Category: The Big Picture

Failure of western democracy, tensions between the US and China, the Arab Spring and other major global events.

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S&P 500 meets resistance while trade talks continue

Trade talks continue, accompanied by reassuring noises from participants. On Wednesday, U.S. Trade Representative Robert Lighthizer will update the House Ways and Mean Committee on progress with China while Donald Trump is away in Hanoi, schmoozing with his new best buddy Kim Jong Un. My guess is that one will prove as intractable as the other. Expect a major announcement in the next few weeks on both fronts but little change on the ground.

Both Kim and Xi play the long game. Trump is focused on next year’s elections and may be tempted to trade short-term gain for long-term pain.

“No matter how many tons of soybeans they buy if China gets to keep cheating & stealing trade secrets it won’t be a good deal for America, our workers or our national security,” Republican Senator Marco Rubio of Florida tweeted on Friday after Agriculture Secretary Sonny Perdue said China offered to buy 10 million tons of soybeans as talks continued.(Bloomberg)

The S&P 500 is testing resistance at 2800. Retreat below 2600 would warn of another decline.

S&P 500

Volatility remains high, however, and a 21-day Volatility trough above 1.0% would signal a bear market.

S&P 500 Volatility

10-Year Treasury yields are testing support at 2.60% and a Trend Index peak below zero warns of buying pressure from investors (yields fall as prices rise). Two factors are driving yields lower: investors seeking safety and the Fed walking back its hawkish stance on interest rates.

10-Year Treasury Yield

It is likely that the bear market will continue for the foreseeable future. The strength of the next correction will confirm or refute this.

Men naturally despise those who court them, but respect those who do not give way to them.

~ Thucydides (460 – 400 B.C.)

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Retail sales fall while trade talks stall

Retail sales

Retail sales growth (USA advance retail sales excluding autos and parts) fell sharply in December, indicating that consumer confidence is fading despite strong employment figures.

Advance Retail Sales

The decline in consumer confidence also shows in lower January 2019 light vehicle sales.

Light Vehicle Sales

Trade talks make little progress

Trivium provide a useful update on US-China trade negotiations:

The latest round of trade talks with the US are finishing up as we go to press. There hasn’t been much progress (Bloomberg): “As of Friday afternoon, there had been no visible progress on efforts to narrow the gap around structural reforms to China’s economy that the U.S. has requested, according to three U.S. and Chinese officials who asked not to be identified because the talks were private……Chinese officials are angry about what they see as US efforts to undermine their state-led economy.”

These are issues that will take generations to resolve. The chance of a quick fix is highly unlikely.

Stocks

The stock market continues to rally on the back of a solid earnings season.

Of the 216 issues (505 in the S&P 500 index) with full operating comparative data 154 (71.3%) beat, 51 (23.6%) missed, and 11 met their estimates; 135 of 215 (62.8%) beat on sales. (S&P Dow Jones Indices)

Index volatility remains high, however, and a 21-day Volatility trough above 1.0% would warn of a bear market. S&P 500 retreat below 2600 would reinforce the signal.

S&P 500

Crude prices continue to warn of a fall in global demand.

Light Crude

As do commodity prices.

DJ-UBS Commodities Index

10-Year Treasury yields are testing support at 2.50% and a Trend Index peak below zero warns of buying pressure from investors seeking safety (yields fall as prices rise).

10-Year Treasury Yield

The Nasdaq 100 shows rising Money Flow but I believe this is secondary in nature. The next correction is likely to provide a clearer picture.

Nasdaq 100

My conclusion is the same as last week. This is a bear market. Recovery hinges on an unlikely resolution of the US-China ‘trade dispute’.

Concessions to adversaries only end in self reproach, and the more strictly they are avoided the greater will be the chance of security.

~ Thucydides (460 – 400 B.C.)

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East to West: US rallies, China falls

The S&P 500 is testing its January high at 2870. A rising Trend Index indicates buying pressure. Follow-through is likely to test resistance at 3000.

S&P 500

A monthly chart of the NASDAQ 100 illustrates tech stock strength, with a rally from 4500 to 7500 in just two years. Breakout above medium-term resistance at 7500 is more likely, offering a target of 8000, while a correction would test support at 7000. Breakout from the triangle pattern on the Trend Index would indicate index direction.

Nasdaq 100

Canada’s TSX 60 index is also advancing. A rising Trend Index suggests buying pressure. Retracement that respects support at 960 is likely and would signal another advance, with a target of 1040.

TSX 60

China paints the opposite picture, with the Shanghai Composite Index testing long-term support at 2700. Trend Index peaks below zero warn of selling pressure and breach of support would offer a long-term target of the 2014 low at 2000.

Shanghai Composite Index

Hong Kong’s Hang Seng Index broke support at 28,000/28,500 offering a long-term target of 25,000.

