grave than anything alleged or unearthed by Special Counsel Robert Mueller, and much of what Mueller revealed was impeachable….”

In an attempt to shore up his ratings, the embattled President has softened  his stance towards an interim trade deal with the Chinese.

“President Donald Trump said Friday that the U.S. and China had reached a “substantial phase one deal” on trade that will eliminate a tariff hike that had been planned for next week.

Trump announced the deal in the Oval Office alongside members of his economic and trade teams, as well as Chinese Vice Premier Liu He and his team, who were in Washington for negotiations.

Trump said the deal would take three to five weeks to write and could possibly be wrapped up and signed by the middle of November….”

The deal is likely to be limited in scope, which will suit China. More from NBC News:

“The White House and China are expected to announce that Beijing will buy more agricultural products, particularly pork and soybeans, from the U.S.

“It seems like they’ve already begun to buy pork,’ said Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics, pointing out that a swine fever epidemic has decimated China’s domestic pork industry. “They want to contain domestic prices,’ he said. “They’re not doing this just to please Trump. They’re doing this because it suits them.’

While there is little expectation that the Trump administration would roll back existing tariffs, a further delay of two looming deadlines would send a key signal to the markets about the trajectory for future trade relations……”

None of the hard issues will have been addressed and an interim deal is effectively a retreat by the Trump administration:

Thornier — and more fundamental — trade issues pertaining to intellectual property protections, market access and America’s push for China to change its legislation around these and other contentious issues would likely fall by the wayside, analysts said. “There aren’t going to be any of these other issues addressed, unless Trump caves,’ Kirkegaard said. “It certainly doesn’t address any of the structural issues…he went to war for.’

….“It’s a ceasefire. It’s not a peace treaty,’ Kirkegaard said. “It’s what the Chinese wanted all along.”

This was always the likely outcome, with the US economy in a stronger position to withstand a trade war but Xi and the CCP stronger politically and able to absorb more domestic pressure than the fragile Trump administration.

What we are likely to get during Trump’s remaining time as President is more ‘extend and pretend’ — a ceasefire rather than a resolution of the underlying issues regarding protection of intellectual property and reciprocal market access.

S&P 500: Upside limited, while downside risks grow

Corporate profits (before tax) ticked up slightly in the second quarter of 2019 but remain below 2006 levels in real terms. The chart below shows corporate profits adjusted for inflation using the GDP implicit price deflator.

Real GDP and Hours Worked

Growth in production of durable consumer goods remains week, reflecting poor consumer confidence.

Durable Goods Production

The chart below shows growth in bank credit and the broad money supply (MZM plus time deposits). Credit growth (blue) remains steady at around 5%, slightly ahead of nominal GDP growth (4.04% for 12 months ending June); a healthy sign. Broad money (green) surged upwards in the first three quarters of this year. Not an encouraging sign when there were similar surges in broad money before the last two recessions.

Broad Money & Credit Growth

The S&P 500 is testing resistance at 3000. Bearish divergence on Twiggs Money Flow warns of secondary selling pressure. Expect a test of support at 2800. Breach would flag a reversal, with a target of 2400.

S&P 500

The cyclical Retailing Index displays a similar pattern, with resistance between 2450 and 2500.

Retail

Our view is that upside is limited, while downside risks are growing.

On the global front, the outlook is still dominated by the prospect of a prolonged US-China trade war. More great insights from Trivium China:

Tariff delays may be aimed at creating warm, fuzzy feelings before the next round of talks in early October, but……These small gestures do nothing to resolve the underlying trade conflict. We’re still pessimistic on prospects for a deal.

Zhou Xiaoming – China’s former top diplomat in Geneva – expressed the same view in a recent interview (Guancha):
“The two sides disagree too much on the objectives of the negotiations……It is almost impossible to reach an agreement in the short term.”

Zhou urged Chinese officials to be clear on the US’s objective:
“Economic and technological decoupling is the objective of the entire US government.”

Zhou said that officials must prepare for that potentiality, even if it is not their desired outcome.

So should we.

Dow Jones – UBS Commodity Index found support at 76 before rallying to 79. Rising troughs on the Trend Index reflect increased support. Consolidation between 76 and 81 is likely but we maintain our bearish long-term outlook for commodities.

DJ-UBS Commodities Index

On the global front, weak crude oil prices flag an anticipated slow-down in the global economy. Trend Index peaks below zero indicate selling pressure. Breach of support at $50/$51 per barrel would be a strong bear signal, warning of a decline to $40 per barrel.

Nymex Light Crude

We maintain our investment in quality growth stocks but have reduced equity exposure to 40% of (International Growth) portfolio value.

China: Exports fall despite weaker Yuan

Reuters says that export orders are falling and the contraction is expected to worsen in coming months:

Beijing is widely expected to announce more support measures in coming weeks to avert the risk of a sharper economic slowdown as the United States ratchets up trade pressure……

On Friday, the central bank cut banks’ reserve requirements (RRR) for a seventh time since early 2018 to free up more funds for lending, days after a cabinet meeting signaled that more policy loosening may be imminent.

August exports fell 1% from a year earlier, the biggest fall since June, when it fell 1.3%, customs data showed on Sunday. Analysts had expected a 2.0% rise in a Reuters poll after July’s 3.3% gain.

That’s despite analyst expectations that a falling yuan would offset some cost pressure and looming tariffs may have prompted some Chinese exporters to bring forward or “front-load” U.S.-bound shipments into August, a trend seen earlier in the trade dispute…..

Among its major trade partners, China’s August exports to the United States fell 16% year-on-year, slowing sharply from a decline of 6.5% in July. Imports from America slumped 22.4%.

Many analysts expect export growth to slow further in coming months, as evidenced by worsening export orders in both official and private factory surveys. More U.S. tariff measures will take effect on Oct. 1 and Dec. 15.

