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Don’t Worry – The Bull Market Is Still On

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No Change to the Bullish Playbook

So far, the economy is moving as we expected:

  • Fed raised rates and remains hawkish (aka more rate hikes coming)
  • Trump’s economic sabre rattling is working. Canada folded this weekend and re-negotiated the NAFTA deal. That makes new trade deals with South Korea, Mexico and Canada. Even China started to show a little flexibility with some tariff reductions. The E.U. & China are playing for time: they want to see what happens after the elections. I don’t think this is the right strategy because the Canada deal provides Trump with all the ammo he needs to keep Congress in line with his trade approach.
  • Manufacturing and other aspects of the economy are very bullish.  We saw the release of some business surveys (PMI, ISM) that underscored ongoing strength.

That’s the background for earnings releases in this upcoming quarter.

However, there are reasons for concern. So let’s review the bricks in the “Wall of Worry” – how the market climbs without getting overly exuberant.

  1. End of tax cut benefits.  The tax cuts drove up EPS and some investors may be looking out to Q1 of 2019 and wondering what comes next.
  2. Rising costs of business: From higher interest rates to costlier steel and oil, margins are getting squeezed.
  3. Peak Housing: A major wealth driver and contributor to the economy is the wealth effect from the housing boom.  There are clear signs that the top is in. Let’s face it: interest rates have risen enough that affordability has dropped.  And with rates likely to rise a further 100bps (or 1% point) in the next year, housing will just continue to slow.
  4. End of the auto boom. Autos have been holding 17 million annualized units and not more for years. This means flat demand for aluminum, steel and other key components.

The key takeaway is the Federal Reserve is removing their punch bowl exactly when housing and autos are weakening – the two key drivers of the U.S. economy.

I would suggest the tariffs will offset a lot of the softness because they are driving on-shoring of manufacturing and related business. That is, the auto sector may not pull the economy forward, but other segments will pick up the baton and run with it.

Sincerely,

Andrew Zatlin

Editor of Moneyball Economics

The Trade War Is About To Heat Up

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Tariffs Will Be A Main Driver Of Volatility

Things are about to get rocky. The market still continues to try and price in tariffs and sanctions.

This is high-stakes poker.

Trump opened with a big raise.

China hesitantly called. They slowed purchases of U.S. goods and agricultural products.

Soy and other farm prices dropped. Trump then raised again. The call was offering farmers billions to offset their losses. His raise was to schedule higher tariffs.

Then came the flop (in poker terms, a round of cards that get dealt prior to more betting).

Bad news for China: African Swine Flu has struck and it is decimating Chinese hogs.

That means demand for U.S. hogs is rising, and undermines China. Pork is the #1 source of protein in China.

U.S. hog prices are down ~10% from last year, but so is the yuan. That’s before the impact of ASF takes hold.  In other words, Chinese consumers are more likely to see food inflation than not.

In the China/US poker game, China did not pull a card it needed.  But the US did.

The next move is Trump’s and he is well-positioned.

Both the selection of goods and the timing work are in his favor.

The first round of tariffs hit products where China is exposed. But the U.S. private sector is not.

Specifically, (1) no U.S. consumer products were targeted and (2) only products where buyers had sufficient alternatives (where Chinese suppliers have less than 20% market share.)

The next round is where consumer pain will be felt.  Smartphones, air conditioners, and so on. Apple will have to decide whether or not to absorb the cost (put differently, Apple needs to decide if they make $50B in profit next year or $48B.)

Here is where timing is Trump’s friend.  The next round of tariffs really won’t affect this holiday season, so smartphones are relatively safe.  And the US consumers won’t notice much of an impact on air conditioners until April or May.

Trump has managed away consumer pressure for now. Corporate pressure is also not a threat for now.

So far, the tariffs have benefited the U.S.  Not everywhere, but overall.  That’s true both anecdotally (steel makers loooooove Trump.) And also economically: GDP is surging and payrolls are strong.

You can also look at this in terms of pure politics.  With manufacturing on-shoring, the Rust Belt is booming: these States voted for Trump.  High-tech hardware companies (Cisco, Apple, HP, etc) are about to get hit but they are based in California, which did not vote for Trump.

Silicon Valley companies tended to lead the anti-Trump charge (yes, Meg Whitman and John Chambers are Republicans and were leaders at HP and Cisco, respectively, but the companies themselves tend to adopt pro-Dem positions.)

To summarize, public opinion is not against the tariff moves and companies that will suffer don’t matter to trump. Even better for Trump, he has them in a lose-lose position.

In fact, when Apple mentions that tariffs will hit their profits, Trump’s response was: then build in the U.S.  And that’s the ultimate goal here: more on-shoring.

My experts say Apple’s $1000 phone’s bill of materials would rise ~$10 per phone if Apple used U.S labor and production.  Sure, that adds up. Apple loses ~$1B in profits and the U.S. gains 10s of thousands of jobs.

This puts Apple in a tough spot.  The public will see Apple forced to make a choice: either support the American worker OR continue to build offshore to earn billions of dollars of profits that they keep offshore and not pay taxes while giving executives billions in payout (Tim Cook just got $120M in compensation).

