More signs the Trump rally is on shaky ground
How solid is the current economic recovery? In late April I argued that the recovery was faltering and that cracks were starting to appear in the “Trump> READ MORE
How solid is the current economic recovery? In late April I argued that the recovery was faltering and that cracks were starting to appear in the “Trump> READ MORE
Common sense would suggest that political uncertainty should weigh on a country’s stock market. If investors can’t determine with a reasonable degree of> READ MORE
Until not long ago, U.S. President Donald Trump was intent on waging a currency war with China. Now… he’s not. What changed? Let me explain. “I will> READ MORE
Canapés and missile strikes, but no Big Macs “I would not be throwing him [Xi Jinping] a dinner. I would get him a McDonald's hamburger and say we've got to get> READ MORE
China’s President Xi Jinping arrives on U.S. President Donald Trump’s home turf tomorrow for a hugely anticipated showdown between the leader of the world’s> READ MORE
In October 2008, in the throes of the global economic crisis, legendary investor Warren Buffett famously wrote: “Be greedy when everyone is fearful,> READ MORE
Since taking office, U.S. President Donald Trump has cast a shadow on many longstanding trade relationships. He's pulled the U.S. out of what was going to be a> READ MORE
“May you live in interesting times” is an old Chinese proverb. While it may sound like a blessing, the saying is actually a subtle curse, something you might> READ MORE
How solid is the current economic recovery? In late April I argued that the recovery was faltering and that cracks were starting to appear in the “Trump rally” in US equities.
I wrote then that a stock market can rally on promises – in the case of the Trump presidency, promises of lower regulation, tax cuts, and infrastructure spending. But it takes concrete results to sustain it, and those results aren’t being delivered.
US equity markets have continued to grind upwards. The S&P500 is up another 2.1 percent since I raised the idea that the Trump rally was sitting on a shaky macroeconomic foundation in late April. And it’s up 8.5 percent in 2017 so far.
The CBOE S&P 500 Volatility index (or VIX), which measures the expected level of equity market volatility has fallen back below 10. This means investors are not bracing for a sharp decline in US equity markets any time soon.
Meanwhile, US economic data continues to be weak.
Last weeks’ US nonfarm payrolls (NFP) data were not encouraging. NFP data provides month-on-month changes in US employment. It’s a key barometer for overall economic health. In May data showed that 138,000 jobs added that month versus expectations of 182,000. That’s a 25 percent miss.
More interesting is what’s going on in the US treasury market.
In the aftermath of Donald Trump’s electoral victory in November, 10-year treasury yields shot up from less than 1.8 percent to 2.6 percent in the space of a month.
When bonds prices fall, yields rise.
This was all part of the “Trump rally” in equity markets. The view was that a Trump presidency would lead to faster growth, higher inflation – and therefore faster interest rate rises. (If the economy grows faster, the U.S. Federal Reserve would likely boost interest rates faster .
As a result, the market sold US treasuries (which perform poorly in a rising interest rate environment). (For bonds, a higher yield equates to a lower price.)
The chart below shows the Commitments of Traders (COT) report on net US treasury futures positions in 2016, up to the end of February 2017. Treasury futures are contracts to buy or sell US treasuries for a specific price at some point in the future. They are extremely liquid instruments used by traders and asset managers to hedge or bet on US treasuries.
This COT data is published weekly and shows to what extent the market is long or short (i.e. betting against) the price of the 10-year US treasuries.
A positive number means the market is generally long US treasury futures contracts, which means traders think bond prices will rise (and hence yields will fall).
A negative number implies the market is betting against treasuries and expects the price to fall (and hence yields to rise).
As soon as Trump was elected, the net futures COT numbers went negative. That is to say, the market began betting heavily against US Treasuries.
The market was anticipating that the price of Treasuries would fall. And it did. Treasury yields increased and bond prices fell.
The graph above shows data from January 2016 up to the end of February this year.
You can see in November 2016, when Trump won the election, that 10-year yields rose quickly, and the net COT postion went negative i.e. traders began betting heavily against the US treasury market.
But take a look at the next chart below. This shows you the COT numbers up the end of May, and in the context of the past decade.
You can see that in recent months traders have suddenly switched from betting heavily against treasuries, to betting heavily on treasuries. It’s the largest and fastest swing ever recorded (in data going back to 1993) in such a short time period.
The reality is, if the US economy is in such good shape, and interest rates are likely to rise as a result, then the market wouldn’t be betting so heavily on treasuries all of a sudden. If the bond market is boss, then right now it’s saying you better look out… the Trump rally and economic recovery aren’t a ‘given’. Traders are now positioned more bullishly on the US treasury market (i.e. betting bond prices will rise and yields will fall) than any time since 2007.