Hang Seng Index

South Korea’s Seoul Composite Index found support above 2200. Retracement to test new resistance at 2350 is likely. A lot depends on progress in peace negotiations with North Korea.

Seoul Composite Index

Japan’s Nikkei 225 is consolidating between 23,000 and 24,000 suggesting uncertainty over fallout from a threatened US-China trade war.

Nikkei 225

India is more on the periphery of current trade disputes, with the Nifty continuing its advance toward a target of 12,000.

Nifty

In Europe, Dow Jones Euro Stoxx 600 continues to reflect uncertainty, with long-term consolidation below 400. Breakout would signal a fresh advance but don’t hold your breath. It could take a while.

Dow Jones Euro Stoxx 600

The Footsie is retracing to test support at 7500 but respect is likely and would offer a target of 8000.

FTSE 100

North America clearly leads the global recovery, while Asia lags. Europe is sandwiched in the middle, with potential loss of trade in the East and West if a trade war erupts.

Thucydides once wrote “When one great power threatens to displace another, war is almost always the result.” In his day it was Athens and Sparta but in the modern era, war between great powers, with mutually assured destruction (MAD), is most unlikely. What we are witnessing is negotiation to define rules for peaceful coexistence in the 21st century. A lack of clear rules increases the risk of miscalculation and rapid escalation to a hard conflict.

Absent the willingness to use military force, the country with the greatest economic power is in the strongest position to set the rules.

War is a matter not so much of arms as of money.

~ Thucydides (460 – 400 B.C.)

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China sees red

From Darren Gray & Kirsty Needham at The Age:

Relations with China have taken another backward step after one of Australia’s biggest exporters, Treasury Wine Estates, was among several companies whose products were being stalled because of new customs rules targeting Australian companies and industries….

2018/2019 Budget Net Debt and Fiscal Deficit/Surplus

“Chinese officials have introduced new and different verification and certification processes and we’ve been working with the Chinese authorities and the officials, as well as with Australian authorities and officials, to ensure that we can meet these new and additional processes, which are not just applied to Treasury Wine Estates, it’s being applied to a number of other companies, across a number of different industries from Australia,” Treasury boss Michael Clarke said.

Australian Trade Minister Steven Ciobo said in Shanghai he had been informed of the situation by Treasury, the largest importer of foreign wine into China, in the past 24-36 hours.

“The questions being asked relate to certificates of origin. We will look at precisely what the situation is and if we can get to the bottom of it,” Mr Ciobo said.

….Amid a looming trade war between the US and China, and threatened punitive tariff packages worth hundreds of billions of dollars, American exporters have also reportedly encountered pre-emptive slow downs and extra scrutiny from Chinese customs in recent weeks.

China is attempting to use trade relationships to coerce trading partners into complying with their political demands, applying Lenin’s dictum “Probe with a bayonet. If you meet steel, stop. If you meet mush, then push.”

Australia faces a clear choice. Acquiesce and the trade issues will likely disappear…for a short time until China wants something else. Effectively we will become China’s southernmost province, responding to the will of the Central Committee in Beijing.

The alternative is a lot tougher: politely but firmly resist any pressure from Beijing and demand to be treated as an equal partner in international relations. The price is high but the rewards are far greater. Our freedom and independence.

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East to West: Headed for war?

Followers of international relations can take their pick of wars at present. There is a trade war brewing between Donald Trump and Xi Jinping, which could descend into a currency war with competing devaluations. We have a Russia waging a cyber war on the West, a Cold War in Eastern Europe and the Baltics, a proxy war in Yemen between Saudia Arabia and Iran, a frozen war in Georgia and Ukraine, and a hot war in Syria that threatens to escalate into a major confrontation between Russia and the West. On top of that we have Kim Jong-un trying to break into the big leagues by test-firing ICBMs over Japan. It’s a tough neighborhood.

The “peace dividend” that was supposed to follow the collapse of Communism is well and truly over. The next major ideological conflict is upon us. Democracy versus the Dictators. For the West to prevail it will have to engage in a coordinated muscular diplomacy over the next few decades. A good start would be Margaret Thatcher’s Statecraft: Strategies for a Changing World (2002):

Margaret Thatcher and Ronald Reagan in the oval office, 1988

Margaret Thatcher and Ronald Reagan in the oval office, 1988

“For my part, I favour an approach to statecraft that embraces principles, as long as it is not stifled by them; and I prefer such principles to be accompanied by steel along with good intentions.

…The habit of ubiquitous interventionism, combining pinprick strikes by precision weapons with pious invocations of high principle, would lead us into endless difficulties. Interventions must be limited in number and overwhelming in their impact.

….I should therefore prefer to restrict my guidelines to the following:

Don’t believe that military interventions, no matter how morally justified, can succeed without clear military goals.

