Investing Donkeys

LiveSquawk @LiveSquawk

57m

China Said To Want The US To Remove Tariffs So They Can Reach $50 Bln In Imports Of US Farm Goods

You thought China would roll over and play nice to Trump just so the tariffs wouldn't be raised again.  No, they want more to give in to Trump's demands for ag purchases.  The Chinese have time on their side.  They know the 2020 election is only a year away, and Trump wants to please the stock market with a trade deal even if its a nothingburger to have a "win" before the elections come up.  Xi has all the leverage in this negotiation.  And he knows it.  That is why after Trump hyped up the "phase 1" part of the deal, the Chinese wouldn't follow, and left room to ask for more before the deal is written and signed. 

And they will want more.  Because if both sides walk away, the stock market will go down, and Trump suffers more than Xi if that happens.  Xi could care less about the Chinese stock market, its viewed as a casino anyway in China, so if he torpedoes the US stock market and drags the Chinese stock market with it, at least he guarantees a Democrat win in 2020, then all the better.  Short term pain, long term gain. 

Xi will push Trump to the limit, to get the most out of a deal while giving up the least.  They know that the political tides are changing in America, and China is now viewed negatively by both the Republicans and Democrats.  So a free trade bonanza with no tariffs is probably no longer a realistic target for China.  They just want to minimize the tariffs as much as possible without giving in on IP theft, forced joint ventures, and other industrial policies that are completely one sided in their favor. 

One of the most overlooked factors about this US/China trade negotiation is that it won't lead to a deal that has any staying power.  And a temporary deal is about as bad as no deal.  Because on November 2020, there will have to be another US/China trade deal, which would basically make the previous deal meaningless, no matter who wins in 2020.  And no one who is actually sane in corporate America is going to make long term decisions based on any trade deals over the next 12 months anyway.  Because if Trump gets re-elected, he will likely break the deal and try to get a better one, and if a Democrat gets elected (probably Warren), then they will scrap whatever Trump did  to get the kind of trade deal that they want. 

The market right now is under the illusion that a US/China trade deal will be very small, and not change much.  Yet they think a substantial US/China trade deal would be a game changer.  The reality is that because of the 2020 election, any trade deal will be meaningless.  So there won't be any "positive" outcome from the trade negotiations.  Which is probably why the best possible scenario for the stock market would be for Trump to milk this US/China trade negotiation for several months, keeping the carrot in front of the donkey that is the stock market investor for as long as possible, without actually giving the carrot.  Because once the donkey eats the carrot, there is nothing else positive to look forward to, and ends up making the donkey feel worse afterwards.

That is why it is actually a positive for the stock market that Trump drags this negotiation out as long as possible, going with the phase 1, and hinting at phase 2 and phase 3.  He is playing the long con on the stock market investor, giving just enough hope for them to keep stock prices elevated, but not enough hope so that the Fed feels comfortable not cutting rates. 

But the uncertainty of the 2020 election and a >50% chance of a Warren win will be too much for fund managers to stay invested and they will sell fast and furious, especially if SPX breaks 2800. 

We got the relief rally on the verbal agreement to a small trade deal on Thursday and Friday, but its only gone up back to levels pre ISM.  There is a distinct lack of rocket fuel provided by the persistent down trend in interest rates that you saw from January to July.  Without that lower and lower rates rocket fuel, the stock market can't go up much.  The earnings growth is just not there, and there is just not enough dumb money in the whole world at this time to keep the SPX above 3000 for long.  The failed IPO of WeWork is a sign that at this stage of the business cycle, the dumb money is not going to play that hot potato game.  They've been burned enough by the debacle that was 2018. 

It looks like the volatility will continue to dissipate as earnings season rolls on, and we get closer to the return of stock buybacks.  With the trade deal event sort of out of the way for the next few weeks, the weak hands will slowly come back in to stocks, but they won't be aggressive, so don't expect any big surges higher.  At the same time, a lot of weak hands were taken out in August, and some more the last 2 weeks, so the market should be safe to trade in a tightening range, perhaps 2920 to 3020. 

From Trade War to 2020 Election

The never ending trade war, it feels like that is all the stock market cares about.  But it is October 2019, 13 months from the 2020 US election.  And less than 6 months from basically knowing who the 2020 Democratic candidate will be.  Whatever is done on trade will have diminishing effects on the market the closer we get to November 2020.  By next year, the focus will be on who wins in 2020 election, which determines much more important factors such as tax policy, corporate regulations, health care policy, and anti-trust actions. 

The most popular political betting market, Predictit, has Elizabeth Warren as a clear favorite to win the Democratic nomination, at 47%.  Even with the average of the polls showing her at about a statistical tie with Joe Biden, the betting markets don't think that will be the case next year, as Biden's popularity is falling while Warren's is rising. 

There was one fund manager on CNBC, who said that the stock market wouldn't open if Warren won in November.  That gives you a general feeling about what Wall Street thinks about her effect on the stock market.  I usually don't agree with these politically charged views on candidates and how they affect the stock market, but I do agree with the consensus this time.  Elizabeth Warren would be a nightmare for the SPX.  This is based on her plans to put a 2% wealth tax, as well as looking to do Medicare for All, a budget buster which would be funded with tax increases across the board, both income and corporate. 

