Trump vs. Xi/Powell

Nonstop action in the overnight market these days.  Xi and Trump exchanging bombs every few hours, and the latest curveball, thrown by Trump, after he drops the tariff hammer down on Friday, and then tries to pump the equity futures higher with an out of the blue trade deal soundbite. 

It is either utter madness or masterful market manipulation by Trump and crew.  Occam's razor and Trump haters would support the first conclusion, and the conspiracy theorists and market cynics would believe the second conclusion. 

Who is the bigger enemy of the US:  Powell or Xi?  Trump comes from the old Nazi propaganda school (Joseph Goebels): "if you are going to tell a lie, tell a big one, and if you tell it often enough, people will begin to believe it".  His repeated attacks on Powell for not cutting rates or providing easier monetary policy is aimed straight at those without a strong opinion on Powell and the Fed.  Those who believe in the Fed and Powell will not be swayed.  Those who don't like the Fed and Powell already want to fire him.  And those in the middle are the ones that Trump is targeting to persuade that Powell is the fall guy if the US economy gets weak in the next 12 months. 

Look at the totality of Trump and Xi's actions over the past few months, it is clear that Trump is getting more desperate, and Xi is getting more comfortable.  There are a few different aspects of the trade war, and one of the most important is optics.  The optics of Trump and Xi couldn't be further apart.  Trump's random tariff approach has created more enemies along the way, from those in industry, to those on Wall Street, to farmers, by creating volatility out of the blue.  It makes Trump look worse and worse not just in US and China, but globally where unwelcome financial market volatility is blamed on Trump, not Xi. 

Xi has quietly wiggled his way out of promises and woven an exquisite path of lies, deception, and timely counterattacks (on a Friday morning, right before the US market open and Powell's Jackson Hole speech and ahead of the weekend) to induce Trump to overreact and hurt the US and himself, as well as China.  But the Chinese with the media under full CCP control, doesn't show the total picture, but a biased one which easily builds up nationalist support for Xi in China, as he battles Trump.  So even though the Chinese economy will feel pain from the tariff measures, the brunt of the pain is felt by US consumers, who end up having to pay the taxes on goods, creating tariff-related cost push inflation. 

Xi is also better delegating the news breaks to the public by going through his underlings and media outlets rather than putting out the news himself.  It gives the illusion that Xi's hands are clean when he delegates the dirty work of releasing counter measures to those below. 

So if the US economy turns sour, most people will not be blaming Xi or Powell, but Trump. 

It is quickly forgotten that the reason there was no trade deal this spring was because Xi backed out and reneged on his promises to make IP theft and forced technology transfer illegal under Chinese law.  That and pretty much everything else that Xi promised up to that point were revised and deleted in the final text of the Chinese offer.  So with the market at all time highs, Trump had plenty of confidence and fearlessness in putting on additional tariffs.  But as soon as the stock market started dropping almost every day (May), he got soft, and backed off Huawei and delayed some tariffs. 

That is why Trump pushed the tariff deadline from September 1 to December 15, not because it would hurt the consumer, as he said, but because he was seeing the stock market dropping and Wall St. panicking over his latest round of tariffs.  When the markets start dropping, Trump goes soft. 

That is what is happening in the overnight markets, as Trump saw the stock market reaction and felt a need to rescue the markets again after his emotional tariff outburst on Friday by giving the market some hope that a Chinese deal is right around the corner.  But Xi isn't going to play along.  It is clear the Chinese are looking for a nothingburger deal that allows the status quo of the last 20 years to continue, with minor concessions such as soybean, corn, and US beef/pork purchases. 

And I just don't see Trump desperate enough to swallow such a bad deal and try to sell it to the American public.  Maybe in another 6 months, if the US economy shows more signs of slowing, and the stock market is notably weaker.  But not now, when the stock market is still trading only 5% below all time highs, and the US economy still hasn't rolled over. 

So if you are going to be bullish on the stock market, it shouldn't be based on possibilities of a trade deal.  It would be because there is some fear out there, the ECB will come out with a big stimulus package, that the European economy is not getting worse, and the lower interest rates are providing a stimulus for housing and through refis.  Those are legitimate reasons, but also not strong enough to provide fuel for a long sustained rally.  So I am still leaning bearish, but would like to see less fear and more complacency before I go back on the short side. 

It is just crazy action since Trump lit a fire under the market with his additional tariffs tweets.  I was expecting the market to grind higher for the next 2-3 weeks, but it may chop around for a few more days before bouncing again.  With this big gap up in pre market, it takes away a lot of the potential juice from the long side so nothing compelling to do here.  Without a Trump pump overnight, we could have made a washout low today, but that has gone out the window.  So its probably lackluster trading from here, with no real edge either way.

