Market Meltdown Update
The One Tweet Global Market Meltdown
Dear Subscriber,
China is a nation and culture that has been around for 5,000 years. As I have shared many times, in their culture losing Face to an outsider is to lose self-respect and prestige. What we are observing is a clash of cultures and a clash of the world's most impatient and volatile leaders and the worlds most patient and non-volatile leader.
When the American delegation in Shanghai demanded last week that China had to agree to an all-or-nothing measurable and enforceable American proposal on state-owned companies aka mercantilism, new IP protections and additional commodity purchases, they overplayed their hand according to my sources the Chinese walked out.
Trump met last Friday with his trade team and they gave him the bad news. 30 minutes later, with one tweet, tariffs of 10% on the remaining goods were promised to start Sept. 1 and, with the currency devaluation, nearly $10 trillion of global market cap went to money heaven in America, Europe, and especially currency sensitive South East Emerging markets.
As I have shared many times, the weakness in America's all or nothing approach is China's currency play and appearance of prestige. So at 9 pm Sunday night they stopped using their Central Bank $US dollar currency reserves to support the RMB in both the onshore and offshore (Hong Kong) currency markets.
It was the easiest and fastest response they could make--so they did. We now have a two-front trade and currency war with what used to be our largest trade partner.
Mr. Trump's m.o. is he thinks we have the slowing Chinese economy over-a-barrel and thus we should expect to see him get "negotiating leverage" by
1) raising all the tariffs to 25% across all exports
2) labeling China a monetary manipulator (which the Treasury Dept. just did a half-hour ago)
3) and in general putting the screws to China
China says "screw you--we can jack up our economy with all kinds of stimulus and quit buying American goods--take that Apple!"
Right on cue, "Secretary Mnuchin, under the auspices of President Trump, has today determined that China is a Currency Manipulator," the Treasury Department said in a statement after the stock market close today. "As a result of this determination, Secretary Mnuchin will engage with the International Monetary Fund to eliminate the unfair competitive advantage created by China's latest actions.
So now we have both a trade war and a currency war and soon a Federal Reserve war with China too. We should assume that with the binary zero-sum Mr. Trump, always the cool calm and collected person that he is, we should expect the next shoe (25% tariffs) unless the sane White House folks get him and our economy back off the ledge. If nothing else, Monday's yuan devaluation and America's "currency manipulator" response dash any hope that the new Trump tariffs wouldn't go into effect on Sept. 1.
My bet is they threaten 25% in back channels, and the response is your basic "fuck you--we'll wait until 2020 Elections and take our chances with a new POTUS." Clearly, China underestimated the White House resolve and the Chinese, at the end of the day, did not negotiate in good faith when they rejected the 75-page agreement both sides agreed to in May.
What Should We Do Here?
The technicals tell the story--we are about 1/2 way through the correction and the highest-flying stocks are being sold by the algorithmic momentum CTA funds and automatic bond/stock asset allocators. With the "monetary manipulator" tag on China, the futures are pointed down for the open tomorrow again. The McClellan Oscillator tells the technical story best. Look at the highs and lows over the last year--we are not near a tradable low yet.
Like I said--we all now live in a world that at least until 2020 ONE TWEET can add or subtract $5-$10 trillion of market value--that is our capital markets reality. America has weaponized tariffs and China has weaponized its currency. But in a real way, when you consider the looming hard Brexit and Japan/Korea trade relationship broken as well, we also are witnessing the very real at least partial break down of global economy that started with China joining the WTO in 1993 but really got going in 2000.
The good news is we will finally get an opportunity with 30%+ growing enterprise SaaS stocks and other non-China related stocks over the next 2-3 weeks. The great news is our Cloudera position is up nicely--especially the options--with Carl Icahn fulfilling my expectation that SOME private equity deal has to be made to fix the horrific merger with Hortonworks. HOLD THAT POSITION or take profits in the option and roll the option to 2020 if you have not already. Chegg (CHGG) gave us KILLER numbers and will pull back under $40 buy under price.
The bad news is all chips stocks will get hit here to try to price in lower volumes of semiconductors sold to China to build iPhones and laptops etc.
We own chipmakers AMD, Nvidia, and Xilinx. If you want to protect your profits and sell them here I guarantee you will be able to sell them in the short term and buy them back cheaper if you are a trader. For our portfolio, I am going to protect our prodigious chip profits with September put options 10% below the closing prices today and selling call options 10% above to pay for the premiums. AMD, Nvidia, and Xilinx make GPUs and FPGArrays that China has to purchase--there is no alternative for them. The Huawei "licenses" so far have been flowing so far--but yes there is a risk of another ban--unchaining Huawei is another trade agreement demand from China.
For our other positions, hold them tight, we should get another chance to double down on many positions if this 8-10% correction goes to the December lows. The Fed will cut another 50 basis points in September if this situation escalates as expected--the Fed is now in a box that Donald Trump has built--and the Fed Fund futures have 100 basis point cut priced in by year-end.
Here Are The Best Wall Stree Notes I've Compiled On This Shit Show from Some of My Analyst Pals
Cowen, Chris Krueger
Krueger called China’s retaliation “massive,” adding that “on a scale of 1-10, it’s an 11.” He cited the Chinese government calling on state buyers to halt U.S. agricultural purchases, while there’s “increased anecdotal evidence that the Chinese government is tightening its overview of foreign firms.”
