August 30, 2019
By Steve Blumenthal
“We advise the U.S. side not to underestimate the Chinese side’s ability to safeguard its development rights and interests.
Don’t say we didn’t warn you!”
– Commentary in the People’s Daily,
the official newspaper of the Communist Party of China
May 29, 2019
Sometimes I find it helpful to look backwards before stepping forward. In January, China and Brexit were on all of our minds. In our quarterly performance update, we called it “The Art of Not Wanting a Deal” and “The Mother of All Messes.” That remains the case today though arguably much more so.
In our Quarterly Performance Update for Q4 2018 (January 2019) we wrote:
The Art of Not Wanting a Deal
After a year of sabre rattling and tit for tat tariffs, the U.S. and China are sitting down to negotiate a trade deal. The stakes are high and the expectations, or more appropriately the hopes of investors for a positive 2019, are even higher. The outcome of these negotiations more than any other event this year may determine whether the global economy expands or declines, potentially into a recession. The success of the negotiations will be determined by the most mercurial politician of recent times. Recent signs from the administration that it is considering removing some tariffs to hasten a trade deal are encouraging. Additionally, Trump is besieged by negative news on all sides and a deal with China would allow him to positively affect the news cycle. The real question is will he take a deal? Aside from immigration, trade and China are the other big issues that Trump cares about. Both issues are the core of his message to a base that has narrowed after losses during the midterm elections. Will that core group of supporters remain energized in the absence of these fights? There is no doubt that a trade deal would be a positive for markets irrespective of the substance of the deal. In fact, the renegotiation of NAFTA yielded little of substance other than a more complicated acronym but markets saw it as an obstacle removed and hence a bullish sign. The ultimate outcome of the negotiations with China may end up looking similar. That’s not necessarily a bad thing.
BREXIT – The Mother of All Messes
The Economist has it right on the cover of its recent edition: the mother of all messes. The start of 2019 has not been kind to Prime Minister Theresa May. After surviving a no-confidence vote from her own party last year, May had her Brexit deal rejected. The scale of the loss was staggering: 432 votes to 202 with her own party members voting against the proposal by three to one. It is the largest defeat for a ruling party on record, a long record at that. Subsequently, May barely survived a full parliamentary no confidence vote (325 to 306) in her government and narrowly avoided a snap election. In a twist of fate, the same members of her party who voted against her Brexit deal helped keep her in power. You can’t make this stuff up. May has spent the last two years negotiating with the EU and the current deal is the best that can be made of trying to, as Boris Johnson put it, “have your cake and eat it too”. There is now not enough time to negotiate a new deal and two things are likely to happen: Britain will ask for an extension to avoid leaving with no deal at the end of March and the calls for a second referendum will grow louder. It is the right thing to do as Brits are extremely divided on Brexit and have been misled on the cost of leaving. Only a second referendum where the specifics of a Brexit deal are presented to voters will move this forward. Will May still be in power to oversee such a referendum? To say her leadership has been uninspiring is an understatement but is there really anyone who wants to take on this impossible task?
The Art of Not Wanting a Deal
I believe our lights are now on about China’s broader mission. Tough on trade is a good thing. You are going to hate me for saying this, “I think we need a pit bull in the White House” and for right or wrong reasons, we sure do have a pit bull. My new friend and China expert, Dr. Jonathan D.T. Ward sent me a podcast interview he did this week. Worth a listen if you are out for a walk or taking a long drive this weekend. You can find it here. (If you’re a regular reader, and I hope you are, you may recall that we’ve talked about Jonathan’s work here and had a fascinating conversation with him here.)
I don’t believe there will be a trade deal. I believe there will be a back and forth with momentary tweets of optimism, but China is likely to hold out for a potential U.S. regime change. Trump will need to kick the can down the road or completely pivot, as he did last week ordering all U.S. businesses to no longer do business with China, indicating he may declare a national emergency. The U.S.-China trade war has advanced to a currency war. We are far closer to “Not Wanting a Deal” than when we wrote in January. That may play well to his base while at the same time economically crippling his base. The risk of recession by November 2020 is quite high. Dare I say, unavoidable?
BREXIT – Boris’s Rash Move
May is out, Johnson is in and he just lobbed the “Hard BREXIT” hand grenade into the room. The EU is being called to task. A hard Brexit is likely October 31, 2019 and maybe it’s a good thing. Yet, in the short-term, it is a monumental disruption to supply chains and trade. And the EU’s political dysfunction runs deep. It’s not just the UK. This from Ambrose Evans-Pritchard:
“There has never been a proper airing of how the ECB was able to write secret letters to the Italian and Spanish leaders ordering detailed changes to labour and social law, and fiscal policy, and even the Spanish constitution, while holding a gun to their head on bond purchases. We do not know who was responsible for anything because power was exercised through a shadowy interplay of elites in Berlin, Frankfurt, Brussels, and Paris – and still is.
