The Week in Review   8 December 2018

The Financial markets are really bruising from the US China Trade War.

Global markets fell sharply one more time taking them deeply into the red for 2018, while all expected solace from the Buenos Aires Truce in the US – China Trade war.

The interesting part last week was American and European stock markets  underperforming substantially while emerging market and Asia Markets held up much better.   

America is finally realizing that it could be the big end-loser in the Trade War game.

The week trading was scary and we are standing at crucial technical support levels in the US, but are there real reasons to PANIC ?

In this issue we explore four important issues

.  Trade Wars
.  Is the Bond Market heralding a recession ?
.  Gold and the US Dollar
.  BREXIT crucial vote next week, The NORWAY Way ?

Finally, Crypto-currencies continue their decent to the abysses with Bitcoins losing another 14 % and trading very close to out long stated target of 3’000

Bitcoins have now lost 82 % of their value since we shorted them on December 19th 2017 when the CBOE Future contract started trading.

Our Weekly Market Monitor tables appear at the end of the Post.

Trade Wars

From discordant tweets following Buenos Aires truce to the arrest of Hua Wei’s CFO in Canada, investors do not really understand what Donald Trump and his administration are up to in what is being seen more and more as a crusade against China.

And right or wrong, more and more westerners are starting to believe the official propaganda that China may be the evil that needs to be combatted and prevented from dominating the world.

Has this campaign anything to do with diverting Donald Trump’s links to Russia and Russia’s meddling into the 2016 elections ? 

No one has the answer but having America and China fighting each other and America painting China as the Devil is exactly what serves Wladimir Putin’s interests.

Needless to say, the week has been rock and roll with European markets closing at 2 years lows on Thursday and US indexes losing 3 to 4 % of their value on Tuesday and again on Friday.

Investors are scared and professional investment managers who were counting on a positive month of December to make 2018 good are fretting,

This may in fact be the real explanation behind the unusual volatility of  last week.  

Investors piled into equities last Friday as the Buenos Aires summit yielded a pause in the US China War and probably leveraged themselves to end the year in positive territory.

Only to get bad news – Trump’s tweets announcing agreements that had not been struck  and do not correspond to the reality of the talks – and again on Thursday the arrest of the heir and CFO of HuaWei, the largest Chinese technology company.

No surprise they rushed to cut their leveraged positions. They sent the markets tumbling on both occasions.  

Donald Trump lost more credibility.  But this time round, he is losing credibility with his own investors as testified by Tuesday’s and Friday’s really bad showing of the US market while other markets were holding up comparatively well.

Investors are starting to worry about the lasting impact of the Trade War on American corporations.  The Chinese have long memories and they know how to be patient.  America will not get out of this great again.

Nevertheless, an extremely important milestone was reached last week in Buenos Aires, even if the communication was lousy. 

Both America and China need to pause the Trade War and they have agreed to it.  Even if the arrest of Hua Wei Meng’s infuriated the Chinese, they will probably stick to their patient and cooperative strategy for now.

They may ultimately start using their massive holdings of US treasures as a weapon at a later stage.

We have argued all along in our various posts that the ultimate resolution of the Trade War would be a structural appreciation of the Yuan, the only thing that can truly eliminate the Chinese structural Trade Deficits.

A clear demonstration of the ineffectiveness of the US imposed tariffs is the explosion of China’s trade surplus with the USA in November even as overall Chinese export growth slowed amid waning global demand.

The trade surplus with the U.S. was almost $35.6 billion, driven by a 9.8 percent rise in exports compared with the same period last year and a 25 percent decline in imports.

Chinese consumers and corporations are starting to source their imports from other parts of the world and are boycotting US products. They do not need to publicize it or to put tariffs to do that. They just do it.

Only a stronger Chinese Yuan is what will eventually modify the trend in the Trade deficit. 

As long as China was threatened, they kept the weapon of a weaker Yuan going.  

Now that America is realizing that it is paying the price of its Trade War through its own stock market volatility, Trump needs to calm the game and China can afford to let the Yuan appreciate without losing face.

As soon as the pause was announced, the Chinese Yuan – and the Hong Kong Dollar – started appreciating.

The timing of the break is perfectly telling and the technical configuration is now highly positive for the CNY, which in turn is highly positive for Chinese asset markets and emerging equity markets.

Another reason why China is going to let the Yuan appreciate is that China’s leading indicators are CLEARLY TURNING UP while the rest of the world is turning down.