US Banana Republic

The exorbitant privilege of having the world's reserve currency has kept the dollar stronger than its fair value.  Of course, it helps to have the next 2 biggest currencies yielding negative rates out to 30 years on the curve.

Recently, Argentina's stock market plunged by 40%, and the US dollar denominated Argentina 100 year bonds dropped 30%.  Here is a look at Argentina's government budget deficit as percent of GDP:

Nothing crazy, but it has gotten above 5% of GDP.  Here is the US budget deficit over the past few years and estimates out to 2021:

As the economy has remained steady since 2014, the US budget deficit has gotten bigger and bigger.  It is now around 5% of GDP.  That is while there is record unemployment and what has been a raging bull market in stocks.  In the past, even as recently as 2000, there was a budget surplus during the business up cycles, but in this current upcycle, the budget deficit hasn't shrunk, but has ballooned higher.

The US economy has basically achieved above trend growth through massive tax cuts and big increases in government spending ($300B for 2018/2019).  That is only sustainable if inflation stays low.  Argentina, Brazil, Venezuela, and other banana republics has shown throughout their history that if you have rampant government spending financed by money printing (QE), the end result is high inflation.

Having the world's reserve currency can buy you a lot of time before the currency starts losing relative value and foreigners start losing confidence in it.  We are not there yet, but the more the US government pushes the limits on how many dollars the free market can handle, the closer you get to the US becoming a banana republic.

The US has one of the lowest effective tax rates among the developed nations while also maintaining a gigantic military.

Taxation is a control on inflation, as it reduces the amount of currency in circulation.  Big budget deficits financed by the central bank (yes, that's the eventual path when the economy weakens, ZIRP and QE) is what will happen, and that is straight out of the banana republic playbook.  The big difference between Europe and the US is that the European Union's charter limits government budget deficits to less than 2% of GDP, and for the most part, its execution is successful.   That is a strong counterbalance on ECB money printing, keeping inflation under control.  The US has no such limits on budget deficits, and the trend is for bigger and bigger deficits, and most of the voting population doesn't care or understand the consequences.  The ones that do worry about the deficit worry that the US government can't pay back its debt, but that's ridiculous.  The government can just print money to pay back the debt.  The consequence of a growing national debt and big budget deficits in both up and down cycles is inflation, or currency debasement.

There has been a lot of talk in the media about a pending recession, many pointing to the inverted yield curve and surging bond prices.  I don't agree on the US recession calls for 2020.  There is just too much government spending, not enough excess capacity, and not enough inflation to cause a recession.  If oil was at $100/barrel, corn at $8/bushel, and natural gas at $7/mcf, then I would be more open to the recession idea.  But that's the opposite situation, with commodity prices low, wage growth the highest it has been since 2008, and with the stock market still close to all time highs.

The strength in the bond market is a relative game of negative yielding European debt causing a chase for "safe haven" yield in the US Treasury market.  The weak European and Asian economies are what's causing the huge plunge in US yields, not any imminent recession signs.  Yes, the leading indicators are slowing down but they mostly point to slow growth, not negative growth.  And with such a huge rally in bonds and yields this low, slow growth is enough to keep the SPX elevated for now.

Eventually, the SPX will fold under the pressure of no earnings growth even with low yields, but that's probably a 2020 story.  The biggest bomb that could go off on the stock market would be a liberal Democrat (non Biden) beating Trump in November 2020 and raising corporate tax rates and pursuing anti trust legislation against the corporate giants.  Anyway, the stock market is so short sighted, November 2020 may as well be November 2024.  But if Joe Biden fades from the top as I expect and a liberal Democrat (probably Elizabeth Warren) wins the Democratic primary, then all bets are off, and a real ticking time bomb will be placed right at the footsteps of Wall Street.

Its a resilient market, we got the classic V bottom off the mini fear low on last Thursday.  Everyone knows the drill, after 10 years of this action, and with FOMO, the things fly on a feather once it hits bottom.   Just watching and waiting, no good trades here.

Bond Bubble?

Every parabolic move has a kernel of truth.  Just because something is going up rapidly doesn't make it a bubble, or irrational.  There are strong reasons backing up the continuous rally in bonds.  I am sure there are a lot of traders shaking their head when they see recent strong inflation and retail sales numbers, and the bonds keep going higher anyway after just a quick dip. 