Let me be clear: if the market was optimistic on the US economic outlook, you simply would not see so many people betting on the US treasury prices rising.
Because of US economic frailties, I suggested earlier that investors look at shifting some of their US equity exposure to Chinese equity markets. I cited a relatively strong economic foundation and stabilisation in the renminbi, the Chinese currency.
Specifically I said “We are bullish on H-Shares.” (H shares are Chinese companies listed in Hong Kong.)
It’s early days, but since then H shares have outperformed the S&P500, with A shares (Chinese companies listed in China) not far behind.
We’re still bullish Chinese equity markets. And in our most recent edition of The Churchouse Letter, Peter makes his case why…
Common sense would suggest that political uncertainty should weigh on a country’s stock market.
If investors can’t determine with a reasonable degree of certainty which policies will be enacted and when – such as whether taxes will be cut or not – it stands to reason that stocks should be less attractive.
Back in January, I wrote that the U.S. was about to become the world’s largest emerging market. I said:
Political risk expert (and a former boss of mine at Eurasia Group, a political risk analysis consulting company) Ian Bremmer defines emerging markets as “those countries where politics matters at least as much as economics for market outcomes”. This suggests that the usual suspects that investors look at for signs of market trajectory – economic growth, inflation, interest rates, for starters – are downgraded to only be as important as politics. And in some cases, individual leaders can change institutions, further swaying markets.
According to this definition, the U.S. is taking on some of the characteristics of emerging markets – that is, where political risk matters more.
U.S. President Donald Trump moves markets with politically motivated comments about companies, industries and countries in a way that’s far more common in emerging markets than – historically at least – developed markets. He talks about the NAFTA trade deal and the Mexican peso gyrates. A seemingly offhand remark about a company can send its market value down by hundreds of millions of dollars.
Earlier in the year, I suggested that if U.S. markets were to act more like emerging markets, they could be in for a fall. That’s because emerging markets historically trade at lower valuations (like the price-to-earnings ratio) than developed markets. So in order to adjust to a lower (closer to emerging market levels, that is) P/E ratio, either earnings would have to fall, or prices – of shares, that is, overall – would have to fall.
Does political uncertainty matter for U.S. markets?
That hasn’t happened (yet, at least). This is partly because the broad policy outlines sketched by President Trump – few of which have come to fruition yet – are seen as pro-growth and market friendly. Infrastructure investment, tax cuts, and taking an axe to regulation perceived as anti-business are all ingredients for a bubbly stock market, at least in the short term.
So far, this has outweighed the greater political uncertainty of President Trump. The S&P 500 has risen a bit more than 6 percent since the U.S. election in November. It’s up almost 7 percent in 2017 so far.
The U.S. market isn’t the only one where uncertain and volatile domestic politics are not hurting (and perhaps even helping) stock market returns.
South Korea is up
South Korea has a nightmare neighbour to its North. Though a war of anything other than words is unlikely, you might think that investors in South Korea’s stock market might sell just in case. What’s more, the country’s president was recently impeached and ousted, and citizens go to the polls for presidential elections on May 9.
Meanwhile… South Korea’s Kospi Index recently hit six-year highs. It’s up 17 percent in U.S. dollar terms in 2017 so far. The won, Korea’s currency, is up almost 7 percent against the U.S. dollar.
So is Turkey
Turkey’s president Recep Tayyip Erdogan recently won a referendum that grants his office significantly expanded powers. Even before the polarising referendum, Turkey was headed in a dangerous direction, by western democratic standards. “Erdogan’s thirst for one-man rule threatens Turkey,” warned a mid-March opinion piece in the Financial Times.
A few days ago the government moved to restrict television dating shows and it blocked access to Wikipedia, as part of a crackdown on the media and internet. By western liberal standards, Turkey is going to the dark side.
So how is the Turkish stock market doing? It’s up 21 percent in U.S. dollar terms in 2017 so far. The country’s currency is roughly flat.
What does it mean?
Trump’s market-friendly policy announcements – even if they’re getting bogged down in execution – are moving markets more than the president’s muddled delivery and his trigger-happy Twitter fingers. The anticipation of a strong economy can mean a lot more than political uncertainty.
Also, what bothers journalists doesn’t necessarily bother investors. The president of the Philippines – like his colleague in Turkey – has become a poster child for stomping on human rights. But the country’s stock market is up 12 percent this year.