China’s transition is in full swing and although the rate of growth of the economy is bound to slow down structurally, it will remain well-north of 6 % in 2019 and should re-accelerate in the second half of the year.

China has ample monetary and budgetary ammunition at its disposal and is not truly affected by the US tariffs beyond the global uncertainty the Trade War has created.

Hua Wei Blunder

The arrest of the Hua Wei’s CFO on Wednesday is clearly a blunder.

Resorting to Kidnapping will not go down well and the fact that this operation was launched precisely at the time Trump and Xi were having dinner in Buenos Aires will not go down well either.

The US stock market reaction was loud.  Is Mr. Trump listening ? He can’t blame the Fed anymore. 

America has just demonstrated a lot of bad faith in its negotiation pattern and the whole story now will be, did Donald Trump Know ?  The similarity with Mohammad Bin Salman and the killing of Kashoggi is striking.

In both case, how could they NOT know ?

This is a blunder that will cost America a lot of credibility way beyond the Chinese US Trade War.  It was un-necessary at this stage and its timing could not have been worse.  It may be years before Mrs. Meng is extradited from Canada, if ever, and if Donald Trump’s thinking was that it would impress the Chinese, it is doing exactly the opposite.

The Chinese are not Cow Boys from the Middle West !  They are extremely refined people who are not going to be bullied like this. And they have very long memories.

The entire world is watching with disbeliefs the rogue tactics used by the supposed leader of the free world and wonder how he or America can be trusted in anything anymore.

The short-sightedness of the operation is also amazing.

Not one US CEO will dare venturing into China or Hong Kong anymore and most Chinese will now refrain from travelling to the US. The move has created another and even deeper wedge in the trust between the two nation, but also between America and the rest of the world

America has crossed a line that will cost it dearly.  

We had always argued that America would end up being the big loser of this Trade War and Meng’s arrest in Canada is just putting America off-limit for almost everybody in the rest of the world.

 The legal and moral validity of US sanctions have always been a question mark.  – Who are the US to decide who can trade or deal with whom in the rest of the world ? – but the use of international treaties to target foreign individual companies at the order of a US President is no different that African dictators going after a political opponent in a foreign country or Mohammad Bin Slamand going after Jamal Khassoggi in Turkey.

Donald Trump imposes sanctions on Turkey to get a US Pastor freed, causing massive damages to the Turkish economy and losses of jobs, and he does exactly the same thing with the executive of what he perceives as a dangerous foreign competitor ?

His last attempt at doing that with ZTE in the first part fo the year ended up being a fiasco, despite the 2 billion fine the company paid ultimately.

This time round, the entire world and America itself are shocked.

It is now the US equity market that is taking the brunt of the fall. 

Investors are now starting to worry significantly about US corporations’ ability to continue operating in China and the rest of the world.

Will Tim Cook decide to move Apple Inc. Headquarters to Ireland after all ?

These were indeed serious events and they will have lasting consequences, but do not justify a global sell-off in equities worldwide.  

American equities have probably started a lasting period of relative underperformance.

But for now, economic growth remains strong and the 4th quarter earnings will also remain strong. And equity markets are sharply oversold. 

Bond Markets and Liquidity

The main fear for equity markets is rising interest rates and tightening liquidity.  

Indeed with short term rates rising from zero to 2.5 % and 10 year bond yields doubling form 1.5 % to 3 % in the past two years, liquidity has tightened considerably, making it more difficult to justify the lofty valuations of the stock market.

Corporate bond yields also shot up to 8 % and 12 % depending on investment grades, a sobering perspective for the cost of financing of corporations and their earnings looking ahead

However, the recent 30 % falling oil prices and the volatility in the stock market are already denting confidence and the market has already scaled down its expectations on terms of rate increases going forward. 

Bond yields made an significant top and are now back below the 3 % mark.

With real interest rates and bond yields where they are, monetary policy is still accommodative and the world economy is not about to fall off a cliff.  

Data will remain strong for the 4th Quarter and even the first quarter of 2018.

Is the Yield Curve Inversion heralding a coming recession

The financial markets were bruising with te words inverted yield curve last week and whether the US economy was heading into a recession.

What Yield curve Inversion ?

The US yield curve is NOT inverted. 

In fact it is relatively steep which indicates that economic momentum will remain strong going into 2019.

The very small inversion on the 3 – 5 year segment which made commentators all hyped-up cannot be construed as a sign that the entire US economy is going into recession. It has more to do with technical arbitrages going into the year-end than with any kind of predictive capacity.

Only a totally flat to inverted yield curve would signal a recession and we still have Fed rates to move up to 3 % before that happens.

