Game of Thrones Stock Market

Dear Subscriber,

I and most other professional investors have operated from the simple position (with TJT everything is simple and complex) that the 2020 election drive requires the US economy to be hitting on all cylinders for the Trumpian base and wealthy capitalists like our subscribers. As the WSJ and others observe "The incentives for a deal are too overwhelming on both sides to screw this up."

So why go the mattresses (as they say in Mafia) at the last minute and revert to brinksmanship and fire a torpedo into the side of this massive economic aircraft carrier and fleet in calm waters?

As an American and business person, I am all for calling China out for violating global trade policies they agree to uphold. China and China companies steal trade secrets and IP and still hold barriers to entry for foreign companies with punitive and stifling regulations. I get it.

My best contact on this issue is Stapleton (Steve) Roy, a former U.S. ambassador to China and founding director of the Kissinger Institute on China and the United States. I emailed him this morning and he replied “It’s a pressure tactic designed to try to get an outcome that you can then live with in terms of your own domestic factors,”

“I think we are still within reach of an agreement," Roy said. "I think both sides desperately still need an agreement.”

What he means in saying "domestic factors" is the Trump base and the fact the rub here is that Xi has to concede more than Trump does but without losing face i.e., being embarrassed. Note: In China, "face" i.e., self-pride and public acknowledgment of status are VERY important--it is their weak point. For instance, every old ugly Chinese biz owner I ever negotiated in China always brought his young hot Hong Kong-based concubine to dinner the last night of a deal--they could not help themselves. Amazing--the drive to show off and "build face" in China is profound. 

The negotiating tool Trump only seems to understand is the hammer and pistol to the head--so that is what he does. US wants the right to impose tariffs without a compensating right for China says Mr. Roy--and that he says is the sticking point. 

Both Steve Roy and the WSJ report that which now concerns me the most in the short term: We all know China already has mostly free access ex-Huawei to the US market. We know that due mostly to WalMart, the average American household at $75k (median is $62k) saves about $1800 per year in cold hard cash from China imports (and no one told these lower-to-middle income Americans that Chinese and Vietnamese and Bangladeshites are very happy to work 12-14 hour days  6 days a week with no overtime to put together stuff at $15 a day all in including room and board that Americans used to get paid $15 an hour for.) Just wait for the robots. 

What the US wants is a LOT more. China’s main demand is that Mr. Trump lifts his tariffs, which is reasonable if China agrees to cease its multiple trade violations. This list I am told by many sources includes protections for IP, a reduction in tariff rates toward U.S. levels, a reduction in subsidies for state-owned companies (which comprise 78% of the market cap of China stock market), more liberal rules for joint ventures, and an end to cyber theft.

Our side wants a "if we catch you red-handed" clause that our companies get paid damages and US gets to add penalties in the form of export tariffs (which any educated person except the POTUS it seems understands is a tax paid by US importers and passed on to US consumers.)

First--cyber intrusions into U.S. business networks have helped Chinese companies gain advantages in key high-tech areas, including artificial intelligence, electrical vehicles, jet engines, and nuclear reactors. America can’t maintain its technological supremacy if this continues, but China won't give up the hacking and espionage that help its entrepreneurs pillage America’s intellectual property and technological crown jewels. My forecast is no deal in this area because for Beijing, crime pays too well. And if we get a deal, it will not be worth the paper it's printed on. 

Second, it’s difficult to monitor and restrict China’s efforts to force the transfer of American technology in exchange for access to Chinese markets unless tariffs remain to aid enforcement. It’s almost as difficult to police China’s intellectual-property theft effectively. IF we reach "an agreement" it's bullshit--each side knows it. China's fast-growing middle-class miracle has always been "too big to ignore" for US multi-nationals--if they were not making money there, they would leave. 

As the WSJ says today "China has a long history of quickly breaking promises to the West. From refusing to abide by the rules of the World Trade Organization after it joined in 2001 to abandoning President Xi Jinping’s promise to President Obama not to militarize the South China Sea, Beijing’s record makes strong enforcement mechanisms a necessary precondition to any U.S. agreement to a deal. But seen through the lens of Chinese history, strong monitoring and enforcement look like humiliation at the hands of the West."

IN China, it's all about "face" i.e. public status and public esteem. 

Third, China’s state-owned enterprise reform is a non-starter--they represent a critical cog in its mercantilist machinery. SOEs roam the globe with massive subsidies, running circles around private-sector corporations. The SOEs are too powerful politically and too important economically.