And don’t forget… it’s all about your time frame. How markets view a policy or a politician changes over time. Today’s contrarian view is tomorrow’s consensus view. Measures or words that bolster markets now may be a slow-burn fuse that blows them up months later.
Until not long ago, U.S. President Donald Trump was intent on waging a currency war with China. Now… he’s not.
What changed? Let me explain.
A month or so ago I killed a couple of hours on a rainy Sunday afternoon by taking my kids to see the new Batman Lego movie. As the movie finished, while the kids were rummaging around under their seats for misplaced/dropped shoes and water bottles, a familiar name in the closing film credits caught my eye – Executive Producer, Steven Mnuchin.
It’s not a common name, so I did a quick check on my phone – yes, this was the Steve Mnuchin, long-time friend of Donald Trump and the same Steve Mnuchin who, when he’s not producing movies about plastic objects coming to life to save the world, has a day job as U.S. Secretary of the Treasury.
As for the Lego movie, it was entertaining and I laughed out loud.
US-China currency war – who would win? Read: Three ways China wins under U.S. President Trump
I had exactly the same reaction this past Sunday morning over breakfast as I read through a recent report from Mnuchin’s Treasury Department.
The report was a summary of Foreign Exchange Policies of major U.S. trading partners. It’s a regular brief to Congress (the U.S. national legislative body) which reviews exchange rate policies from global U.S. trading partners. It provides an update on which countries are engaged in unfair practices or are outright manipulating their currencies.
The Treasury monitors three specific criteria that a trading partner must trigger to potentially incur further enforcement i.e. being “labelled” a currency manipulator.
The three criteria are:
If these three criteria are triggered by China, then the Treasury is mandated to spend a year trying to resolve the issue through negotiations with Chinese counterparts. And if those steps fail then there can be retaliatory measures such as stopping U.S. government development agencies from financing programs in China – although these have already been halted for years anyway after the 1989 Tiananmen square crackdown.
The “labelling” of China as a manipulator is more of a risk factor in its ability to further weaken Sino-U.S. relations through uncertainty – we don’t know how China would react. What would a war with China and its currency, the renminbi, look like?
What we do know, or at least what we thought we knew, was Donald Trump’s view on the matter. He has consistently attacked China’s “devastating currency manipulation”.
Trump realizes a currency war with China is not a good idea
This is why Steve Mnuchin’s Treasury Report is so interesting. So what did the Lego movie master decide?
To save you the suspense, the Treasury Department gets straight to the point (on the first page in fact) and states the following:
Treasury has found in this Report that no major trading partner met all three criteria for the current reporting period. Similarly, based on the analysis in this Report, Treasury also concludes that no major trading partner of the United States met the standards identified in Section 3004 of the Omnibus Trade and Competitiveness Act of 1988 (the “1988 Act”) for currency manipulation in the second half of 2016.
So to be clear, Donald Trump’s Treasury Department has confirmed what we’ve been saying all along (below is an excerpt from January’s edition of The Churchouse Letter)
“It’s pretty hard to argue that China is guilty of anything here…
Pressure on the renminbi is not being engineered by the central bank. It is a by-product of an increasingly open Chinese capital account and the desire for individuals and companies to invest (or simply take money) offshore.
There is genuine demand for capital outflow which necessitates selling renminbi.
If anything, China is trying to stem capital outflow in a bid to soften the pace of depreciation!
Bear in mind, these capital outflows are both expected and long overdue. We wrote about this particular phenomenon nearly two years ago in ‘A $35 Trillion Dollar Bonanza’.”
But what I found so amusing in this report was the new additional language that Trump’s Treasury has now inserted. I immediately recognised the new text because I’d read the October 2016 report.
I’ve highlighted the significant additions in yellow below.
The first highlighted section complains that although the renminbi did appreciate against the dollar, China didn’t let its currency appreciate fast enough from its initial “deep undervaluation”. As a result (according to this line of argument), this caused significant and long-lasting hardship to American workers and companies. Sadly, however, the report doesn’t reference any supporting evidence of this hypothesis.
The second highlighted section finally acknowledges that China’s “recent intervention in foreign exchange markets has sought to prevent a rapid RMB depreciation that would have negative consequences for the United States…”.
So, according to the Treasury, first China damaged American workers and companies by not letting its currency appreciate fast enough… but now China is not only preventing depreciation, but that depreciation would also have “negative consequences for the United States”.
So now the U.S. is grateful China is intervening in its currency market because if it didn’t, the renminbi would depreciate faster!
It seems clear now why the Chinese haven’t taken this threat of labelling them as a “currency manipulator” terribly seriously.