Apple is screwed one way or the other.  And they have no leverage.

To keep it simple: Trump has time and politics on his side.  And he has crafted his approach to maximize his leverage.

So what is China’s move?  Likely they want to wait until the mid-term elections pass and the political winds are clearer. But I suspect that Trump will be in a good place insofar as domestic politics are concerned as they impact trade.

China could try and weaponize their stock market holdings.

Everyone is afraid China could dump their massive dollar holdings. But that hits all of China. I think a better move would be for China to force their conglomerates to sell U.S. holdings of real estate and stocks. You get the middle class attention when you unleash a bear in the 401ks and property markets. This leaves the most of China unaffected.

This would result in about 8 weeks of turmoil in the stock market as the game continues to unfold.

But underneath it all: a stronger U.S. economy.

Stocks that have international exposure are problematic.  They face a rising dollar and less Chinese consumption.  Avoid these stocks.

 

Sincerely,

Andrew Zatlin

Editor of Moneyball Economics

September 6, 2018: Financial Survival Network – It’s All About Trump

Trump Is Winning The Trade War

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Market will rip on a Mexico/US Deal

Trump continues to throw the U.S.’s economic weight around.

He has picked fights with pretty much every major trading partner: Europe, Canada, Mexico and China.

Any movement in his favor means major economic boosts in the form of greater exports and domestic production. The stock markets have already concluded that he holds the winning hand.

Here’s Trump’s strategy: flip the smaller economies to get to the bigger economies.

In addition, negotiate directly instead of through trade bodies; trade bodies protect the weaker members in a strength-in-numbers environment.

Under this approach, Trump went after NAFTA first (Mexico and Canada are the small fish) and he is negotiating separately instead of under a pan-NAFTA banner.

In this game of dominos, Mexico will topple first and next will come Canada. But the real prizes are the European Union (E.U.) and China.

The Counter Strategy: A Waiting Game

Tariffs and trade are the domain of the President of the United States, which means that Congressional mid-term elections don’t have direct impact. But they do matter because a shift in Congressional power in favor of the Democrats will force compromises in general but will also lead to more attacks on, and distractions for, Trump.  A distracted and/or weaker Trump undermines his leverage.

With that potential political shift, China and E.U. are playing the waiting game.

However, this approach will fail.

First, because Trump will only harden his position if Mexico compromises – it validates and vindicates his efforts. (Or, put differently, he’s a shark who smells blood in the water).

But more critically, Trump is forcing the Democratic party to support him or risk being on the wrong side of the upside benefits of winning trade wars and the spoils it brings.

Politics matters. But not in the sense that China and the E.U. believe.

They think a Democrat controlled House of Representatives matters to slowing the Trump Tariff train. That’s wrong because Dem’s have to get on board that train or risk losing popular votes.

What will happen? We’re about to find out.

Sincerely,

Andrew Zatlin

Editor of Moneyball Economics

Is Bitcoin The New Safe Haven Trade?

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Bitcoin Is Becoming The New Safe Haven Trade

Emerging markets are continuously using bitcoin (BTC) as a way to get their money of their respective countries.

Crypto currencies are attractive to individuals in less developed economies for a few reasons:

  • Transaction costs are the same as gold.  BTC’s higher price volatility is offset by gold’s higher conversion fees
  • Liquidity favors BTC
  • BTC only requires access to the internet
  • Easier to transport and hide $20,000 of BTC offsets gold’s bulkiness

As recent events in Turkey and Iran show, hard currency and precious metal confiscation is a very real threat.  Crypto is now a very real alternative.

Turkish citizens flocked to bitcoin as the Turkish lira continues to plummet. The lira is down nearly 40% this year alone. An insane drop for a currency.

In dollar terms, gold continues to trade lower as bitcoin catches a bid.

Here’s a chart of bitcoin demand from within Venezuela

The Emerging Markets can be grouped into two categories: those that are adopting BTC and those that are panic buying.  Russia is an example of a late adopter.
Examples of panic buying: Argentina, Chile, Columbia, Hungary, India, Mexico, Peru, Philippines, Russia, Venezuela.
Here’s Chile.
Here’s Columbia:
Here’s Hungary:
Here’s India:
Here’s Mexico:
Here’s Peru:
And here’s the Philippines:

 

Interpreting the BTC Currency Signal
One signal coming from BTC: indication of underlying economic/capital strength.

It’s still a bit too early to assign a definitive value for regional BTC demand. But the fact that millions of people around the world are flocking to bitcoin is a sure sign there is a value of it.

Sincerely,

Andrew Zatlin

Editor of Moneyball Economics

Trump Is Winning – Which Is Good For Stocks

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It’s the start of the third quarter. The market ended slightly up for the first half.

We’ll see where it goes, but it’s promising considering the rising global trade war that Trump kicked off.

Apparently the market has decided trade wars aren’t going to be so bad for the U.S. after all. In fact, I would note that very few companies delivered downward guidance as trade war rhetoric heats up.

In fact, the U.S. market is a beacon of strength compared to others: it’s flat for the year.