Don’t fall into the trap of imagining that the West can remake societies.

Don’t take public opinion for granted — but don’t either underrate the degree to which good people will endure sacrifices for a worthwhile cause.

Don’t allow tyrants and aggressors to get away with it

And when you fight — fight to win.’

But the West also needs to clean up its own house and correct many of the abuses to which Capitalism has been subjected over the last few decades. Martin Wolf sums up the challenges in US-China rivalry will shape the 21st century:

‘The threat is the decadence of the west, very much including the US — the prevalence of rent extraction as a way of economic life, the indifference to the fate of much of its citizenry, the corrupting role of money in politics, the indifference to the truth, and the sacrifice of long-term investment to private and public consumption….’

Bold leadership is required. To fight the wars we have to but, more importantly, to resolve conflicts by other means wherever possible. That doesn’t mean avoiding conflict by retreating from red lines. It means establishing and vigorously enforcing new rules that benefit everyone. No one wins in a war. Whether it is a trade war, a cold war or a hot war. Everyone pays a price.

‘It must be thoroughly understood that war is a necessity, and that the more readily we accept it, the less will be the ardor of our opponents….’

~ Thucydides (circa 400 BC)

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Outlook for 2018

At this time of year we are usually inundated with projections for the year ahead, from predictions of imminent collapse to expectations of a record year.

We live in a world of uncertainty, where both extremes are possible, but neither is likely.

We are clearly in stage 3 (the final stage) of a bull market. Risk premiums are close to record lows. The yield spread between lowest investment-grade (Baa) bonds and equivalent risk-free Treasuries has crossed to below 2.0 percent, levels last seen prior to the 2008 global financial crisis. The VIX is also close to its record low, suggesting high levels of investor confidence.

Corporate Bond Spreads and VIX

Money supply continues to grow at close to 5.0 percent, reflecting an accommodative stance from the Fed. MZM, or Zero Maturity Money, is basically M1 plus travelers checks and money market funds.

Zero-Maturity Money

Inflationary forces remain subdued, with average hourly wage rates growing at below 2.5 percent per year. A rise above 3.0 percent, which would pressure the Fed to adopt a more restrictive monetary policy, does not appear imminent.

Average Hourly Wage Rates

Tax relief and higher commodity prices are likely to exert upward pressure on inflation in the year ahead. But the Fed’s stated intention of shrinking its balance sheet, with a reduction of $100 billion in the first 12 months, is likely to have an opposite, contractionary effect.

The Leading Index from the Philadelphia Fed gave a bit of a scare, dipping below 1.0 percent towards the end of last year. But data has since been revised and the index now reflects a far healthier outlook.

Philadelphia Fed Leading Index

A flattening yield curve has also been mooted as a potential threat, with a negative yield curve preceding every recession over the last 50 years.

Yield Differential 10-Year compared to 2-Year and 3-Month Treasuries

A yield differential, between 10-year and either 2-year or 3-month Treasuries, below zero would warn of a recession. When long-term yields fall below short-term yields financial markets stop working efficiently and bank lending tends to contract. Banks, who generally borrow at short-term rates and lend at long-term rates, find their margins are squeezed and become strongly risk-averse. Contracting lending slows the economy and normally leads to recession.

But we are some way from there. If we take the last cycle as an example, the yield curve started flattening in 2005 (when yield differentials fell below 1 percent) but a recession only occurred in 2008. The market could continue to thrive for several years before the impact of a negative yield curve is felt. To exit now would seem premature.

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Gold as ‘Trump insurance’

Yesterday’s solid blue candle on the gold chart [XAUUSD] confirms my view of the precious metal as a form of “Trump insurance”. After Trump and North Korea exchanged threats suggesting nuclear retaliation, gold gained 1.32%, breaking resistance at $1275/ounce. Follow-through above $1300 would signal a primary advance, with a target of $1400*.

Spot Gold

* Target calculation: 1300 + ( 1300 – 1200 ) = 1400

From the BBC:

US President Donald Trump says North Korea “will be met with fire and fury” if it threatens the US.

His comments came after a Washington Post report, citing US intelligence officials, said Pyongyang had produced a nuclear warhead small enough to fit inside its missiles.

This would mean the North is developing nuclear weapons capable of striking the US at a much faster rate than expected.

The UN recently approved further economic sanctions against the country.

The Security Council unanimously agreed to ban North Korean exports and limit investments, prompting fury from North Korea and a vow to make the “US pay a price”.

The heated rhetoric between the two leaders intensified after Pyongyang tested two intercontinental ballistic missiles (ICBM) in July, claiming it now had the ability to hit the US.

Mr Trump told reporters on Tuesday: “North Korea best not make any more threats to the US. They will be met with fire and fury like the world has never seen.”

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