But the Treasury saves the best ‘till last:
“China will need to demonstrate that its lack of intervention to resist appreciation over the last three years represents a durable policy shift by letting the RMB rise with market forces once appreciation pressures resume.”
“Lack of intervention to resist appreciation over the last three years”? There’s been no ‘appreciation’ pressure to resist!
See the chart below of the renminbi against the dollar over the past three years.
Go ahead, try and defuse that logic bomb.
China has spent the past three years fighting depreciation, not appreciation. The renminbi is down 14 percent against the dollar and it would be down a heck of a lot further had the People’s Bank of China (PBOC) not spent a trillion dollars in foreign currency reserves since early 2014 trying to defend it.
So, the first half of that sentence makes no sense.
But Trump’s renminbi capitulation comes in the second half where it says, “letting the RMB rise with market forces once appreciation pressures resume”.
This puts the entire “China currency manipulator” argument on ice for the foreseeable future. The Treasury has effectively just asked China to keep doing what they’re doing (that is, to resist further renminbi weakness), but to let the currency re-appreciate when the times comes. That could be five years away.
It’s hard to know what triggered this dramatic change of course by the Trump administration on the renminbi. The White House simply remarked that “circumstances change”, and Trump himself said, “Why would I call China a currency manipulator when they are working with us on the North Korean problem?”
Regardless of why the White House has completely backtracked on this issue, it does remove a potential negative overhang on Sino-U.S. relations.
It also affords us more certainty and stability with regard to our view on investing in China. Here’s one of the best ways to invest in China according to my colleague, Kim.
Canapés and missile strikes, but no Big Macs
“I would not be throwing him [Xi Jinping] a dinner. I would get him a McDonald’s hamburger and say we’ve got to get down to work because you can’t continue to devalue [the renminbi]… I would give him a very — yeah, but I would give him a double, probably a double-size Big Mac.”
Donald Trump, August 2016
At the President’s Mar-A-Lago resort last Thursday evening Donald Trump and Xi Jinping dined on Caesar salad, Dover sole and New York strip steaks, paired with a 2014 Girard Cabernet Sauvignon, a wine which one reviewer on wine website Vivino describes as tasting “like a swamp in a good way”.
Big Macs were conspicuously absent from the menu.
But midway through dinner, Trump informed his counterpart that he had launched 59 Tomahawk missiles at a Syrian airfield in response to Syria’s use of nerve gas against civilians two days earlier.
With no congressional approval, and Trump’s statement ahead of the meeting that “If China is not going to solve North Korea, we will”, the message was clear: Despite the Floridian diplomatic niceties, China should expect the unexpected from Donald Trump.
In reality, the Syria strike completely overshadowed the summit between the two leaders.
In my previous note on the subject last week I said:
“I expect there to be no grand bargain on issues of that magnitude because there are no quick and obvious solutions in sight that are palatable to both Trump and Xi.
Rather, I think we can expect to see Xi Jinping come bearing some economic gifts for Trump, preferably something that Trump can boast about in 140 characters or less.
My hope is that Trump will take the opportunity to appear ‘presidential’. Xi Jinping is a measured, calm individual and if Trump can come across as a businessman who’s ready to do deals (an aspect about Trump that the Chinese actually respect) then the summit will provide an opportunity to reset relations.”
We certainly didn’t get any grand bargains on the likes of North Korea, South China Sea militarization, or the renminbi. There were no formal conclusions or even a press conference attended by both leaders.
However, Xi and his team did bring some of those tweetable gifts for Donald Trump. Officials involved in the Mar-A-Lago talks discussed China’s willingness to end a ban on U.S. beef imports into China (in place since 2003) along with allowing U.S. companies increased China financial sector market access.
On the relationship front, the two leaders appeared to establish a rapport, with Xi saying they had built a “good working relationship”, and Donald Trump’s assessment that “tremendous goodwill and friendship was formed”. Trump has also accepted an invitation from Xi to visit China later in the year.
From a Chinese perspective, this was a successful trip.
There were no diplomatic fumbles, so no problems for Xi Jinping to be portrayed strongly in the Chinese media. A photo from Chinese news agency Xinhua widely circulated across mainland China shows a poised and confident Xi Jinping, with his more relaxed and perhaps less commanding American counterpart leaning back on the sofa.
It’s hard to overstate just how seriously this kind of imagery is taken by the Chinese. Projection of power is extremely important when it comes to these visuals.
Take a look at this recent photograph of Xi Jinping with Philippine President Rodrigo Duterte. Xi standing over Duterte, who appears hunched, dishevelled and diminutive. There’s no doubting who’s in charge.
