@theMarket: Markets Await a Brexit Vote
Great Britain's House of Parliament is voting on yet another proposal to exit the European Union this weekend. While Prime Minister Boris Johnson and the President of the European Union, Jean-Claude Juncker, have a tentative agreement, there is no guarantee parliament will vote for it.
In this world of binary events, financial markets are looking at the vote as a black or white outcome. Parliament votes yes and the British pound, world stock markets, and the European Union (EU) celebrates. If, as they have done in the past, the British politicians vote no, then gloom and doom will likely beset the markets.
My own opinion is that a no vote will simply send the various parties back to the drawing board to hash out another compromise, which, in turn, will be presented to parliament for a vote. As I wrote several weeks ago, I do not believe a "hard" Brexit will on Oct. 31, occur as Boris Johnson has threatened. Either there is a resolution this weekend, or the can is kicked down the road one more time.
And speaking of ongoing debates, once again there seems to be a wide distance between what President Trump announced last Friday and the facts. While Trump claimed a "Phase One" deal was done, Chinese spokesmen said there is no deal forthcoming, unless the U.S. removes the tariffs Trump has levied on China.
In this age of disinformation, there is little trust in any news story, government announcements, presidential tweets or political speeches and press conferences. What passes for truth is largely propaganda, and depending on your political persuasion, you believe what you want to believe, regardless of the facts. Facts have become dispensable. You believe them if they conform with your opinions, you deny them as "fake news" if they don't.
This week, many market participants have been confounded by the continued strength of the markets in the face of the phase one trade farce. By all rights, the markets should have given back all they have gained, but they didn't. Instead, all the averages have ground higher and are now within a percentage point or two from all-time highs. The explanation is simple and summed up in two words — the Fed.
Traders are expecting the Fed to cut rates once again at the end of this month and possibly to indicate further interest rate cutting is in the offing. That expectation should be enough to at least support the markets. What could move stocks higher would be a robust earnings season, which has just begun. Week one of third-quarter results was not too bad.
The banks reported mixed results, but that was better than most analysts expected. Many investors want to see earnings results from the technology sector before making up their minds to either hold what stocks they have or just buy more. I suspect earnings will come in better than expected, but forward guidance will likely be neutral, or at least not as bad as some may have feared.
Between the Fed and earnings, the markets should be able to at least muddle through the rest of the month. Of course, that prognosis could fly right out the window with just one tweet from the Mad King. Hopefully, between the impeachment inquiry, the new outrage over Trump on picking his own golf club to host the G-7 meeting, and his fight to keep his taxes (two sets of books) secret, Trump won't have enough time to melt-down on China or the Fed.
But don't underestimate Trump's penchant to create chaos. Just look at this week's disaster on the Turkish-Syrian border. Of course, voting in a Vietnam draft dodger as our commander-in-chief was beyond me in the first place, but what do I know?
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The Independent Investor: Was There Really a Trade Deal?
Last Friday a "phase one" trade agreement between the United States and China was announced with great fanfare. The problem is that nothing was written down, nor were the terms agreed upon. In the end, we only have a gentlemen's handshake. Will that be enough?
With the stock market up by over one percent, President Donald Trump spent most of the that day in front of the cameras crowing that China had agreed to buy $40-$50 billion worth of food imports from our nation's farmers. He repeated those numbers over and over, throwing in comments of how famers were going to have to buy bigger tractors to handle the business.
China's Vice Premier Liu He smiled in the background, yet he never backed up those numbers, preferring instead to deliver a note by his boss, President Xi Jinping, that simply referred to a "healthy and steady relationship."
However, before the weekend was out, the official, government-backed news agencies in China disputed the Trump's take on what was accomplished or agreed upon. For example, China wants the U.S. to drop all the tariffs the White House has imposed on them thus far in exchange for Trump's $40-$50 billion in imports.
And by the way, that was a number that could be imported over three years, not next year. And no, the Chinese have not "already begun buying," as President Trump claimed. Many on Wall Street believe that the entire announcement was little better than a public relations stunt to woo Trump's farming base of voters back into the fold. Unfortunately for the president, few farmers or ranchers seem to be falling for the ploy. It may be that they also know who will benefit the most from these additional exports and it won't be the family farmer.