The bond market could care less about lagging or concurrent economic indicators.  All the leading indicators are pointing towards a weaker economy over the next 6 months, so the bond market is looking ahead. 

The inverted yield curve is a reflection of the large amount of front end supply being issued by the US Treasury, while there is a rush for long end duration as fixed income managers believe that Powell is being too hawkish and slow in cutting rates.  It has nothing to do with a recession signal.  The recession signal happens when the yield curve bull steepens, expecting a Fed easing cycle. 

The short end of the yield curve is much more economically sensitive than the long end, so the bull flattening is actually signaling an economy that isn't facing an imminent recession.  Usually the belly of the curve would be the best performer in risk off moves, but this time, it has been the long end.  This move has been more about a supply/demand imbalance in long duration bonds, rather than a weakening economy.

Stocks are getting pulled from both sides, the bullish side being the lower rates across the curve, the bearish side being the overvalued levels and lack of earnings growth.  It is a tug of war right now, so not much edge right here.  If stocks were to get flushed out in the next few days, that could be a short term bottom, but at SPX 2840 it seems too early here to go bottom fishing. 

Better Pickings Later

The SPX got up to 2940 and there was a mountain of supply waiting to meet the demand and it hardly traded at that level for more than an hour before promptly going back down to the middle of the range.  The new range in this post-shock market is roughly SPX 2830 to 2940.   I don't foresee a bigger move down during this pullback solely because of the immense strength of the bond market.   Bonds are providing a super hedge for stock/bond mix portfolios and have kept equity investors from becoming rabid sellers. 

The news looks horrible: intensifying US/China trade war, recessionary economic data coming out of Germany, continuous Hong Kong protests, and a Fed that is still not as dovish as the market wants.  Yet, we are at SPX 2875, less than 5% from all time highs. Eventually the fundamentals will come to bear on this stock market, but only after the bond market gets weaker.   And there are still no signs of that happening. 

I don't expect a US China trade deal unless Trump totally capitulates and gives everything that China wants.  And that is very unlikely.   China will definitely not budge from their position, their stance has become hardened and they will become more difficult to deal with as the days go by.  China is in no rush, and would prefer to wait out Trump.  As for Trump, he will only make a weak deal if he sees the US stock market act much weaker, a 5% pullback doesn't get his attention.   Its got to be another December 2018 type of correction for him to at least consider capitulating to China.

 Despite this negative trade war view, I would not be surprised to see the SPX make another move towards 3000 within the next few weeks.  I just don't view the trade war as being that big of a deal, its definitely much less important to the stock market than the bond market.  And the bond market is very supportive of stocks here. I am not bullish now, but am definitely not bearish.  There are better spots and probabilities to pick from on the short side, so I am waiting.  The time for a longer term bear raid is still ahead of us.

Bonds are Too Strong

Sometimes you have to know when to fold them. I wasn't expecting this kind of bond market strength on such a normal pullback. The SPX sold off 6% from last Wednesday's open to this Wednesday's open. Normally, that would cause year yields to drop about 15 bps. These are not normal times. The 10 year dropped 40 bps over those 4 days. That is why stocks shot up like it was released from a cannon yesterday. It is also why I eventually closed my short position, albeit a few hours too late, getting too caught up in my long term thinking, instead of focusing on the current picture.
The current picture is a market that is aggressively pricing in low yields for an extended period, even with Powell reluctant to signal a lot of rate cuts.
A strong bond market is the best defense for equity market weakness. It provides a buffer for investors who are making money on the fixed income side to make up for a lot of the losses on the equity side of the portfolio. That makes investors less nervous, and less nervous investors don't panic. No panic, no big selloff.
Here is a summary of some of the SPX pullbacks and bond market reaction since 2018: Feb 2018: SPX 10% selloff, 10 yr +19 bps. Oct 2018: SPX 9% selloff, 10 yr -13 bps. May 2019: SPX 7% selloff, 10 yr -40 bps. Aug 2019: SPX 6% selloff, 10 yr -40 bps.
As you can see, the 2019 market is seeing the bond market strengthen considerably when there is equity market weakness. If that continues, that will make a big selloff very unlikely. But there is good news for the stock market bears: Bunds are trading at -0.56%, 16 bps lower than the current deposit rate. There is very little upside left for Bunds, if you consider that the ECB with an overnight rate of -0.40%, can probably only cut another 40 bps and then will start facing the barrier of alternatives to cash storage in vaults rather than in a bank account if banks start passing on the costs to customers.
Without the Bunds rallying, the Treasuries are on their own, and that requires a weaker US economy with recessionary signs. And strong recessionary signs is a much stricter condition than equity market weakness. So without explicit signs of an impending recession, the days of don't ask, don't tell bond rallies are mostly behind us. That makes the stock market more vulnerable to a big selloff going forward.
Like the first several months of 2015, selloffs are likely to be more frequent but less severe, as the weak global economy keeps equity investors from becoming too optimistic, which keeps the upside limited, at the same time, making the market less likely to selloff a lot, because of the more defensive positioning.