When the Commission’s chief accountant revealed abuses in the EU’s internal finances the Brussels press corps closed ranks in silence. It is a curious tribal reflex. Call it what you want but it is not what we in Britain would take for a free press that speaks truth to power.
Ultimately, the logic of monetary union is incompatible with democratic self-government. It can be made to work over time only by moving to fiscal union, giving Brussels control over taxation, spending, and the core economic policies of nation states.”
That hasn’t happened and is not likely to happen. Pritchard continues,
For me the line was crossed when the EU smuggled through the Lisbon Treaty, enabled by a Merkel-Sarkozy executive stitch-up, after the text had already been rejected by French and Dutch voters in its earlier guise. It is one thing to advance the European Project by stealth and the Monnet method, it is another to override the outcome of a plebiscite.
And Lisbon matters. It extended the jurisdiction of the European Court to all areas on Union law for the first time (not just Community law), and arguably over everything by making the Charter of Fundamental Rights justiciable.
Ireland alone held a referendum on Lisbon. When the Irish people voted no, they were made to vote again, just as they were made to vote again when they rejected the Nice Treaty.
This is the EU method. All votes that go its way are conquered ground, Acquis forever. All votes that go against are to be massaged, reworked, and ultimately recast until they go the right way … until Brexit, the referendum that the EU must reckon with.
The last three years have been messy for British democracy but have also been intoxicatingly vibrant. The fights have been conducted through Parliament, the courts, the press, and on the streets through passionate but peaceful civic protest. There has been nothing like the Gilets Jaunes here. And let us hope that Boris’s rash move does not precipitate it. In short, British democracy is in rude good health.
“British democracy is in rude good health.” I like that quote!
But it’s messy. Shocks to business supply chains are not a tomorrow thing, they are here today. It can be mind-bending but in simple form, it’s like throwing a monkey wrench into the global economic supply chain engine. Where is the manufacturer going to get the specialty parts required to make whatever it makes? It takes time to find new partners, negotiate new deals and ramp up facilities. Workers are laid off if management can’t source the parts needed to make stuff.
Nouriel Roubini wrote an excellent piece this week highlighting three potential supply shocks and what this might mean to businesses, the economy and the Fed’s response mechanisms. In short, not good. You can find the article here. It is an important read.
A couple of other things caught my eye this week. One was this chart from David Wilson at Bloomberg (with a hat tip to Morgan Stanley). It shows the separation in market gains from earnings growth, which is not positive for stocks.
A few observations:
- The blue line plots the S&P 500 Index. The white line plots U.S. after-tax corporate profits.
- Over time, companies grow their earnings and investors benefit from that growth. After all, we are investing in future growth.
- However, sometimes the markets price gains get too far ahead of earnings growth and sometimes earnings growth is ahead of price.
- It is best to buy when prices are undervalued (price below earnings growth) – refer to the line in 2002 and 2009-2012.
- It is best to harvest gains when prices are overvalued (price way above earnings growth), such as we saw in 2000.
- U.S. after-tax corporate profits have been flat since 2010, peaked in 2014 and look to be trending lower. Looking at the blue price line relative to the white profits line on the far right-hand side of the chart. Looks a lot like 1999.
And how might supply chain shocks impact corporate profits? It looks like this…
Interesting times. More on valuations, the Fed and MMT in coming letters. Buckle up – the next 10 years will look nothing like the last 10 years.
Grab a coffee and find your favorite chair. This week’s letter is short. You’ll find the link to the latest Trade Signals post and while some early warning signs are present (and I share a few below), buy signals remain across the various equity markets, gold and bond market indicators. Even high yield moved back into an uptrend buy signal a little more than a week ago. Point is, HY is not yet signaling recession. That’s good news.
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Included in this week’s On My Radar:
- Trade Signals – Look at Gold Go
- Personal Note – End of Summer
Trade Signals – Look at Gold Go
August 28, 2019
S&P 500 Index — 2,861
Notable this week:
Market Commentary: Look at gold go (vertical move right-hand side of following chart)! Trade and currency wars? Fading confidence in governments and central bankers? Likely. The intermediate-term trend for gold remains bullish. Here is how to read the chart: Buy and sell signals are generated when the 13-week moving average trend line (blue line in chart) moves above or below the slower moving 34-week moving average trend line (red line in chart). “Cyclical Bull” signals are indicated by green arrows and the “Cyclical Bear” sell signals are indicted with red arrows. The late-December 2019 buy signal on GLD (the SPDR Gold ETF) at approximately $120 is looking good. GLD is currently at $145 per share. And up handsomely in August while equity markets are lower by more than 3%.