If we take pork, for example, (one of the products that China is interested in importing), the lion's share of benefits will go to global mega producers that are domiciled in the United States. Eleven of the world's 26 such producers are in the U.S.
And guess what company dominates pork production in this country? Smithfield Foods. And guess who purchased Smithfield back in 2013? WH Group LLC; and who are they? WH Group is a publicly traded food and meat-processing company owned by and headquartered in China.
As for soybeans, another potential target of additional Chinese imports, can you guess who controls 90 percent of U.S. production? No? I will give you a hint -- the same company that is up to its eyeballs in 13,000 lawsuits over Roundup -- the Monsanto Corp. I could go on down the list naming companies such as Cargill, Dow, and Dupont, but you get the drift.
Thanks to the outbreak of the deadly African swine fever last year, China's domestic hog production has been decimated. As a result, China's pork prices have climbed 69 percent, while overall food prices in China gained 11.2 percent in September. That's not something you want to see happen when you have one quarter of the world's population to feed on a daily basis.
As you might imagine, China's sources of food production are a critically important strategic concern. Since they are nowhere near self-sufficiency in food production, the Chinese are reliant on other nations for food. And they also have a long memory.
Most readers probably forgot that back in the 1980s, the U.S. targeted the food security of the then-USSR, establishing a partial grain embargo in retaliation for Moscow's invasion of Afghanistan back in 1979. The embargo was finally lifted when our politicians realized that the only losers in the embargo were our farmers, since Russia quickly established alternative supplies of both corn and wheat.
Imports of American grains to Russia have never recovered. Fast-forward to today where Donald Trump (most likely not an avid reader of U.S. post-war history) is either ignorant or failed to learn from that lesson. But the Chinese have.
I believe that China may increase food purchases from America in the short-term, because it is expedient to do so and suits their purpose for now. But over the longer-term, China, like Russia, will seek to develop more reliable (less political) sources of food supplies.
It is already happening as China imports more from Brazil and other food producing nations around the world. Reducing their over-reliance on the U.S. for food will most assuredly hurt our agricultural sectors a few years out, but hey, by then it will be another president's problem and who knows, maybe we can blame the Democrats.
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@theMarket: Stocks Soar on 'Skinny' Deal
Global markets regained their footing this week, as expected good news on the trade front produced a "relief" rally in equities. Who cared that there was little substance to the deal? Investors decided that even a tiny deal was worth more than no deal at all.
As I wrote last week if "Trump believes he needs a 'win' to counter the slowing economy and the impeachment inquiry, then even a half-hearted deal might be in the cards. In which case, we could see a 10-15 percent move higher in the averages."
But before we pop the champagne, I want to see exactly what the trade deal agreement actually says. So far, we know that both sides have agreed to some kind of currency manipulation. Sources say the Chinese promised not to devalue their currency, which is something that they have been doing to reduce the impact of U.S. tariffs on their exports for the last six months. In exchange, the U.S. will not levy new tariffs on their goods.
Then there is the Chinese willingness to buy more food from the United States. We don't know the details, but grains and maybe hogs might be on their shopping list. The real substance of any meaningful deal from a U.S. point of view would be progress on protecting our companies from intellectual property theft and technology transfers. There has not been any mention of those issues.
I will go out on a limb here and call this a win-win for China. None of the substantive issues have been addressed. The currency agreement, as well as the Chinese agreement to buy more agricultural products, are Chinese offers that have been sitting on the negotiating table since February, if not before.
As for the currency agreement, international investors should be overjoyed since it mitigates one of the two main risks of investing in Chinese stocks and bonds. As in all foreign countries, you have market risk (stocks go up and down) and exchange rate risks.
For example, a few years ago in Europe, stock markets enjoyed double-digit returns. At the same time, however, the Euro weakened considerably. While that was great for EU exports, it really clocked U.S. investors. Just about all the capital gains generated by stocks were whittled away by the currency losses. It is one reason why foreign investments are almost always riskier than those at home, which are denominated in the U.S. dollar. The deal should make Chinese investments more attractive, while allowing the Chinese to return to their comfortable and stable managed currency float.