As Xi said of the summit “We had long and in-depth communication. And, more importantly, we have further built up understanding and established a kind of trust, and we have initially built up a working relationship and friendship.’’
The two leaders also agreed on a new 100-day plan for trade talks with the aim of boosting U.S. exports and reducing the overall trade deficit with China which, as we’ve written before, is high on President Trump’s agenda.
But we take such ‘plans’ with a huge pinch of salt, and you should too. Substantial trade deals take years, not months. And we still fully expect that Trump and his team will continue to throw jabs in China’s direction. As the President himself tweeted on Saturday: “goodwill and friendship was formed, but only time will tell on trade.”
Overall though the lack of visible controversy or open conflict between the two leaders paved the way for the first step of a much-needed ‘reset’ for their relationship. This can only be a positive for Chinese stocks.
P.S. Our special report on Chinese stocks “Unlocking China’s Hidden Trillion-Dollar Opportunity” is available for free to Asia Wealth Investment Daily subscribers. Click here to get your copy.
China’s President Xi Jinping arrives on U.S. President Donald Trump’s home turf tomorrow for a hugely anticipated showdown between the leader of the world’s hegemon and its principal rising power.
Don’t expect to see the pair hit the golf course. The sport is generally viewed as a symbol of indulgent corruption in China and all but banned for the 90-odd million Communist Party members.
Trump rode a fierce anti-China narrative all the way to his electoral victory last year. He threatened to label China a “currency manipulator” on his first day in office and implement tariffs of up to 45 percent on Chinese imports. Since he took office the relationship hasn’t improved.
It got off to a chilly start after he took a phone call from Taiwan’s President Tsai Ing-wen. The act of taking the call, referring to her publicly as the ‘President’ of Taiwan, and then suggesting that China’s bedrock “One China” policy – which decrees Taiwan to be an inalienable part of China – was a chip on the table for negotiations offended Beijing greatly. In their eyes, it constituted a direct attempt to undermine Chinese sovereignty.
Did Trump play his cards wrong?
Whilst nobody knows for sure whether this represented a highly calculated tactical manoeuvre on Trump’s part, or just bone-headed ignorance, China responded as we predicted.
In the January edition of The Churchouse Letter, “Asia in a Trumped-Up World”, we wrote:
“By calling this bedrock assumption of one China… Trump is establishing a marker that he can ‘back down’ from in return for economic concessions.
Before we move on to what these concessions might be, it’s worth re-emphasising just how important “One China” is to the Chinese. The last time it was actively threatened was in 1995 when Bill Clinton granted a U.S. visa for Taiwan’s President to attend a University alumni reunion. Beijing threatened retaliatory measures against U.S. business in China, or even offering nuclear cooperation with Iran.
You can guarantee that Beijing will be readying exactly the same inventory of potential ‘pressure points’ they believe that Trump will respond to. These could include North Korea, military exercises around Taiwan, further militarisation of the South China Sea…
You can also bet your bottom dollar that President Xi Jinping isn’t going to be in the mood to offer anything in return for Trump’s attempt to rattle the hornet’s nest…
And Xi wasn’t in the mood to offer anything.
Ultimately, it was Trump who backed down in the face of radio silence by the Chinese by committing to “One China” in his first phone call with Xi Jinping after taking office.
Trump has recently attempted to ratchet up the geopolitical pressure back on China in the lead up to the meeting.
North Korea is a perennial thorn in both countries’ sides. Trump said in a recent interview that “if China is not going to solve North Korea, we will. That is all I am telling you”.
The deputy White House national security adviser KT Macfarland is quoted as saying “There is a real possibility that North Korea will be able to hit the US with a nuclear-armed missile by the end of the first Trump term.” This is an unacceptable potential threat from a nation led by a man who’s unpredictability makes Trump look like a beacon of statesmanlike stability.
China keeps the North Korean regime afloat with exports of fuel and commodities, providing up to 90 percent of the country’s energy supplies.
But North Korea also acts as a buffer between China and South Korea, where the U.S. has deployed military assets, specifically the Terminal High Altitude Area Defence systems (or THAAD), designed to shoot down short, medium, and intermediate range ballistic missiles.
Beijing is unhappy with THAAD for the surveillance benefits it brings to the Americans, particularly with regard to improving early tracking on Chinese missiles and the fact that its radar penetrates deep into Chinese territory.
There are other geopolitical hot button issues beyond North Korea and Taiwan. China’s militarization of the South China Sea is another one. But I expect there to be no grand bargain on issues of that magnitude because there are no quick and obvious solutions in sight that are palatable to both Trump and Xi.