China’s Shanghai Composite is down 25% since February (when Trump began his attack.) The German DAX is down 10% in the same period.

The U.S. market is resilient because investors are looking past the sabre rattling and the Kabuki theatrics and public histrionics by all players.  

Investors see that Trump can’t lose by attacking our trade partners. Worst case scenario is some farmers get bruised. Best case is real change to these trade deals. Investors are actually betting on Trump winning some battles.

Fall Market Surge?

I agree with the market. Remember, the market is forward looking. And I see the stock market surging again when Summer ends.

Let me explain.

To begin with, focus on timing: the market is pricing in what they expect from elections in November.

Is this good policy? Absolutely: patriotism sells at election time.

Trump’s base will love that he is following through on campaign promises to ‘fix’ NAFTA. Fix NATO spending. And stopping Chinese trade abuse. Even if he wins nothing but enmity from trade partners, the U.S. voter will love him for ‘sticking up for Americans.’

I would even argue this has been a two year plan.  

Everyone thinks he’s an idiot. But I see a plan of attack that is effective in its simplicity.  

The first stage was a tax cut that was, not coincidentally, passed right as the holiday shopping season started.  

Santa came early last year. This primed the economy such that it could absorb the economic blowback of trade wars, which he then initiated.

It’s a series of self-supporting economic initiatives, with one launching every six months. I suspect he’ll introduce more tax cuts after the trade wars settle down. Followed by an infrastructure bill. It’s a coordinated economic blitzkrieg that will run up to the 2020 Presidential elections.

But let’s ask another question.

Why did Trump initiate a trade war months before a mid-term election? Because he thinks he will win and results will be visible by September (any later and he loses ground in election momentum).

So why does he think he can show off results by then?

For starters, because the U.S. has a lot of leverage.  

First, because there is a certain high moral ground to his approach. NATO partners are shirking their military and financial agreements. China does abuse trade with the U.S., and so on. I am no expert on the details of trade agreements, but it is odd that German auto tariffs are 10% while the U.S. is at 2%.

The main source of leverage is we have the market everyone wants to access. Trump is cutting off that access precisely when other economies are struggling.  

Germany’s growth has fallen to a standstill. China’s is slowing fast.China’s PMI is pointing to barely expansionary. Exports have fallen 3 months in a row. Europe’s latest production data (PMI) fell to the lowest since December 2016. Its future expectations fell to 2015 levels. 

So on the one hand we have a booming U.S. economy and a stable stock market. On the other hand the U.S. has trading partners slowing down and stock markets falling. The only path out for them is access to the U.S. market – which Trump is starting to withhold.

Simply put, investors and businesses around the world agree: Trump really does have a lot of leverage and is willing to use it.

Another reason to expect success is the multi-front strategy: Trump is brawling with Canada, Mexico, the E.U., and China (plus a military battle with North Korea, Iran and Russia) – all at the same time.  

This makes sense: in this divide-and-conquer approach, he is waiting for one entity to bolt and that becomes leverage against the others.

(At this point, some might question the entire wisdom of initiating these battles. It’s a cardinal sin, they say, to pick a fight with friends and to add to the misery by doing so in public. And yet…Reagan confronted Japan over its horrible trade and mercantile tactics – which worked. Germany has had multiple Presidents take them to task for failing to meet the minimum agreements on NATO spending, but they did nothing. Now, confronted by Trump and in public, they will finally move. When politeness fails, it’s time to get serious. Threats made in secret will only backfire because markets and people get even more surprised.

I don’t believe antagonizing our allies over trade will lead to some permanent scaring. Quite the opposite: it can be very uplifting and reinforcing. It’s like an example of couple’s counseling, where we have to do a little yelling and airing of grievances in order to move forward to remembering why we are in a relationship to begin with. At the end of the day, the E.U. has no better partner than the U.S. The same goes for Southeast Asia, Asia and India.)

This is why Trump is winning this campaign. Germany and China are already scrambling to assuage him. Germany has quickly agreed – behind the scenes – to lower their auto tariffs. China is trying to figure a way to do the same.

This makes September the month this all comes to a head – that’s when the tariffs kick in. It’s also when Trump wants to show some gains for his efforts. (Which, by the way, is also his weakness. Everyone knows that he needs something soon.)

In any case, here’s a way to invest on the likelihood that it plays out in Trump’s favor:

  1. Military & Aerospace: The easiest way for the E.U. to get Trump off their back is to buy a lot of military gear. Buying a few billion dollars of U.S. military hardware is the easiest way to (1) move the spending dial fast and (2) meet NATO spending agreements. It’s easy to buy a few big ticket items and quickly rack up billions in spending. Germany could buy 50 new planes and stop Trump from talking.
  2. Long the dollar, short gold.
  3. Long bitcoin. It is easier to smuggle your wealth out with crypto than it is with bullion. The fear trade will favor crypto over gold.
  4. Long the S&P 500. Crazy as it sounds to buy the market when the dollar is rising, the U.S. will be a safe haven as other economies start to stumble. An end to the trade sabre-rattling will bring a relief rally.

Sincerely,

Andrew Zatlin

Editor of Moneyball Economics