The US Dollar is Turning and so is GOLD

These two charts are extremely telling.   The US dollar is now weakening as investors question the strength of the economy ahead and, by the same token, GOLD of finally moving out of its 2018 doldrums.

BREXIT – the NORWAY deal ?

Next Tuesday, the UK Parliament will vote on Theresa May’s draft agreement with the EU and the outcome is far from being guaranteed.

Prime Minister Theresa May could actually be forced into a Brexit that keeps the U.K. inside the European Union’s single market after she loses the crunch vote on her draft proposal next week.

That is the view among some senior officials inside the government, on both the pro-and anti-Brexit wings of the Conservative Party.

On Tuesday, Parliament is slated to vote on whether May’s Brexit deal should survive or die. All the signs are that politicians in the House of Commons will choose overwhelmingly to stop the agreement May has struck after 18 months of talks with the EU.

Rewriting her plan to maintain the closest possible ties with the bloc after the split would be the best chance of winning a majority in Parliament, officials think.

The British premier will take a decision on Monday on whether or not to push ahead with the vote, given that the stakes are so high. If she loses, the U.K. will be facing a chaotic exit from the EU without a deal, and May herself could be forced from office in the political upheaval that could follow a heavy defeat.

The question is what will happen after May’s deal is voted down. For now, ministers argue in public that no other plan can command a majority in the Commons, but in private senior officials take a different view.

The idea that’s gaining ground among both euroskeptics and pro-Europeans in the government is for the U.K. to become a member of the European Economic Area.

That would see the U.K. adopt a relationship with the EU modeled on that of Norway or the Principality of Liechtenstein

Two officials, speaking on condition of anonymity, said Cabinet ministers including Pensions Secretary Amber Rudd, Chancellor of the Exchequer Philip Hammond, and Business Secretary Greg Clark — all pro-EU politicians — would back that option.

This plan would involve the U.K. joining the European Free Trade Association (EFTA), and thereby taking part in the European Economic Area, which includes access to the single market. 

That would be good news for business, particularly exporters and the finance industry, which would probably be able to maintain its current access to the bloc.

Pro-EU Conservatives support this Norway model, as does a significant part of the Labour Party. Smaller parties could also back it, and there’s a chance May’s Northern Irish allies in the Democratic Unionist Party would too.

Unlike Norway, the U.K. would need a customs union with the EU to avoid a hard border with Ireland. The glitch is it would mean free movement of people would continue, which many — including May — consider a betrayal of the referendum result.

Former minister Nick Boles, who’s championed the so-called Norway-plus model, says he believes it will appeal to both pro- Leave and pro-Remain members of Parliament.

“Norway Plus is a compromise that has broad appeal to the
pragmatic middle,” Boles tweeted on Friday
. “It delivers a
softish Brexit with a deal that preserves membership of the
Single Market and keeps the union of the U.K. intact.”

EU leaders are ready to explore the option of Norway and it wouldn’t necessarily delay Brexit, according to European officials. 

That’s because Brexit is in two parts — first the divorce, then the future relationship, which has only been agreed in vague outline for now.

The EU would probably impose stricter conditions on the U.K. than it currently does on Norway, officials said. This could include tough “level playing field” rules to restrict the British economy and ensure the U.K. can’t undercut European businesses. 

It also could include giving EU countries better access to U.K. fishing waters.

Weekly Market Monitors

Currencies

As expected, the US dollar is rolling over and most currencies have appreciated against the greenback.

Equities

Very negative week for American stocks and technology companies in particular after America sought to arrest HuaWei’s CFO. The market is now worried that US technology companies will be targeted by China and their business significantly affected.

Chinese equities reacted rather well and several Asian minaret actually ended. the week in positive territory, with Vietnam being the best performer there on the back of strong economic figures.

European stock were badly affected as well with Germany, Austria, Ireland and Sweden losing more than 4 % while Greece, our preferred stock market in Europe was in positive territory.

Commodities

Soft commodities cheered the truce between America and China with Wheat and Soybeans taking the lead on hopes that China will buy American soft commodities swiftly. 

Gold and Silver are starting a significant rally now that the US dollar is turning.

Bonds

FLIGHT TO QUALITY !    Roiling equity markets and weaker economic numbers sent bond markets shooting up with 10-year bond yields falling by 10 % on average.

Friday’s labor numbers showed that hiring has softened in the past month while wage pressure remained tamed. These numbers together with sharply lower oil prices are good news for inflation ahead.