Banks are suffering a liquidity squeeze:

The PBoC says the new cuts will release RMB 900 billion of liquidity. That’s more than the RMB 800 billion and RMB 280 billion released by the January and May cuts, respectively. (Trivium China)

Consumer confidence is ebbing.

Google Searches for Recession

China’s response to tariffs has annoyed the Trump administration, making prospects of a trade deal even more remote.

China’s response to U.S. trade actions appears to reflect a cynicism about the efficacy of democracy. Beijing’s strategy appears calibrated to exploit the fact that the American people elect the head of their government, by attempting to influence how the American people will vote. In effect, it seems to be gambling on its ability to turn American democracy against itself.

At the center of China’s responses are the tit-for-tat tariffs intended to hurt American farmers, a constituency that tends to support President Donald Trump and to live in crucial swing states. These tariffs appear designed to deliver political pain in the U.S., not to produce any economic benefit for China. China’s other political meddling, as Vice President Mike Pence recently laid out, includes attempts at interference in the 2018 U.S. midterm elections. Recent targets of Chinese Communist Party influence campaigns also include state and local governments, Congress, academia, think tanks, and the business community. (The Atlantic)

A massive increase in stimulus is the likely eventual outcome, focused on housing and infrastructure. That would fuel demand for raw materials such as iron and steel.

If not, expect a sharp drop in imports to impact on China’s major trading partners.

Hope is not a strategy

Bob Doll’s outlook this week at Nuveen Investments is less bearish than my own:

Trade-related risks seem to be growing. President Trump looks to be holding out hope that the U.S. economy will stay resilient in the face of escalating tariffs and rising tensions. So far, the U.S. economy has not faltered, thanks largely to continued strength in the consumer sector and labor market. But if business confidence crumbles (as it has in parts of Europe), it could lead to serious economic damage…..

The president’s recent actions to delay the implementation of some new tariffs show that he is sensitive to the market impact of his trade policies. But the erratic nature of his on-again, off-again approach adds too policy uncertainty. At this point, we can’t predict the ultimate economic impact from these issues. Our best guess is that the U.S. remains more than a year away from the next recession, but risks are rising. In addition to the solid consumer sector, we don’t see financial stress in the system. Liquidity is still broadly available, and fixed income credit spreads are generally stable outside of the energy sector.

With additional Federal Reserve rate cuts already priced into the markets and bond yields falling sharply, the only catalyst for better equity market performance could be improving global economic data. We hold out hope that the global economy will improve, and still think there is a better-than-even chance of manufacturing activity and export levels to grow. But those improvements will take some time, suggesting equities will remain volatile and vulnerable for now.

Where we seem to differ is on the inevitability of the US-China trade war escalating into full-blown disengagement. This week’s events have not helped.

China’s national English language newspaper, Global Times, under the People’s Daily, announced new tariffs.

Global Times

Followed by an admission that the timing of the announcement was intended to cause maximum disruption to US stock markets.

Global Times

The inevitable Twitter tantrum ensued.

Donald Trump

The President also tweeted “Now the Fed can show their stuff!”

He is deluded if he thinks that the Fed can help him here. The best response would be announcement of a major infrastructure program (not a wall on the Mexican border). Otherwise business confidence will decline due to the increased uncertainty. Business investment will contract as a result and slow employment growth.

Retail sales have shown signs of recovery in recent months but will decline if consumer confidence erodes.

Retail Sales

Especially consumer durables such as light motor vehicles and housing.

Consumer Durables Production

The global economy is already contracting, as indicated by falling crude oil

Nymex Light Crude

…and commodity prices.

DJ-UBS Commodity Index

Volatility (21-Day) is rising as the S&P 500 tests support at 2840. Breach is likely and would test primary support at 2750.

S&P 500 Volatility

Bearish divergence (13-Week Money Flow) on both the S&P 500 and Nasdaq 100 (below) warn of selling pressure. The Nasdaq 100 is likely to test primary support at 7000.

Nasdaq 100

The Russell 2000 Small Caps ETF (IWM) is testing primary support at 146. Follow through below 145 is likely and would signal a primary down-trend.

Russell 2000 Small Caps ETF

Fedex breach of support at 150 would also warn of a primary down-trend and slowing activity in the US economy.

Fedex (FDX)

We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value because of elevated risk in the global economy.

Approaching stall speed

With 89.7% of companies having reported, S&P are projecting 4.4% earnings growth for June quarter 2019 compared to the second quarter in 2018. Even more interesting is their projection of 3.4% growth for the September quarter. With EPS growth boosted by a stock buyback yield of 3.5%, this warns that the economy is close to stall speed.

S&P 500 Earnings per share Forecast

The daily chart for the S&P 500 shows support at 2830/2840, while a higher trough on 21-Day Money Flow indicates (secondary) buying pressure. I expect another test of resistance at 3030; breakout above resistance at 2940 would confirm.

S&P 500

But divergence on 13-Week Money Flow, as on the Nasdaq 100 below, warns of longer-term selling pressure.

Nasdaq 100

Small-cap stocks, as depicted by the Russell 2000 ETF below, are not enjoying the same support as large caps. A sign of rising risk aversion.

Russell 2000 ETF

Bellwether transport stock Fedex is testing primary support at 150. Breach would warn of a primary decline, suggesting a slow-down in activity for the broad economy.

Fedex

We maintain a bearish outlook on the global economy and maintain less than 50% exposure to US and International equities. Our view is that probability of a US recession in the next 6 to 12 months is as high as 70% to 80%.

We expect stocks to rally for another attempt at the 3020/3030 high for the S&P 500 and will use opportunity to further reduce our exposure to equities.

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%.