Rather, I think we can expect to see Xi Jinping come bearing some economic gifts for Trump, preferably something that Trump can boast about in 140 characters or less. Xi will no doubt be acutely aware of Trump’s limited successes in office so far and his historically low polling numbers. Trump needs a ‘win’.
According to Chinese news agency Xinhua, during Xi’s February call to Trump, he communicated that “China is ready to boost mutually beneficial co-operation with the United States in various fields such as trade and economy, investment, science and technology, energy, culture and infrastructure”.
Last year China invested around US$45 billion in the U.S. When he meets with Trump, Xi may take the opportunity to announce a few more job-creating investments.
Although Xi arrives at this summit with significantly more political stability and momentum than his counterpart (the “grown-up in the room” as my colleague Kim Iskyan puts it), we have no idea how Trump will behave.
He has to make some noise about trade, given the US$347 billion 2016 trade deficit the U.S. ran with China, as we’ve written about before. But when it comes to the currency he doesn’t have a leg to stand on given that China is trying to slow depreciation of the renminbi.
Which Donald will show up?
Will he be needlessly confrontational, looking to pick a fight? Will he be tweeting in between meetings? Will he have figured out how to properly shake hands with world leaders yet?
Bear in mind his key advisors are far more confrontational on China than he is. Early last year his Chief Strategist Steve Bannon said “We’re going to war in the South China Sea in five to 10 years… There’s no doubt about that. They’re taking their sandbars and making basically stationary aircraft carriers and putting missiles on those.”
My hope is that Trump will take the opportunity to appear ‘Presidential’. Xi Jinping is a measured, calm individual and if Trump can come across as a businessman who’s ready to do deals (an aspect about Trump that the Chinese actually respect) then the summit will provide an opportunity to reset relations.
But make no mistake, this is only the beginning of a four-year Trump-China saga and how well or poorly this summit goes will have profound implications on the relationship between the two largest global economies.
In October 2008, in the throes of the global economic crisis, legendary investor Warren Buffett famously wrote: “Be greedy when everyone is fearful, and fearful when everyone is greedy.” Over the course of his career, he has made a fortune from this contrarian philosophy of going against the herd.
If he’s right, it might be time to be fearful. Why? Because the stock market “fear index” is at its lowest level since 2007. Those who saw this, foresaw the stock market crash, in fact the global economic crisis, which was coming. (Here are 5 things to do before any crisis hits.)
How to measure fear
The “fear index” is another name for the VIX index, which is a measure of anticipated market volatility.
It’s based on option prices of individual stocks in the U.S. S&P 500 index. When investors expect more price fluctuation (that is, for prices to bounce around more), the VIX goes up. And volatility is greatest when markets fall.
As the old saying goes: The market takes the stairs up, and the elevator down.
Quoted as a percentage, the VIX is currently around 11. That generally means the market expects an 11 percent range of movement in the S&P 500 index over the next 30 days. For comparison, the VIX hit an all-time high of 89.53 on October 24, 2008, in the depths of the global economic crisis.
The VIX rises when investors are surprised and scared. Investors panic-buy options to protect against further losses. As a result, implied volatility increases.
(One estimate suggests that if the VIX had existed in 1987 – it was instituted in 1993 – it would have hit 120 during the October 1987 stock market crash in the U.S.)
So the VIX index is a measure of how anxious large investors in the S&P 500 are to insure their portfolios. Put options – which increase in value when the underlying security goes down – are widely used by institutions as insurance against losses in the stocks they own. When investors fear a market decline, put options are increasingly in demand, so the price of put “protection” rises.
Generally speaking, the VIX goes up during times of uncertainty and fear, and goes down when investors are complacent or greedy.
The lowest VIX reading ever recorded was 9.39 on December 15, 2006. In recent days, the index has dipped under 11. According to investment bank Goldman Sachs, since its inception, the VIX index has traded below 11 on only 1.8 percent of trading days (grey lines on chart below).
In recent years, there have been some short-lived declines in the S&P 500 and spikes in the VIX. In August 2015, for example, the S&P 500 dropped 11 percent in a little more than a week, causing the VIX to briefly peak above 50. And in the beginning days of 2016 the VIX surged to more than 30.
But the stock market hasn’t seen elevated volatility since 2011. And, based on current VIX readings, investors don’t expect much volatility.
