We remain in a trading sardine market – not an eating sardine market
Hastily crafted policy that conflates politics is dangerous in a flat and networked world
The return of an untethered Orange Swan is market unfriendly … brace yourselves
The Supreme Tweeter will likely “Make Uncertainty and Volatility Great Again” (#MUVGA)
The First Half of 2018
The first half of 2018 has been a tale of two markets. Maybe three markets.
January brought a market fervor – in which global equities rose dramatically, likely in response to the expected stimulative contribution and impact of the Administration’s reduction in statutory tax rates.
As interest rates began to climb in January, bullish investor sentiment crested and the risk parity trade went array.
Stocks fell violently in February and the new regime of volatility commenced – in a market revealed as increasingly illiquid.
The S&P Index fell from nearly 2900 and successfully tested the 2550 level twice. Several meek rallies commenced but the S&P had 2-3 more successful tests at about 2600 and stocks recently closed in on 2800 (S&P Index).
1Q-2018 corporate revenues and profits didn’t disappoint but the complexion of the market had clearly changed – and valuations (the S&P Index’s price earnings ratio expanded by almost 3 points in 2017) began to contract. Wall Street, which outperformed Main Street in 2017 – reversed roles in the first six months of 2018.
While the stock market reeled with volatility since January 1, the FAANG stocks generally stood tall throughout the year as the market narrowed and investor interest focused on the 5-10 anointed stocks.
The first half of 2018 was also characterized by a series of questionable and controversial presidential policies (the most recent being trade/tariff decisions) at the same time the Federal Reserve was pivoting on monetary policy. By overtly playing to his base, having little sense of economic history, Trump has contributed to even greater volatility in a market without memory from day to day.
Finally, during the second quarter the European Union’s economic instability and weak banking foundation (read: Deutsche Bank (DB) ) contributed further to the new regime of volatility.
Despite these intrusions - up until a week ago - stocks climbed steadily higher. I shorted into that rise.
Since my marshalling assignment at the US Open at Shinnecock, the markets have declined for six consecutive trading sessions. (It also has been a bad time for six others: Jordan Spieth, Rory McIlroy, Phil Mickelson, Tiger Woods, Jon Rahm and Jason Day).
President Trump’s aggressive negotiating strategies with regard to trade is a crude tool and is clearly disruptive and destabilizing to the markets. That policy and those negotiating tactics hold the risk that business confidence could be jeopardized and supply chains may be disrupted.
In turn, the real economy is vulnerable.
The Administration is trying to get a “better deal” for America but the way to get a better deal is to make us more competitive and the Trump strategy, rooted in the past and not the present, is not the way to do it.
The Second Half of 2018
My concerns are multiple over the balance of the year:
The possibilities of policy errors (fiscal and monetary) are multiplying.
The Fed is tightening. If the global economic foundation is as weak as I believe, our central bank may go too far in raising rates.
A poorly and hastily crafted trade policy, though not having a large direct impact on the domestic economy, could deliver a big psychological drain to business confidence.
In a flat and interconnected world economy, global cooperation is at an all time low.
The corporate tax reduction will likely trickle up and not down.
Debt is out of control and politicians are paralyzed.
Both the Democrats and Republicans are guilty of fiscal irresponsibility. With rates rising, ‘the judgment day” is nearing.
With over $50 trillion in non financial domestic debt, every 100 basis point increase in rates produces a $500 billion economic drag.
The Global Citigroup Economic Surprise Index is weakening (even China is slowing) — worldwide growth is becoming more ambiguous, less steady and less reliable.
Short dated Treasuries now yield more than the S&P dividend yield.
The yield curve continues to flatten – underscoring the fragility of domestic economic growth.
Technicals are deteriorating: (1) The market is narrowing (see my repost of Bob Farrell’s Ten Rules of Investing), (2) New highs are contracting, new lows are expanding, and (3) Valuations of the median stock on the NYSE is already contracting. More contraction may lie ahead.
The markets are growing more illiquid and with so many market participants worshiping at the altar of price momentum – market structure is a risk (with so many on one side of the boat).
With strength in the US dollar and emerging weakness in the EU and elsewhere, US denominated debt concerns could continue to raise issues regarding the emerging markets.
I have long argued, in my 15 Surprises for 2017 and for 2018 and in my Diary, that the “Orange Swan” would ultimately be market unfriendly – that an untethered Trump would “Make Uncertainty and Volatility (in the markets) Great Again.” (#MUVGA)
And, I have recently argued over the last few months, that the President’s behavior is now beginning to impact the capital markets.
