No, we shouldn’t be. Not yet at least.
Granted this whole issue does have our attention now, given that “fear” and “turmoil” were the words used to describe markets this last week. However, I believe the game has changed since the subprime financial crisis, and I’ll get into that shortly.
But first let’s get right into the action: The Dow sank 3.1% on Wednesday, along with the S&P 500 dropping 2.9%. The Straits Times Index hit 3084. The Hang Seng Index has dropped for a fourth straight week and briefly fell below 25,000 for the first time since end 2018. China, Germany, and Italy have all reported poor economic data, and of course, the most critical element in all of this, the U.S. and U.K. Yield curves inverted.
2y10y Yield Curve Inversion: Why It Matters
The yield curve we are talking about looks at the 2-year and 10-year treasury notes of any government’s bonds. Why? That’s because it is a gauge of investor sentiment and also critical to the model of banking. If investors are bullish on the long-term outlook, the 10-year term premium will be greater than the 2-year premium since investors expect to be compensated according to the greater risk they face when holding a longer-term bond.
When the yield curve inverts, it means investors expect greater compensation for shorter-term bonds than they do for longer-term bonds. US 30-year bond yields have also dropped significantly and this shows that there is a flight to bonds by investors. Throw in a Gold rally and a clearly strengthening Japanese Yen, and we are definitely in Risk-Off mode now.
A yield curve inversion is also critical to banks. Banks lend long-term and thus earn on longer-term rates while paying out on deposits on short-term rates. Therefore, a bank’s profitability will be crimped by a yield curve inversion. If the yield curve stays inverted for an extended period, expect bank lending to slow significantly.
Singapore: Don’t worry, we’ve been here before, from 2011 to 2012.
Yes, Singapore’s NODX (Non-oil domestic exports) data is down, and most recently dropped 11.2% in July. Add in a bleak GDP outlook from MTI, and it seems like we’re headed for rougher times ahead. Singapore Markets reflect that sentiment. But if memory serves, we’ve seen this before, sometime between 2011 and 2012. Just look at this article from SBR in 2012. Let’s also look at some of our own economic data, from NODX to Unemployment.
As you can see from the NODX data above, we’re not really in dire straits. We’ve seen worse NODX data along the way since the end of the subprime crisis in March 2009.
The same goes for our manufacturing PMI. Nothing too much to worry about just yet.
Lastly, our unemployment rate looks pretty decent given the current issues surrounding our economy. Of course, unemployment might go up slightly as a result of the economic headwinds but unless it really starts to tick up towards levels not seen since 2009, we don’t need to be too concerned.
U.S. : The economy is healthy but Trump wants his big rate cut.
As per my previous article on “Trump and The Orchestrated Market Boom”, I mentioned that the FED had no business cutting rates. The anticipated slowdown is mostly artificial as a result of the trade war, and Trump’s desire for a more substantial rate cut. 3 days after I published my article theorising what Trump was really up to, he states his intentions loud and clear; Trump wants a bigger rate cut from the FED. Hence, nothing really changes the U.S. outlook at the moment. The US Economy is healthy and slowly improving or at the very least reaching steady state. Only until we see economic data and corporate earnings sliding drastically do we need to worry.
Eurozone: Germany and Italy, basically more of the same.
Italy has far more serious issues that run deep, beyond simple economic numbers. Italy has had nearly 20 years of non-existent economic growth, and are facing a demographic crisis with an ageing population. They are also facing an erosion of their cultural heritage and immigration, and this could hurt their tourism revenue. Critically, Italy’s banks are in very bad shape, and coupled with a flat economy and high debt-to-GDP ratios, Italy could very well be one of the triggers of the next great crisis, and may well be the cause of the EU collapsing. But this talk has been going on for the last 3 years, so until something finally gives way, we’re just going to have to bide our time.
Germany’s economic slump is largely down to the US-China trade war. Looking into the numbers with greater detail, Germany’s economy isn’t in a recession yet, but teetering on the edge of it because of the poor sentiment being felt in the German economy as a result of the trade war fallout. What that means is, Germany’s economy is, like China and Singapore, being artificially strangled by the trade war issues. Until the trade war eases up, or disappears, Germany will likely stay depressed, maybe enter a technical recession, but overall should not spiral into a steep fall.
Hong Kong and China: Of Protests and Trade Wars…..
Hong Kong is currently experiencing violent protests and rallies, so expect Hong Kong’s markets to be slow and flat for the near-term until their political issues get resolved.
China is basically facing the same issue as Germany as the US-China trade war takes a hit on the Chinese economy. Recent economic numbers showed a significant drop, and it seems that the pressure is mounting for them to find ways to keep their economy in good shape. All this could force China’s hand in striking a win-win deal with Trump, which is of course what Trump will want, but only once the FED cuts rates to a level that Trump is happy with. So until then, we’ll wait.
Yield Curve Inversions? Not when the game has changed…..