Our overall market commentary remains unchanged. We believe the market is forming a top and a re-test of the December 2018 low at 2,300 in the S&P 500 Index is probable. However, all of our Equity trend signals are weakening but still positive. I favor diversifying to trading strategies and read the current environment as neutral given the weakening technical conditions. You’ll find the latest signals in the dashboard section below. Notable this week: both the weekly and monthly MACD lines for the S&P 500 Index have turned lower. MACD stands for Moving Average Convergence Divergence: a trend-following momentum indicator that shows the relationship between two different moving averages that measure a security’s price. Highlighted (yellow circles) in the bottom section in S&P 500 Index Charts 1 and 2 below are various signal points (data is 2007-present). Signals are triggered when the shorter-term black trend line crosses above or below the longer-term red trend line. There are a number of whipsaw signals, but overall the processes have done a good job at signaling risk. Also note that both the 30-week moving average and the 20-month moving average lines are being tested (top section of each chart). It will be important for the support lines to hold. Chart 1 is the weekly price data. Chart 2 is the monthly price data.
Chart 1 – Weekly Data
And note how important the MACD sell-signals were in 2000 and late-2007 (left two yellow circles Chart 2). The most recent sell signal was in October 2018.
Chart 2 – Monthly Data
Market Trends: While MACD is not my go-to signal for trading, as there can be quite a bit of lag from signal to correction, it is a technical indicator helpful in signaling major turning points (especially the monthly data). Market tops tend to take time to form. Both the weekly and monthly MACDs are in sell signals. Lights on. In the next section, you will find the updated “Equity Trade Signals.” While weakening, the trend signals remain bullish. As for the bond market: The Zweig Bond Model remains in a buy signal, suggesting higher bond prices and lower yields. The HY trend signal moved back to a buy signal last week. Short-term investor sentiment indicator continues to signal “extreme pessimism,” which is generally short-term bullish for equities. The NDR Crowd Sentiment data (an intermediate-term indicator) is neutral. The trend in Gold remains bullish. The indicator dashboard is next, followed by the updated charts with explanations.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Click here for this week’s Trade Signals.
Personal Note – End of Summer
“When Albert Einstein met Charlie Chaplin in 1931, Einstein said, ‘What I admire most about your art is its universality.
You do not say a word yet the world understands you.’
‘It’s true,’ replied Chaplin, ‘But your fame is even greater. The world admires you when no one understands you.’”
We could sure use a little magic from both Chaplin and Einstein today. Some humor to lift us and some genius solution to the global macro challenges we face. I do believe we will find our way and we’ll be ok. Let’s navigate the challenges the best we can.
Despite the clear and present dangers, the U.S. equity market trend remains positive. It’s weakening, as shared in the Trade Signals commentary, but not yet in alarm mode. You may know by now that I favor a disciplined risk protection process that enables you to seek growth while protecting your capital against the significant market decline. Such dislocations have happened and will happen again. In Trade Signals, I share with you several of my favored processes. There are, of course, others. I encourage you to work with your advisor to establish a game plan that suits your needs and risk tolerance. You can shape your risk and return levels up or down depending on how you mix different trading processes together. Set a plan in place and then stick to the plan. You can always make a few tweaks along the way. I favor diversifying to trading strategies. Makes for a better night’s sleep. None are perfect, perfect does not exist and you don’t need to be perfect to make money.
The end of summer is here. I have yet to put my toes in the sand but Susan and I are determined to do so. We’ve made a last minute audible and heading down to Stone Harbor, NJ early Monday morning. We’ll stay the night at our favorite place, The Reeds, and head back to work Tuesday morning. I’m looking forward to the sand and the sound of the crashing waves. There is something about it that helps me center and find balance.
On Tuesday, I had the pleasure of going to the Phillies game with business colleagues and my daughter, Brianna. Such a great night with Brie and many friends! A big thank you to our hosts!
I’m rushing to hit the send button. It’s opening day for stepson Kieran’s Malvern Prep Friars soccer team. Susan is coaching his team and now I’m rooting for both of them and of course the entire team. There is now “we in me” and “no I in team.” We are better together. A fun season and some interesting dinner discussion remain ahead. Go Kieran, go Coach Sue and go Friars. Enjoying the journey and hope you are too.
Travel picks up pace again in September. NYC the week of the 10th and 11th and St. Louis September 24 to 26 for a meeting with one of our advisor teams.
Enjoy your last few days of summer. Wishing you a fun holiday weekend!
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
Click here to receive his free weekly e-letter.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
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