Right now, investors fear little
One thing is for certain – global stocks have been on a roll. The S&P 500 is up 9.8 percent since the election, and global indices aren’t far behind. The so-called “Trump Rally,” which we expect to end, is based on expectations of higher corporate profits from the new U.S. president’s pro-growth policies. Trump has proposed slashing corporate income taxes from 35 percent to 15 percent, and eliminating many regulations in financial, energy and other industries. (We previously wrote about the industries that will do well under a Trump administration… here.)
Is there a stock market crash coming anytime soon?
Does a low VIX reading point toward an imminent market top? Not necessarily. The rock-bottom VIX only indicates that optimism and complacency are high among the largest investors in the S&P 500 index. This attitude could continue for a while, but it’s a warning (re-read the Buffett quotation at the beginning of this piece).
While rising prices may have already priced-in Trump policy benefits, the implementation of these policies is by no means a certainty. Also, the U.S. Federal Reserve has indicated that it expects to continue to raise interest rates – which will counter President Trump’s expected economic stimulus plans. The more that risk assets (like stocks) rally, the more aggressive the Fed is likely to be in raising rates. After nearly seven years of near-zero rates, tighter monetary policy will be a big challenge to global markets.
This is a difficult mix. The timing is difficult, but the low VIX suggests that the U.S. and global markets might be primed for a correction.
That doesn’t mean it’s time to panic… it just means that you should be careful and selective. Just because the market is complacent, it doesn’t mean you should be.
Keep watching your stop-loss levels carefully, and keep an eye on the VIX index.
How else should you protect your portfolio? I’ll write about that next week.
Since taking office, U.S. President Donald Trump has cast a shadow on many longstanding trade relationships. He’s pulled the U.S. out of what was going to be a transformative trade deal with Asia. He’s attacked Japan’s and Korea’s trade policies. Threatening a trade war with China was a staple of his campaign for the presidency. He’s talked about imposing a tariff on goods imported from Mexico.
With a new victim almost every week since his inauguration, what country could be next in Asia on his hit list?
Countries posting a trade surplus with the U.S.
One way to predict Washington’s next move is to look at countries that run a large trade deficit with the U.S. A trade deficit is the amount by which the cost of a country’s imports exceeds the value of its exports. If the U.S. runs a trade deficit with country X, it means that a country X sells more to the U.S. than the U.S. exports to country X. There’s nothing inherently wrong with running a trade deficit. But a trade deficit is like a red flag to a bull for a U.S. government focused on bringing manufacturing jobs back to U.S. soil.
As the graph below shows, China is the leading offender. The country posted a US$347 billion trade surplus in 2016. (If a country runs a trade surplus with a trading partner, by definition the partner is running a trade deficit.) After China, in 2016, Japan, Vietnam and South Korea are the next three Asian countries that have the biggest trade surpluses with U.S.
In contrast, the U.S. actually runs a trade surplus with Hong Kong and Singapore. (Still, in November, Trump singled out Singapore as a country that’s taking jobs away from Americans.)
Another issue raised by Trump administration is whether a country is “artificially” trying to achieve an “unfair” trade advantage with the U.S. by causing its currency to fall in value. A weaker currency relative to the U.S. dollar makes that country’s imports cheaper in U.S. dollar terms. And a weak currency is an important factor in the trade balance.
By this measure, Japan, Indonesia, India and Malaysia are the biggest culprits over a five-year time horizon, as shown below. These countries have seen the greatest weakening (that is, depreciation) in their currencies relative to the U.S. dollar. Over the past year, the Philippines, China and Malaysia have seen the most depreciation.
One of the U.S. government’s contentions has been that China has been trying to manipulate its currency to gain an unfair trade advantage over the U.S. But in fact, China has been trying to prevent the depreciation of its currency – not promote its depreciation.
According to a U.S. Department of the Treasury report, “China’s intervention in foreign exchange markets has sought to prevent a rapid RMB [or renminbi, China’s currency] depreciation that would have negative consequences for the Chinese and global economies.” The department estimated that from August 2015 through August 2016, China sold more than US$570 billion in foreign currency in an effort to prevent rapid depreciation of its currency.
The U.S. government is constrained in what it can do to retaliate against offending trade partners by World Trade Organisation (WTO) rules. And as the U.S. steps away from its prior role as the custodian of global trade, China is ready to fill the gap with a raft of other trade deals.
To learn more about how to protect your portfolio as Donald Trump searches for his next trade battle target, read our free special report… here.
“May you live in interesting times” is an old Chinese proverb. While it may sound like a blessing, the saying is actually a subtle curse, something you might wish upon an adversary. The implication is that “interesting times” are chaotic and painful.