Fourth, Beijing’s currency manipulation has harmed the trade balance--but not lately. The market for US bonds has proven it does not need the Chinese $$$-- Bernie Sanders may want to ride his Sancho Panza stallion to tilt against this windmill, but its old news

Given these challenges, it’s hardly surprising that the long-negotiated deal is getting jiggy at the final stage--it was jiggy when we first started. 

The Reality

First --and this drives me nuts--"we are not being ripped off by $500 billion in trade with China" ok? First with services the trade deficit is $360 billion. Second, at $1800 in cost savings time 75 million $60K+ households that's @ $135 billion in $$$ savings. Third--for chrissakes--when we go to our grocery store of Costco and spend $200 with them, they don't spend $200 with us, right? As most economists point out, by this twisted logic we all lose when we go shopping in a store. Insane--what an economically retarded analogy and conclusion. 

Like I mentioned, the politics and optics of this stand-off are strange for those of us who have been to China and negotiated deals. #1 ANYONE who has negotiated a deal with a Chinese business person or state-sponsored company knows that it is DEEP in Chinese culture to repeatedly go back to square one on the deal point list many many times. Renegotiating with the round eyes goes back for hundreds of years--Chinese LOVE to renegotiate--it's like dim sum and ping pong. 

I can remember being in the Four Seasons Hotel in Shanghai for 18 hours working on an acquisition deal and literally every time our team got to point 3 friggin 6 the Chinese negotiator would stop--take a 10 minute break while talking on the phone--and say "Ok--lets go back to deal point 1." String the round eyes out, and then try to take back previous concessions from the "gullible barbarians."

Almost every culture I have been in or around does the same thing against the Westerners--ask any friend or family member who has negotiated with Syrian Jews or Israelis or Iranians or Lebanese or Turks etc etc etc. Its all a game of mental attrition--wear out the weak white guys.

My guess here is the US folds on subsidies to state-owned companies--impossible to enforce--and gets unilateral penalties on IP theft and forced IP sharing in JVs (which if you ask any American company who does a technology JV with a Chinese company is an agreement for slow IP theft).  We get a deferral of tariffs Thursday or Friday on a partial agreement--and we kick the can down the Silk Road for another 60 days.

If I am wrong, we get a great buying opportunity for high growth high margins companies that don't sell a dime of product into China or don't pay tariffs or make technology components that China has no alternative but to buy. SaaS (software as a service) has no tariffs and little exposure;  Bloom Energy (BE) under $14 today for about 10 minutes is performing perfectly. 

So finally--I am macroeconomist and equities analyst/portfolio manager. I ain't no mystic or mind reader. But I do know a full-blown trade war is a political suicide for Mr. Trump in the heartland already dying from export tariffs into China and now the massive flooding. 

And how have steel and aluminum tariffs worked?  The conservative Peterson Institute reports each of the 12,700 news jobs created since the tariffs divided by the 10% more for steel since Trump's tariffs went into effect nearly a year ago, amounts to about $11.5 billion per year, So do that math--each job has cost about $900,000 in tariffs paid by the US Steel industry.

Before the GOP fell under the hypnotic trance of Trumpian economics--we the GOP ran on fair trade (which we never did much about) and zero tariffs (which we understood kept us from another Smoot-Hawley debacle and the Great Depression) and balanced budgets during expansions. 

Now I don't know what it means to be a "fiscal conservative" anymore. After interviewing DJT multiple times during my Fox Business News days, I can tell you that he has been making things up as he goes along for decades and whatever subjectively he believes is right is right--regardless of empirical fact or history.

If any of our international crew of subscribers has a real clue about Trumponomics, please send me a note and explain to me what I am missing. 

But a Chinese trade war will have winners and losers==amd we will find them.

Hedge here?

Too late for the VIX hedge I was about to recommend on Monday--shit! Basically, our data now says "Anytime the VIX goes under 12 for 5 trading days 120+ days after a correction, hedge with the 15 calls out 3 and 6 months." We were ready to execute Monday--but Sunday night during a wonderful dinner my phone lit up like the proverbial Christmas tree with the news of the new Trumpian negotiating tactic.

We are on high alert for bargains and dislocations (ie. stuff punished for no reason). BE Bloom Energy with a beat on revenue and earnings on Monday under $14 is one. 

Cheers

Toby