Shock Market

These are not your old fashioned markets.  There is very little short term money controlled by human discretionary managers.  The short term money is now mostly quant strategies or simple CTA models.  Stock mutual funds are fading away into the sunset, as that is what the baby boomer generation grew up on, and now its either bond funds or equity ETFs. 

Bond funds don't move the market, and equity ETFs aren't really a factor either.  What moves the markets in the short term are hyperactive quant strategies and CTAs, which go from leveraged long to leveraged short within days.  What happened in the stock market post FOMC meeting and post Trump tariff announcement was mostly quants and CTAs going bananas, all going from big net long exposure to neutral and probably now to net short exposure.  It doesn't take them long, and they are not price sensitive.  They are trend sensitive, and don't want to be caught on the wrong side of the trend, even if its for only a few days. 

We are seeing a repeat of August 2015, February 2018, October 2018, and May 2019 (mini version).  It is no coincidence that these shock drops in the stock market are happening more frequently.  It is rooted in the trend of quant based strategies which encourage overshoots on the way up and on the way down.  On the way up, the market grinds higher, longer than most humans expect, and then without many clues, suddenly plunge as the fundamentals don't support prices and the process repeats. 

One of these days, the trend will stay down and keep going lower beyond comprehension.  It nearly happened in December 2018, except for Powell throwing in the towel and going super dovish.  Next time, that won't be enough.  The stock market will demand faster and bigger rate cuts, and eventually QE4.  It is not as far away as it seems, another repeat of December 2018, which is likely within the next 12 months, will be enough to force the Fed's hand, and the bond market will price in ZIRP and eventually expect QE4. 

The Fed is no longer an independent institution.  It is controlled not by the President, but by the financial markets, which have veto power over their actions.  If they don't get what they want, all hell will break loose.  December 2018 was a perfect example.  Powell is well on his way to being totally neutered by the markets.  He tried to resist at first, wanting to run wild, and sow his oats.  But the market won't let that happen.  The market is a stern teacher, not just towards traders, but towards Fed chairmen.  It wants easy money.  The market is the veterinarian and Powell is the dog.  The veterinarian will win all the time. 

It doesn't matter who the Fed chairman is anymore.  In this new age, the chairman of the Federal Reserve is the SPX and the Treasury market.  And that's not going to change anytime soon. 

Well, that escalated quickly.  From SPX 3020, to SPX 2960, to SPX 2920, to SPX 2780.  All in 4 trading days. 

Don't blame Trump.  The market was vulnerable to any little shock to the system and was ready to blow.  The global markets and the US stock market breadth gave you those warning signs.  And it is blowing up.  This is not because of a trade war.  This is because there is no earnings growth.  That is not due to a trade war, but because of late cycle dynamics of higher wages, slowing growth, and market saturation.  The easy excuse is to blame Trump and his tariffs.  That is meaningless in the grand scheme of things.  10% of $300B is $30B a year, that's literally pennies now in this money bloated financial world. 

No, its not the tariffs.  The problem is the underlying fundamentals of no earnings growth, grossly high valuations, and pitiful amounts of potential monetary stimulus available with these already low interest rates.  And 2020 will be a horror show if the economy weakens and nails the coffin in killing Trump's chances of winning reelection.  A Democrat president would be this market's worst nightmare, as the threat of tax increases and a breakup of the tech giants would be a monster 1-2 blow.  That isn't on anybody's radar now, but it will be all the market will be thinking about in 2020. 

The strategy is to add to shorts on bounces, and wait for a move down to 2720 to cover all. 

Hunger Games

These are the type of markets where you can't even go out for lunch, for fear of missing a huge move.  Literally having to stay hungry to trade the action.  And there is a lot of action now, you can always tell when the DOM thins out and the algos pull bids and offers at the hint of iceberg orders or size coming into the market.  That also goes for the ES overnight market as well. 