To understand why additional Chinese purchases of food from the U.S. is a win for them, readers need to understand that China has a lot of mouths to feed -- almost one quarter of all human beings on the planet. A daunting task for a country that only holds 7 percent of the world's arable farmland! To make matters worse, urban expansion and break-neck industrialization over the last three decades have put even more pressure on China's agricultural land bank.
In addition, as I pointed out in a column a few months ago, China is also grappling with a highly contagious and fatal hog virus that has decimated their pig production. It has practically wiped out half of their entire herd, sending prices skyrocketing and consumption of hog products falling. So, any deals on importing more food to China is a hands-down win-win for China.
The problem I see for the U.S. stock market and our economy (as well the global economy), is that without an end to the U.S./China trade dispute, this "skinny" deal will simply kick the can down the road. It will do nothing to change the dynamics of the last year and a half.
Corporations will still stand back, investments will continue to falter, Trump will continue to threaten more tariffs (when he feels like it), and confidence will sag. Over time, the manufacturing recession will spill over into the rest of the economy and at some point, the stock market will recognize this.
On the political front, I suspect there will be no final deal until after the 2020 election (if ever). The Chinese got what they wanted and can play the long game, while Trump faces impeachment. The president will likely try to use his skinny deal to impress and distract his base while promising a real "tough" deal if he is re-elected. In the meantime, I expect the global economy will continue to slow with the U.S. economy dipping into recession sometime next year.
Readers may recall that I saw right through the Trump tax cut of 2018. After an initial bounce, the stock market has gone nowhere, the economy has fallen (instead of growing), and none of the president's or the Republican Party's promises amounted to a hill of beans. It took the stock market some time to figure that out. We have a similar situation today, only now it's the China deal.
I say enjoy the ride while it lasts. As a cynical contrarian, I suspect we could see new stock market highs ahead. However, for me, it feels more and more like the final run before a change in strategy. Sometime this fall into winter, investors should begin to contemplate an exit strategy. Let's monitor the situation and by all means keep reading.
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The Independent Investor: Brokerage Business Not What It Used to Be
Last week, Charles Schwab, the mega-discount broker, disrupted the brokerage industry yet again by dropping its per-trade commission rates for U.S. and Canadian stocks, exchange traded funds (ETFs), and options for both mobile and internet trades. It was inevitable and simply recognizes what the future holds for that segment of the financial industry.
Since Schwab's announcement on October 1, three additional big brokers — TD Ameritrade, E-Trade and Fidelity Investments — have thrown in the towel leaving only Vanguard (among the big houses) left out of the zero-commission trend.
The stock market reacted in shock. Traders hit the sell button on their computers sending the brokerage stocks down in double-digit losses. E-Trade, for example, fell 17 percent on the announcement. Many pundits predicted the end of the brokerage business, but those forecasts, in my opinion, were based on an antiquated notion of where the brokerage business is actually heading.
The internet and the introduction of smart intelligence has changed financial services forever. Personally, I cannot remember the last time I actually called a broker to place a trade. It is all done through the internet now, so why should I be paying Schwab (or anyone else) $4.95 per trade?
I'm not the only one who must have felt this way. The recent success of upstart retail brokerage businesses such as Robinhood, which promises commission-free trading, social media, cryptocurrencies, etc., was not lost on Charles Schwab. Neither were the offers by more serious competitors like Bank of America's Merrill Lynch and JPMorgan Chase that are offering free trading on a limited basis.
So how can Schwab, or any of the other discount brokers, make money when they aren't charging commissions? The answer is simple. Commissions mean less and less when it comes to the bottom lines of most brokers. Most of us still have an image of a three-piece business suit, tasseled loafers and cufflinks when the word "broker" is mentioned, and I am sure there may still be some of those dinosaurs left out there in some corner office or another.
However, nowadays, it is more likely than not that the markets move too fast to dilly dally on the phone with a broker, or worse still, to waiting on the phone listening to Muzak while the stock skyrockets past you (or is dropping like a rock). Since just about all trading is done electronically, (by people in hoodies and sandals) the costs of executing those trades have dropped too.
