@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?
@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.
@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!
@theMarkets: Markets Muddle Through
As we close this quarter, investors are having a hard time deciding what the stock market’s next move will be. Since the future appears murky right now, equities are trapped in a tight trading range. Will we break out? And, if so, in which direction?
For the bulls, we are tantalizingly close to breaking out to all-time highs, but every time we do, something happens to spoil the parade. The bears, on the other hand, believe the markets are fraught with risk and should be sold. Both sides have a good case, but that decision is going to be made elsewhere, specifically, in Washington, D.C.
You would have to be marooned on a desert island not to know the events that have transpired this week in the political arena. From the speeches and meetings early in the week, to the bombshell announcement by the Democrats of a presidential impeachment inquiry, one could accurately describe the week’s events as tumultuous.
However, in this debate, I am going to side with the bulls simply because of how well the markets held up under the news. Make no mistake, the threat of impeachment is real and here to stay and, in my opinion, will be with us through the 2020 election. Like the Mueller report, it will take on a life of its own, spreading out and around looking for dirt. And in Washington, it is not difficult to find dirt, especially in a swamp.
Look for the controversy to impact the trade talks. Why would the Chinese want to cut a deal with a president under the cloud of an impeachment inquiry? Why not wait and let the Democrats do the work of undermining Trump’s standing and authority? Of course, they could get a deal on their terms, if Trump feels exceptionally vulnerable.
Impeachment is yet another blow to expectations that a trade deal will happen anytime soon. As a result, despite economic data to the contrary, the bears will be expecting our economy to falter further. Talk of "Recession 2020" will once again gather momentum. That will lead to rising expectations that the Federal Reserve Bank will need to save our faltering economy and the stock market with more interest rates cuts. You see where this is going?
I wonder sometimes, if we couldn’t actually talk ourselves into a recession. It seems that on all fronts, there is indecision. Investors are divided on the prospect of recession, on a trade deal, on whether the Fed will cut rates again in October or maybe December. Is it any wonder that the markets are locked in this trading range with so many unanswered questions?
If we now throw in the circus of impeachment, is there any chance that we can carry on and push stocks higher?
Well, yes, actually, there is. Have I not just described one humongous “Wall of Worry”? And what happens to stocks in that kind of environment — against all odds, equities usually climb higher.
We could get a trade deal, simply not the deal Trump wants, but one that is good enough for government work. The Fed could back-stop the economy again with one more rate cut, which, in my opinion, would be more than enough to satisfy everyone, at least into next year.
As for impeachment, I have enough faith (may be a poor choice of words) that Trump is adept at covering his bupkis in just about any circumstance from paying off prostitutes to obstructing justice. Why should something as nebulous as an impeachment inquiry slow Donny down?
Now that we are heading into October, be prepared for some volatility. It is a notoriously bad month for stocks, although not always. If the markets get tripped up on any of the above concerns, look through them. This too shall pass. Stay positive and stay invested.
@theMarket: Investors Discover Value Stocks
Value stocks, those equities that have fallen out of favor, have made a comeback this week. These underpriced orphans have become the new darlings of Wall Street, while high-flyers (think software and some tech) have sold off. What does this say about the markets?
The short answer is that we have more room to run. It means, in my opinion, that we will reach and break historical highs in the U.S. averages and that we should have fairly smooth sailing into October. If, at that point, there are breakthroughs in the trade issue and the Federal Reserve Bank cuts interest rates, we could see the markets continue climbing. If, on the other hand, Trump trashes Chinese exports again and/or the Fed disappoints, than be prepared for a rout.
Now, let's handicap this binary event. If one asks Corporate America what's the chances of a deal, some 65 percent of Chief Financial Officers would tell you there is no hope of a deal over the next six months. That was the results of a CNBC Global CFO Council survey released on Friday. The survey included some of the largest public and private companies in the world.
This echoes what has become consensus among investors. The Chinese will wait until after the elections next year before striking a deal in the hopes that Trump loses the election. As a contrarian, that bothers me, so I started looking for what could go right in this area.
This week the White House floated an idea, first denied, and then confirmed. Trump is considering an "interim" trade deal with the Chinese. To me, that makes sense. It allows the president an escape hatch in a trap of his own making. He can claim a shallow victory (but more than anyone else has been able to win from the Chinese) by announcing a deal before the elections. Yes, it may simply be the same deal that the Chinese offered him a year ago, which begs the question of why he didn't take it a year ago and save investors and the world so much anguish? In any case, the tariffs could then be set aside, allowing companies and the economy to recover from a burden they have been under for the last two years.
Of course, President Trump (and everyone else) would rather get a whole trade deal with China, but why not settle for half a loaf and worry about the rest after the election next year? Several additional actions this week support my argument.
First, the president announced he would delay the imposition of tariffs on another $250 billion in Chinese exports "for two weeks." In response, the Chinese Ministry of Commerce, headed by Beijing's hard-liner, Minister Zhong Shan, said it will exempt U.S. agricultural products, such as soybean and pork from additional tariffs. These products have been added to 16 other types of U.S. imports that will be exempt from tariffs.
Does anyone sense a deal in the making?
As for the Fed, I expect at least a 25 basis-point cut in the Fed Funds interest rate. Now that the European Central Bank announced a new stimulus program this week (see yesterday's column on the event), the pressure is on for our central bankers to at least act a bit more dovish.
But back to value stocks and their recent outperformance. Recently, the price divergence between value and momentum/growth stocks has been greater than at any time since the 1990s. The same holds for small-cap companies versus large-caps. The darlings of the investment world, the FANG stocks, for example, have carried the stock market higher for years. A rotation into the sectors that have largely been ignored by investors makes sense to me.
As such, the averages that most investors use to gauge performance may not be telling the whole story. Basic materials, industrials, small cap, even commodities, may outperform, while the growth and momentum names could underperform, at least in the short-term until they catch-up to the markets in terms of valuation.