A yield curve inversion has for the longest time, been thought of as an indicator that a recession is looming, with all 9 previous inversions preceding a recession that came anywhere between 6 to 24 months later. However, over the last decade since the subprime crisis, central banks have undertaken mass bond purchases. Most notably the ECB and the Fed. Such methods have likely dampened, if not completely discredited yield-curve inversions as a reliable predictor.
All the economic data we are seeing looks more like an economic slowdown instead of a full-blown recession. With this latest market selloff more than likely a result of artificial chokes on the global economy (see Trump and US-China Trade War).
The current selloff is based on the FEAR that a recession is looming ahead, but the recession is not here yet, and until the data starts to show it, we do not need to worry too much, other than managing the risk in our portfolios, taking profit when necessary, and finding opportunity in a market dip.
Above all, investors and traders need to be aware of this: markets evolve.
And I do believe the game has changed….
Crazy, not stupid.
That phrase, is perhaps one of several phrases that could possibly be used to describe Donald Trump, the 45th President of the United States. In 2016, many people didn’t even think Trump had the slightest chance of becoming President. The very idea of Trump as President was considered too “crazy” to comprehend, and yet, here we are.
Also back in 2016, several naysayers thought the people of the UK would easily vote “Remain”, and look where we are with that as well. That vote in 2016 was in favour of Brexit, and along the way, Boris Johnson looked like he was done, having pulled out of the Tory leadership race at the time. His hopes of becoming PM dashed. And yet, on the 29th of July 2019, he moved into 10 Downing Street.
The point here, is that we should begin accepting “crazy” ideas.
After all, as we have seen, they ended up becoming reality.
So what’s the next crazy idea? How about Donald Trump, possibly trying to orchestrate the next market boom? Sound crazy? Here’s why it’s not too far-fetched:
Trump, The Master Tactician
We know Trump himself isn’t stupid. At the very least, the team of people he keeps close to him are not. If one recalls, they played the 2016 election campaign beautifully in terms of the tactics used, and outwitted Hillary Clinton who won the popular vote. Fast forward to 2019, we know that Trump absolutely wanted a rate cut from the FED (Federal Reserve). We also know that the escalating US-China trade war is causing a global economic slowdown, and the fallout of this whole “tit-for-tat” trade war is being felt around the world in one way or another.
So what does Trump do the moment he gets a small rate cut from the FED? Simple, slap more tariffs on, and continue to escalate the trade war. The fact that Trump announced the new tariffs the day after Jerome Powell announced the FED rate cut should strike you as more than just a random coincidence. Trump is likely to carry on doing what he feels will help him get what he wants; a more substantial rate cut from the FED.
The FED had no business cutting rates….
All this talk of a recession being dangerously close at hand is really just talk. Both the Dow and S&P hit new highs this year, economic data has been positive, and corporate earnings have been stellar. In the most recent round of earnings releases, most of the companies on our watch list beat estimates (e.g. AAPL, GOOGL, MSFT). And for those companies that didn’t beat estimates (e.g. GPRO, NFLX), it was largely down to industry or company specific issues as reasons that they fell short. Not because the economy is doing poorly.
In fact, numbers for economic data have never been better. The unemployment rate reached a low of 3.6% for April and May of this year, which is a level not seen since December of 1969!
If we look at Total Nonfarm Payrolls, a measure of the number of jobs being added to the US Economy, we see a very solid uptrend. The same goes for Average Hourly Earnings.
With positive economic data and mostly stellar corporate earnings, it is safe to say that overall, the economy has been doing very well. That stable economic growth has not faltered even after the FED started rate increments in December 2015.
So why then, is the FED cutting rates? Fair to say that a rate increase might not have been the smartest move given the trade war issue, but why not just hold rates steady? Why a rate cut? The numbers just didn’t really support a rate cut, no matter how small. But the FED’s official reason isn’t a surprise; they were reacting to hints of an economic slowdown due to the trade war. The FED wants to be ahead of the curve this time, and not wait for poor economic data or a full blown recession. This means that Trump, has indeed got his way and “forced” a rate cut out of Powell and the FED. With that in mind, Trump’s additional tariffs the day after Powell announces a rate cut are clearly not coincidental, and that means Trump wants more rate cuts.
A play for the 2020 Presidential Election
The 2020 presidential election is just around the corner, and Trump has already got his campaign primed and ready to go. His campaign slogan is again another cleverly devised play on voter psychology; “Keep America Great”. As the slogan implies, America is already great again thanks to Trump, so vote Trump and continue to KEEP America great. An incredible market boom leading up to the polls would be exactly what Trump wants, and he could very well get it.
If Trump keeps up this trade war with China, global markets are likely to continue slowing and the fallout from the trade war could worsen. The FED, responding to this, then lowers rates even further to keep the growth steady. At some point though, Trump will be happy with the FED’s rates, and when that happens, what’s stopping him from simply removing most, if not, ALL the tariffs, and then striking a win-win deal with China?
Low rates, and zero tariffs, can you imagine how incredible that market boom would be? And how convenient if that boom happened right in the months leading up to the 2020 Presidential Election. After all, if the people wanted to continue enjoying the longest bull run in history, they’d have to vote to keep it that way.
A vote to “Keep America Great”.
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