2017 is shaping up to be very interesting. Since the victory of Donald Trump in the U.S. presidential elections in November, global stock markets have surged higher, with the S&P 500 up about 8 percent since the U.S. election and 2.6 percent year-to-date. Meanwhile, the MSCI Asia ex-Japan index, after dropping in the wake of Trump’s victory, has reversed course and is up 6.7 percent in 2017 so far.
However, as I’ve written before, I think that the so-called Trump rally is due to reverse soon, as mean reversion comes into play. And with high levels of uncertainty in markets, now is also a good time to buy one of the assets that performs best during times of uncertainty – gold.
As the graph below shows, gold prices are up nearly 6 percent so far in 2017. Precious metals had a bout of weakness after Trump’s surprise victory. Global investors bought U.S financial and manufacturing stocks and sold “defensive” assets like gold.
From the election to mid-December, gold dropped about 13 percent. However, since then, it’s rallied to about US$1220, a gain of 9 percent. Gold remains nearly 8 percent below its highs from June of last year – a level it’s likely to revisit before long. It’s not going to happen immediately, but I don’t think it’s a stretch for gold’s 2011 highs – of US$1,837/oz, or about 50 percent above current levels – to be in sight.
Three reasons why 2017 could be a big year for gold
The U.S. dollar is likely to weaken
Trump recently said the U.S. dollar is “too strong.” He has accused China of manipulating the yuan lower relative to the dollar to benefit China’s exports. The dollar is up 2 percent since the election, but for Trump to bring manufacturing jobs back to America, he will need it to weaken. As gold and the dollar usually trade in opposite directions, a softening dollar will be positive for gold.
The “Trump Rally” will eventually succumb to mean reversion
As I mentioned, global stocks have been strong since the election. Investors have been anticipating Trump’s anti-regulation, pro-growth plans will stimulate global corporate profits. But these policies face political obstacles and will take time – if they are ever enacted. It’s only a matter of time until the current “risk-on” environment turns to “risk-off.” Gold—the fear asset – will benefit.
Odds of a “Black Swan” event that will ignite gold prices are increasing
Black swan events are unexpected events that have outsized and serious ramifications – such as the global economic crisis of 2008, for example. The unpredictability of some of President Trump’s early actions in office, and the poorly thought-out implementation of some of the new government’s policies, suggest that a black swan (which by definition is almost impossible to predict) may emerge from the depths. (Last week we talked about another possible black swan, here.)
I believe it’s crucial as an analyst and investor to be objective. Letting your political views cloud investment decisions is a good way to go broke. It makes a lot more sense to position your portfolio to profit from what may happen (see here for one idea that’s working out) – and protect it at the same time.
Fresh demand from Islamic Investors is hitting the gold market
As we discussed here and here, Islamic investors in modern times have shied away from gold-related financial products. This is because the legality of gold investments has long been unclear under Islamic Finance law.
However, as anticipated, a Sharia Gold Standard was approved on December 5. The Accounting and Auditing Organization for Islamic Financial Institutions and the World Gold Council teamed up to clarify the rules for Islamic gold investing under Sharia Law.
The Standard allows gold-based Sharia-compliant products, like ETFs, to be offered throughout the Muslim world. Indications are that the SPDR Gold Trust – the largest gold ETF in the world – qualifies under the guidelines.
The Sharia Gold Standard will stimulate gold demand across Muslim markets like Malaysia, the UAE and Saudi Arabia, where Islamic Finance is well established. Indonesia and Pakistan are pushing for Islamic Finance to play a greater role in their economic infrastructure.
Islamic savers and investors currently hold almost US$2 trillion in assets, an amount that is expected to grow to US$6.5 trillion by 2020, according to the Islamic Finance Stability Board.
President Trump’s ban of immigrants from seven predominantly Muslim countries, and the ensuing backlash, underscores the uncertainty many Muslims face around the globe. The world’s 1.6 billion Muslims may increasingly be able to invest in gold as a hedge.
Just a 1 percent allocation to gold among Islamic investors would equate to nearly US$65 billion, or 1,700 tonnes, in new demand. That’s almost double China’s estimated total 2015 demand for gold.
So as the Trump rally loses steam, and investors get a reality check from political and geopolitical risks, expect risk-on to become risk-off. Meanwhile, the chances of a black swan of some sort are rising. Finally, a major new source of gold demand is arriving via Islamic Finance.
One easy way to own gold is through the SPDR Gold Shares Trust ETF (code O87 in Singapore; ticker GLD on the New York Stock Exchange) or the Value Gold ETF on the Hong Kong exchange (code: 3081).
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