Sure, cutting most commissions will hurt the bottom line, but not nearly as much as you think. The way brokers make money today, for the most part, is using the cash in your account until you need it. They invest the money in whatever high-yielding instruments they can find for as long as they can. It is called net interest income and last year Charles Schwab, for example, made 2.6 percent on average from doing so. That may not sound like much, but it amounted to $5.8 billion or 57 percent of the company's total revenue. Investment management and administrative fees accounted for only 32 percent of revenues. Commissions, trading and such accounted for the rest.
Throughout the financial services sector, commissions, fees, and other charges are shrinking as more and more retail and institutional clients demand a better deal. As electronics and automation increasingly become the lion's share of the services provided by the financial industry in the future, investors can expect to see this trend continue.
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@theMarket: An October to Remember
October is certainly living up to its reputation. This week, we witnessed a more than 1,000-point decline in the Dow Jones Industrial Average before recovering at the end of the week. Behind the volatility: worry over a slowing economy.
On Thursday morning (Oct. 3,2019), the Institute for Supply Management (ISM) announced that the non-manufacturing index hit a three-year low. This was on the heels of earlier negative news from the manufacturing sector. The Institute said that sector had experienced its worst contraction since 2009 with the index falling to 47.8 percent from 49.1 percent in September.
Economists and traders alike already knew that manufacturing was in a recession as a result of the global slow-down brought on by the U.S. trade war. They were hoping that the weakness in manufacturing would be contained and not spill over into the overall economy. Thursday's data shot a hole into that theory.
Consumer spending, as readers are aware, is the end-all, be-all to the U.S. economy. Therefore, any weakness in the economy, investors fear, could translate into job cuts, lower or static wages, and a subsequent drop in consumer spending. This would deep-six the economy. And the consumer can change sentiment on a dime. If the consumer lacks confidence in the future, an economy can go from moderate growth to near recession in a couple of months.
As such, all eyes were on Friday's non-farm payroll report. Economists were expecting job gains of 147,000. Instead, jobs totaled 136,000, while the official unemployment rate (only politicians and the uninformed care about) dropped to 3.5 percent, which was the lowest rate in 50 years.
Although the job gains were a somewhat disappointing shortfall in expectations, it was the average hourly earnings that Wall Street focused upon. They came in little changed from last month at 0.4 percent — better than many feared. With a collective sigh of relief, the markets rallied, recouping much of the damage wrought in the beginning of the week.
However, all is not as it seems. Much of the job gains were fueled by government jobs and not the private sector. While the strike by GM workers influenced the numbers, it appears that there is less enthusiasm in hiring among U.S. corporations.
Clearly, there has been a down-shift in job growth this year but given the string of employment gains that date back to 2011, a fall-off in growth is to be expected. The trick will be to continue to grow the economy enough to fuel continued wage gains (and therefore consumer spending) but not too much, or we could trigger an uptick in inflation.
It is why I think the president's demands that the Federal Reserve Bank cut interest rates a full percentage point would be an unmitigated disaster. Far better that he focus on getting a trade deal with China. If that were to happen shortly, a huge weight would fall off the global economy, which would likely fuel growth both here and abroad, and make further interest rate cuts unnecessary.
As it stands, the two nations resume high-level trade talks next week in Washington. Two weeks later, the Fed meets again. The recent negative economic data has brought forward the market's hopes and expectations that the Fed may cut interest rates again by 25 basis points at the end of the month (instead of waiting until December).
I warned readers that October would be volatile. This first week has been a doozy! I also forecast that we would be trapped in a trading range until an outcome on the trade deal becomes apparent. If Trump continues to stall, or ups the ante on tariffs, or worse, breaks off talks again in another temper tantrum, the outcome would be fairly predictable. It would be an October to remember.
If, on the other hand, Trump believes he needs a "win" to counter the slowing economy and the impeachment inquiry, then even a half-hearted deal might be in the cards. In which case, we could see a 10-15 percent move higher in the averages. Don't you just love politics!
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