I trust everyone had a wonderful Independence Day, and that the second half of your 2018's has started off the way you wish. Markets have zigged and zagged a bit this week, though when half of the country is really off work it is not always the best barometer of market conditions. This week we look at all sorts of topics, from the normal cast of characters (trade and tariffs and the Fed) to some special ones that don't make the cut every week (bitcoin, Japan, emerging currencies). It's a shorter holiday-week version, but chart-friendly and content-rich ... So come on into the Dividend Café this warm summer weekend, and let's get into it.
We will skip our Advice and Insights podcast this week but will be bringing a special, longer version next week with a deep dive into all aspects of the first half of 2018. A full year-to-date review and analysis will be our objective - it will be a podcast you won't want to miss.
What could push this market higher?
In the short term, it seems reasonable to assume that another big earnings quarter could drive markets higher. But in and of itself, I suspect markets already expect another big earnings quarter. And in fact, the Q1 earnings results were some of the best in history, and markets puttered around in April and May, despite record earnings and revenue growth. Why? (A) They expected it. (B) The good news of earnings was being offset by the fears around trade. So if another good earnings quarter is already baked in, what could be a catalyst to short-term price? I would argue that the lowest hanging fruit is a dramatic, perhaps unexpected, and convincing reversal on this whole trade/tariff front. Some indication that the trade war is not going Defcon 5 would be hugely welcomed by markets. Another possibility is that a dovish bug gets put into this Fed. Right now the markets rightly perceive Powell and company to be resolute in their mission to normalize monetary policy. If Powell and company blink, markets could love the sugar high of less vegetables and more sugar from the Fed. Will either of those things happen? I haven't the foggiest idea. But both possibilities make high conviction bearishness difficult to justify.
A lighter, softer Fed?
Do not confuse my above forecast that if Jerome Powell and the Federal Reserve soften their plans for monetary tightening, it will cause a rally in global stock prices, as a desire on my end that such a thing happen. Ultimately, it would be yet another delaying of the inevitable. No matter what the cost ends up being in suppressed risk asset prices and elevated volatility, a normalization of monetary policy is necessary to recalibrate the policy tools the Fed has, and to decrease the risk of malinvestment throughout the economy. I get that excessive tightening at this time would be catastrophic, but a retreat from healthy tightening could be equally problematic.
Everyone loses in a trade war, and some more than others
The threat of tariffs against China has been most severe on U.S. companies who have had the most exposure to China. Those who sell a lot to China have been hit in anticipation of retaliation, and those who bring a lot in from China have been hit from the direct cost of tariffs.
Appetite for Cash Flow
How interested are Japanese investors in better income, better cash flow, and better growth? Asset purchases of U.S. stocks, corporate bonds, and mortgages have exceeded $1 trillion, surpassing even their holdings in U.S. treasuries …
Reiterating the stuff that matters in emerging markets
After a gigantic start to the year, emerging markets have faced real stock price pressure as the U.S. dollar has moved higher, liquidity has contracted from global markets, and obviously trade tensions have escalated. Emerging currencies have particularly struggled, feeding the volatility in their stock markets. The Fed's tightening of monetary policy via short-term rate hikes is part of the issue driving these things, but frankly, the fear that the Fed will elevate its hawkish stance has an equally potent cousin on the other side of the fence - that a reversal of that hawkishness and unexpected refrain from a rate hike in the face of an inverted yield curve could rally emerging markets. More than the rate hikes, the quantitative tightening (i.e. reduction of balance sheet) the Fed has begun has served to take liquidity out of global markets, exaggerating the effect in emerging economies. There are less dollars floating around, both because of this balance sheet reduction, and because of larger U.S. deficits. This removes dollar liquidity from emerging markets countries.Our positions on all this are as follows, with only the last one mattering to us: (1) We suspect the bulk of Fed tightening and dollar liquidity issues are already felt and priced in emerging markets (2) But if that proves not to be true, we don't care, as we don't believe currency, liquidity, and monetary matters can or should matter be a part of an emerging markets investment thesis, no matter how much short-term noise and impact they create, because ... (3) We invest in emerging markets to compound the growth of fantastic companies with attractive metrics, and entry prices that, if they were not in an emerging market, would be the envy of all investors. Those companies are still what we own in this asset class, and will continue to own. And the return we hope to make over the next 5-10 years here is wholly divorced from anything else!
When human nature repeats itself
Pension Partners summarized nicely the story of so-called "crypto-currency" in the last year. Stratospheric returns in late 2017, with anywhere from half to all of that given back in the first half of 2018. Of course, what the chart cannot capture, is that those absorbing the 56-90% losses in 2018 were largely not those who received the huge gains last year, but rather those who jumped in AFTER the run-up, just in time for the first few innings of reality to kick in.
Politics & Money: Beltway Bulls and Bears
- The Trump administration's trade war with China officially launched today, though with tariffs on $32 billion of goods instead of $50 billion (284 goods are being reviewed after U.S. companies requested an exemption). That means that roughly 7% of the total imports of goods have thus far been hit; there exists a lot of room for this to get worse before it gets better.
- The entire question in markets right now comes down to whether or not tariffs on $30-40 billion of Chinese imports becomes the worst of it (along with the silly, counter-productive multi-country steel and aluminum tariffs already implemented), or if tariffs on up to $300 billion of car imports becomes a reality, and an additional $400 billion of Chinese imports, and a full NAFTA disruption, etc. Does this spiral out of control, or stay contained and in fact improve? Let's just say no one on either side of the bull/bear spectrum has done well formulating investment forecasts the last few years around guessing what Donald Trump will do
Chart of the Week
Yes, oil prices have surged, and yes, this has been because demand has been on fire, and supply has been constrained enough to not maintain that "glut" narrative of 2014/15. But many energy stocks have not moved with this resurgence, though new life has been breathed into the sector in recent weeks. And historical correlations would indicate to us there is room to go!
Quote of the Week
“Professional investment may be likened to [this] ... we have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.“
-- John Maynard Keynes
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We'll leave it there for the week - a slightly shorter than normal Dividend Café (holiday week and all that). Enjoy your weekends, and please do look for the mid-year check-in next week on the Advice and Insights podcast, as well as here in that ever-familiar home of the Dividend Café.