Acting upon his impulses, growing more isolated and becoming more unhinged — the Supreme Tweeter is now an Orange Swan headwind. In my view, this is market unfriendly and one of the reasons the markets may continue to act poorly.
Past is indeed prologue as Trump’s White House is now replicating The Trump Organization – both are built on a small body of personnel with policy developed on “gut instincts” (and without thoughtful planning). We witnessed this during the campaign and we now see it in the government of the U.S.
As I wrote in “A Presidency of One” a few months ago:
- Trump’s behavior may finally matter to the capital markets
- The Administration’s disorganization, revolving door and impulsive policy actions may soon intersect with market valuations
- Investors should consider taking C.I.T.A. (“cash is the alternative”) to the prom and should consider avoiding a dance with T.I.N.A. (“there is no alternative”)
“Rex, eat your salad…” – President Trump
Since 2017 year-end, the White House has been a poster child of turnover and disorganization.
After the recent multiple changes (of senior government officials) in the first months of this year, impulsive policy decisions/statements, the lack of shared policy conviction, a seeming Administration agenda of fear (rather than hope) and given potential legal problems, the President has likely seriously cut off his ability to hire capable people for White House assignments.
Without counsel, the President’s decision making process poses a threat to the markets.
Nowhere is it as clear as in the trade tariffs being levied towards China and other nations.
Meanwhile, the sounds and pictures of recent immigration policy grow move vivid and a potential Blue Wave may loom only four months from now – creating the potential for even more uncertainty. It is looking increasing likely that the November mid-term elections could result in important changes in the majorities and point to the increased likelihood that little meaningful legislation may be forthcoming over the balance of the Trump Presidency. As I put it in my Surprise #1 in my 15 Surprises for 2018:
Surprise #1: President Trump’s Behavior Finally Does Matter
“The tax reform bill becomes the sole landmark piece of legislation of his presidency.”
It took a while but I believe the weight of the Trump Administration has now become an influence on the markets (but not in a good way) – as also carved out in my 15 Surprises for 2018:
Surprise #2: Politics is Upended in 2018 as the U.S. Electorate Pushes Left in Mid-Term Elections
The tax cut for the rich is election manna for the Democrats.
The U.S. economy falters next year, more due to monetary tightening, but everyone blames Trump and the ineffective tax reform initiatives put in place in late 2017 that do little to encourage capital expenditures and feather the bed of corporate executives.
With a malfunctioning and disorganized administration, almost nothing gets done in Washington, D.C.
The House falls to the Democrats in the November mid-term election, but the Senate remains barely (by one seat) in control of the Republicans.
Establishment Republicans — seeing an intermediate and longer-term threat because of large losses in voters who are minorities, females and those under age 35 — panic and begin to reconstitute the party’s leadership toward a more youthful profile and try to expand the party’s tent in order to survive the reduced support seen for the Trump administration.
House Speaker Paul Ryan, recognizing the need for party change, resigns.
* Price momentum and hope float but fundamentals propel.” – Kass Diary
My S&P forecast remains unchanged:
Market Downside: 2400 to 2450
‘Fair Market Value’: 2500
Trading Range: 2550- 2750 to 2800
Monday Close: 2775
So, according to my calculus, downside risk remains far greater than upside reward and I remain net short.
The market’s reaction to news over the last few months indicates that there is not a lot of conviction out there.
While I remain concerned about the monetary pivot of the world’s central bankers, higher interest rates, fiscal irresponsibility (on both sides of the political pew), too optimistic consensus on corporate profits and domestic economic growth, a potential trade war with China, and other possible headwinds – the Presidency (and his actions) will now likely continue to weigh on the markets (and on the Republican Party over the balance of the year).
When we superimpose the market structure (with so many in one side of the investment boat), the secondary market implication of all this is a continuation of a new regime of heightened volatility and a wide trading range – which favors trading sardines over eating sardines.
Moreover, if we are 12-18 months from a recession – we will blow out our deficit to more than $1.5 trillion – which I can’t imagine the bond market will like very much.
Finally, I don’t see, given the above concerns, that the FAANG stock price rises are sustainable. I feel like a lot of people are waiting for the moment to jump off the train – it could be a hard fall.
Investors should consider taking C.I.T.A. (“cash is the alternative”) to the prom and should consider avoiding a dance with T.I.N.A. (“there is no alternative”).