The current US health care system is a huge source of profits for the health care sector in the S&P 500, cutting out the middle man and making the US government the health care insurance provider would be getting rid of a huge source of economic rents the health insurers and pharmaceuticals take from the general public. 

The increase in taxes is obvious, because anytime there are more taxes taken from the wealthy and from corporations, it reduces the amount of buying power available for stock buybacks and stock buying from the public.  The only reason the markets went up so much in 2017 was because of the anticipation of the huge corporate tax cuts and overseas fund repatriation amnesty which fueled the stock buyback frenzy in 2018.  Those aftereffects are what are keeping the SPX at such high valuations. 

Looking ahead, the current obsession over the trade war will be mostly forget and will be almost meaningless in the heat of the 2020 election season.  And a Warren presidency would be so much more bearish for the stock market than any escalation in the trade war that Trump goes with if he wins in 2020. 

We got a nasty little selloff yesterday based on dimming hopes of a trade deal.  The expectations are getting really low now, so any tiny bit of good news over the next few days will probably have an oversized positive effect on the stock market.  If we get bad news and no deal, we may get a knee jerk selloff day but I don't think it lasts for long, as the current consensus is that there won't be anything substantial done. 

SPX is the Best Leading Economic Indicator

All of a sudden, it turns to October, and the bad ISM and the ISM Services Indices have turned into huge market movers.  The crowd has been walking on egg shells, worried about recession (fear peaked in mid August), and those recession fears have spiked again with the back to back weak ISM numbers. 

Let's not forget, ISM index is a PMI, which is a survey of purchasing managers, so it is soft data, not real numbers.  The reason so many are freaking out is because they think the ISM is a leading economic indicator, but its more like a lagging stock market sentiment indicator.  Look at what happened to the ISM over the past 5 years: 

When you see the stock market react so strongly to economic data, it is usually during a time of weak market sentiment, or seasonal fears (bearish October, repeat of last fall), or most likely, lack of stock buyback support during this stock buyback blackout period (late Sep to late October).  Those are usually times when the market has already been going down and the bad economic data punctuates the final move lower, usually forming a bottom immediately or within 2 trading days.  (examples: June 4, 2012, October 2, 2015, October 3, 2019?).

I am sticking with my view that a recession will not start because of a trade war or because of weak Europe/China.  The most likely cause of a recession will be a bear market in the US stock market after the Fed has already reached the zero lower bound, unable to lower rates.  The stock market is the only real dynamic part of this low growth era, and it has reached such a huge size of GDP that it is the tail that wags the economic dog. 

So looking at economic data to try to forecast future stock prices is nonsense.   It should be the other way around.  The best leading economic indicators are not things like building permits, yield curves, or PMIs.  It is the SPX.

Yesterday, we made an intraday V bottom off a very oversold condition on the bad ISM services number.  And the bond market went up strongly, which is the risk parity trade working again.  On the in-line nonfarm payrolls number, bonds are not selling off even as stocks are going up.  Again, risk parity positive.  I will not be interested in long term shorts until we get sustained bond weakness when stocks rally.  Still nowhere close to that.

Recession Fears

The ISM number coming in at 47.8, below 50 for the 2nd straight month, was enough to fan the flames of recession fears and cause a 40 point drop in SPX yesterday.  The bond  market has a PhD in providing a leading forecast of future economic numbers.  The big drop in yields in August was a clear warning sign that the economic data for the next few months were going to come in weak.  That has happened as the August jobs number and ISM index were well below consensus, along with a bunch of other global PMIs.  That has continued with yesterday's weak ISM number.   Below are historical ISM charts.  We are back to late 2012 and late 2015 levels.

Another factor is the October effect.  The fear of October itself is enough to make investors sell at the slightest bit of bad news.  Especially after last October's brutal selloff, they aren't taking any chances and are playing it safe, selling first, and waiting it out.  It doesn't help that the US China trade talks are happening next week, and most are expecting a disappoint result.  

I am getting flashbacks to late August, when the trade war headlines were so negative, and it felt like a slam dunk to short any rallies, towards SPX 2930.  Once again, we have the negative trade war headlines, and now weak economic data on top of that.  It feels like another obvious time to short.  The trading gut tells me that now at SPX 2925, it is actually more dangerous to be short here than be long.  It doesn't make me want to be long, especially with the stock buyback blackout period lasting for the next few weeks, but it makes me cautious to play the short side.  

Not many are thinking about bullish catalysts, but here a few that I am thinking of:

1.  A truce and a can kick on further China tariffs after next week's US/China trade talks.  Trump seems more desperate to save the stock market, even lying back in late August about having talks with China to boost stocks after they took a dive on more tariffs.

2.  A more dovish Fed that starts QE4 lite to fix the repo market, and probably another 25 bps cut at the October 30th meeting, could ignite sidelined cash into stocks, especially with buyback blackout period ending at that time.  

3.  Germany announcing a fiscal stimulus package as it is becoming quite obvious with the latest Germany PMI that Germany is in a recession.  

Right now, I don't want to go long until I see extreme fear, and we aren't even close, and I don't think it will happen this October.