It was a classic overnight session, as Thursday night is the official Fright Night for SPX, as equity traders hate to go long over the weekend when markets are weak, and sell out early ahead of the weekend.  As much as the patterns are more random and less influenced by human traders, at the end of the day, the risk managers are all human, and the tendency is to avoid taking on risk exposure when volatility goes up and markets are weakening.  That means selling stocks. 

When the VIX jumps like it has over the past 2 days, usually the stock weakness lasts another 2-3 days at minimum, before the first significant rally attempt.  That means I don't expect much upside from current levels (2945) until next Wednesday.  The downside will probably somewhat limited for the next few days also, as I see support coming at 2920, near the tops from last October, and area of short term support in late June, and 2890, the top of the range during the volatile trade, post Trump tariff announcement in May. 

Powell is no Bernanke

Jerome Powell is a lot more easily influenced by Fed media coverage than either Bernanke or Yellen.  How often did you see Bazooka Ben and Yellen backtrack on their statements because they were too hawkish to please the markets?  They rarely had to.  Bernanke was just an over the top dove and a horrible Fed chairman, so he never had to take back his words.  After all, market participants only complain if the Fed causes the markets to go down by being too hawkish.  Being too dovish is ignored, just water passing under the bridge.  Yellen made one miscue about timing of Fed rate hikes at the beginning of her term, the media complained, and after that, she took the easy way out and became overly dovish, pleasing the markets by dragging out the beginning of the rate hiking cycle way too long. 

On the other hand, Jerome Powell actually seems to try to tamp down the animal spirits from time to time.  And market watchers hate it, because it causes the markets to go down.  Yesterday was one of those times he tried to pull back the punch bowl.  They call it miscommunication.  No, its not miscommunication.  Its idiots who still think that all Fed chairman are supposed to be like Bernanke and are surprised and disappointed when they don't get everything they want and more. 

Bernanke would ALWAYS promise lots of goodies and then overdeliver!  So it led to some inane monetary policy decisions, like QE2 and QE3, with the length and amounts of bond purchases for QE2 longer and bigger than the market expected.  Same with QE3.  He was a knucklehead who was scared of his own shadow, who saw a Great Depression around every corner. 

Bernanke's 8 year reign of free money distorted Wall Street expectations of what the Fed would do during its meetings.  That's why the Eurodollars were so grossly overpriced during Yellen's reign in 2016 and 2017, because the markets just didn't expect the Fed to come through with the rate hikes because it always kicked the can under Bernanke, and under Yellen, she delayed hikes at the slightest bit of market turbulence, (even a 5% correction in the SPX would stop them in their tracks! (March 2015). 

When Powell came on in 2018, he sent a strong message to Wall Street, and it was often ignored.  He would talk up the economy, calling it solid, pushing in rate hikes and continuing QT as promised even when the markets had a tantrum a few weeks prior (Tantrum: February 2018, hike: March 2018.   Tantrum: April 2018, hike: June 2018, Tantrum: October-November 2018, hike: December 2018).  He was the first Fed chairman since Volcker who actually followed through on his rate hiking plans and didn't water it down or slow it down, due to market weakness. 

So when he finally relented to the pressure and admitted that he got too hawkish and the market got too weak, the stock market celebrated by going up in straight line for 4 straight months! 

With backwards looking economic data showing strength in July, Powell was running out of good excuses to cut, so it showed in his press conference.  He was stammering to find the right words to match his actions, because he was basically cutting rates because the financial markets put a gun to his head and forced him to. 

Unlike the super doves that preceded him, he has a conscience, and is affected by the media criticism of the Fed bowing down to Trump, being servants to the stock market, not being data dependent anymore, etc.  And there was a lot of critics of his dovish words and his rate cut hints even though nonfarm payrolls came in strong and the SPX was at an all time high.  The media pressure got to him, and he didn't want to sound too dovish.  Now the media will criticize him for miscommunicating his policies, which is another way of saying you caused the stock market to go down. 

The financial media is a joke, and can't be taken too seriously.  It talks out of both sides of its mouth.  What we have found out though is that if the SPX keeps going down, eventually Powell will relent and signal more rate cuts.  The stock and bond market has an iron grip on his balls.  If he's too hawkish, they will squeeze hard, and only let go until he turns dovish again. 

The SPX is in a vulnerable place, what Powell said yesterday wasn't even newsworthy in my opinion, but with great expectations come disappointment.  And yesterday's price action is what happens when markets are disappointed.  I expect the disappointment to last a few days before the next rally attempt.  In any case, I am more interested in adding to my short position on the next rally attempt.  Yesterday was just a sneak preview of bigger things to come in September and October.