“While there were measures that could have been chosen with larger direct effects on supply chains, the announcements from Beijing represent a direct shot at the White House and seem designed for maximum political impact,” Krueger said. “ We expect a quick (and possibly intemperate) response from the White House, and consequently expect a more rapid escalation of trade tensions.”
“There now will be increased expectations that the Fed will cut again in September to offset the drag caused by this escalation in the trade war,” he added. “Such moves will only be partial, lagged offset to the recessionary headwinds a cycle of retaliation would cause.”
Morgan Stanley, Michael Zezas (policy strategist)
“The dynamics of U.S.-China negotiation and macro conditions mean the next round of tariffs will be enacted, and investors are likely to behave as if further escalation will follow in 2019 until markets price in impacts,” Zezas wrote. “This supports our core view of weaker growth and skews the Fed dovish.”
Zezas sees incentives for the U.S. to escalate quickly. If the administration “understands the Fed’s trade policy reaction function, then it may also perceive that a more rapid escalation could deliver one or more of three beneficial points ahead of the 2020 election: 1) A quicker, potentially more aggressive Fed stimulus response that could help the economy heading into the election; 2) More time to re-frame the potential economic downside; and 3) A major concession by China (not our base case, but it is, of course, a possibility).”
Veda, Henrietta Treyz
“The U.S. and China are moving into one of their most aggressive phases yet in the year-plus long trade war and we fully expect things to escalate from here,” Treyz wrote in a note. Treyz added that China’s ability to quickly adjust its currency is an advantage they have over the U.S. that “goes to the heart of the issue for the Trump administration.” The administration views China’s communist mercantilist regime as a “systemic advantage” versus “free markets and democracy” in the U.S., as the Chinese can “subsidize domestic industry, quickly, enact lower tax rates and provide stimulus.”
Furthermore, her conversations with Republicans point to the belief that “China’s economy is on the brink of collapse,” she said, with turmoil in Hong Kong “considered evidence of an organic domestic uprising that many believe the Chinese government cannot contain.” Republicans may also believe Trump will “galvanize” his base behind him, while attracting “anti-trade and union Democrats in the Rust Belt as he takes on the mantle of a wartime president going into 2020 by engaging in this trade war.”
I have known Henrietta for a long time--I think she is dead right.
This is going to escalate. The Trump Put--i.e. a tweet that says "China meetings going great--we have an incredible deal!!!!" is now bullshit--everyone knows it now. The Fed Put--cutting Fed Fund Rates 100+ basis points to offset the trade war is going to happen. But here is what I am afraid of--a Fed/China negative feedback loop. Here is what I mean. First, the calculus on preventing a break of 7.0 is over--the two sides are now locked into a stalemate/escalation scenario-- there is no incentive to stop the CNY from depreciating more.
As far as the Fed goes, life is now miserable. Jerome Powell took a big risk by placating Trump, who now knows he can co-opt monetary policy in the trade war simply by engineering outcomes in short-end rates markets. By acting increasingly unhinged on trade, Trump can force markets to price in Fed cuts which it now has., and when that pricing becomes extreme enough, it puts the Fed in a position where policymakers have to choose between disappointing markets at the risk of tightening financial conditions or effectively doing the president’s bidding.
“On Wednesday, Fed Chair Powell said that concerns about the trade war were one reason for the Fed’s 25bp rate cut, then on Thursday, President Trump escalated the trade war further”, BofA wrote in a Friday note. Little wonder the president said, on Thursday, that he isn’t concerned with the market reaction to the tariff bombast. In a very real sense, the market is doing precisely what he wants it to do. Past experience indicates that once the short-end becomes wholly convinced that more cuts are coming, stocks will rebound on the assumption that easing in September and December is assured.
Once Trump locks in that additional easing, it will embolden the administration to push the tariff envelope further. It’s a trap sown the road when we finally have a real recession--no more bullets. Here’s how it works:
The combined trade and monetary battle make life very, very difficult for the Fed. For one, [the Fed] will probably be trying to offset an even larger negative economic shock. But even if that shock does not materialize, the rally in rates means that the Fed will have to use up more ammunition if it wants to meet market expectations and avoid financial tightening. The risk is this perverse feedback loop in which trade-war escalation keeps offsetting Fed easing, leaving the Fed with very little ammunition to fight the next recession, while at the same time the economy remains relatively soft--lose/lose scenario.
Suffice to say Trump does not care about the long-run ramifications of this for monetary policy or for the US economy. Shockingly, he is fixated on short-term gains, and his economic myopia will only increase as the election gets closer.
We are updating our 10-year bond rate forecast but needless to say, it is going to be lower. The inverted yield curve (short rates higher than long term) is a concern for our $10k-a-Month "ballast" plays and frankly if we get the 10%+ correction they will fall in value/yield increase and we will get ANOTHER opportunity to double-down with 25% yields!
The best advice I can give you right now is to BUILD SOME CASH in our Infracap's PFFA ETF that is yielding 9% and been increasing in value every month!
IF for some reason the market goes into a meltdown crash like Dec 15-24th--don't panic--we may get the buying opportunity of the year and lock in 12% yields. This chart tells the story.
So friends, hang on, be smart, don't panic but PFFA and cash are your freind here as the global market price in a currency war and a trade war (and yea a hard Brexit too.) I will add some additional hedges if we get a sharp sell-off and then Fed rumors fly tomorrow and we get a melt-up situation from short covering.
Donald the Global Disruptor is working overtime--so we are too!