the Trump rally and its aftermath (so far)

the Trump rally

From the surprise election of Donald Trump as president through late December 2016, the S&P 500 rose by 7.3%.  What was, to my mind, much more impressive, though less remarked on, was the 14% gain of the US$ vs the ¥ over that period and its 7% rise against the €.

the aftermath

Since the beginning of 2017, the S&P 500 has tacked on another +4.9%.  However, as the charts on my Keeping Score page show, Trump-related sectors (Materials, Industrials, Financials, Energy) have lagged badly.  The dollar has reversed course as well, losing about half its late-2016 gains against both the yen and euro.

How so?

Where to from here?

the S&P

The happy picture of late 2016 was that having one party control both Congress and the administration, and with a maverick president unwilling to tolerate government dysfunction, gridlock in Washington would end.  Tax reform and infrastructure spending would top the agenda.

The reality so far, however, is that discord within the Republican Party plus the President’s surprisingly limited grasp of the relevant economic and political issues have resulted in continuing inaction.  The latest pothole is Mr. Trump’s refusal to release his tax returns–that would reveal what he personally has to gain from the tax changes he is proposing.

On the other hand, disappointment about the potential for US profit advances generated by constructive fiscal policy has been offset by surprisingly strong growth indications from Continental Europe and, to a lesser extent, from China.

This is why equity investors in the US have shifted their interest away from Trump stocks and toward multinationals, world-leading tech stocks and beneficiaries of demographic change.

the dollar

The case for dollar strength has been based on the idea that new fiscal stimulus emanating from Washington would allow the Fed to raise interest rates at a faster clip this year than previously anticipated.  Washington’s continuing ineptness, however, is giving fixed income and currency investors second thoughts.  Hence, the dollar’s reversal of form.

tactics

Absent a reversal of form in Washington that permits substantial corporate tax reform, it’s hard for me to argue that the S&P is going up.  Yes, we probably get some support from a slower interest rate increase program by the Fed, as well as from continuing grass-roots political action that threatens recalcitrant legislators with replacement in the next election.  The dollar probably slides a bit, as well–a plus for the 50% or so of S&P earnings sourced abroad.  But sideways is both the most likely and the best I think ws can hope for.  Secular growth themes probably continue to predominate, with beneficiaries of fiscal stimulation lagging.

Having written that, I still think shale oil is interesting   …and the contrarian in me says that at some point there will be a valuation case for things like shipping and basic materials.  On the latter, I don’t think there’s any need to do more than nibble right now, though.

 

 

a French sovereign debt default?!?

First there was the surprise Brexit vote in the UK, after which sterling plunged.

Then there was the improbable victory of Donald Trump in the US presidential election, which sent the dollar soaring.

Now there’s France, where the odds of a far-right presidential victory by the Front National have improved.  A competing right-of-center candidate, former frontrunner François Fillion, has been hurt by allegations that his wife and children did little/no work in government jobs he arranged for them (with aggregate pay totaling about €1 million).

If Marine Le Pen, the FN leader and standard bearer, were to win election in May (oddsmakers now give this about a 1 in 12 chance), her victory might conceivably snowball into a similar sea change in the National Assmebly election in June.  Were the FN to win control of the legislature too, the party says it will leave the euro and re-institute the franc as the national currency.  In addition, it intends to, in effect, default on €1.7 trillion in French government bonds by repaying the debt in new francs, at an exchange rate of 1 Ffr = 1 €.

Improved prospects for Ms. Le Pen–plus, I think, President Trump demonstrating he means to do his best to keep all his campaign promises–have induced a mini-panic in the market for French-issued eurobonds.  Trading at a 40 basis point premium to similar bonds issued by Germany as 2017 opened and +50 bp in late January, they spiked to close to an 80 bp premium last week.

my take

At this point, the conditions that would trigger a French exit from the euro and its refusal to honor its euro debt instruments seem high unlikely.  Still, the possibility is worth thinking through, since the financial markets consequences of Frexit would likely be much more severe than those of Brexit.

More tomorrow.

 

 

 

 

 

 

 

internal and external economic adjustment

This is ultimately about the euro and the EU.  Today’s post is about creating a framework for thinking about this issue.

It’s a condensed version of a longer post I wrote six years ago on Balance of Payments (actually, a series, for anyone who’s interested).   Although a big simplification of what is actually going on in the world, it highlights what I believe is a central structural issue facing the EU and Japan today   …and potentially the US, at some point.

 

imports and exports

The residents of any given country typically don’t consume only items made in that country.  They buy imported goods as well.  In fact, the marginal propensity to consume imports is normally higher than the marginal propensity to consume, meaning that as spending increases imports rise at a faster rate.

paying for imports

The country as a whole gets the money to pay for imports in one of a number of ways:  it can make things to sell to foreigners, it can use accumulated savings, it can sell assets to foreigners or it can borrow.

imbalances

In an ideal world, every country would make and sell exactly enough goods and services through export to pay for the imports it purchases.  That’s seldom the case, however.

chronic deficit

Consider a country that, year after year, buys more from foreigners than it can pay for with the proceeds from what it sells.  To continue consuming foreign goods at the same rate, such a country has to either sell assets, like land or companies, or borrow from foreigners.  At some point, however, it will reach the limits either of what it has that others want to buy or the amount foreigners will lend.

This situation sets the stage for a potential foreign currency/trade/economic growth crisis.

internal/external adjustment

Here’s where we get to internal/external adjustment.

There are two ways of dealing with this issue:

internal

–the government can slow down overall consumption (essentially, create a recession) by raising interest rates/taxes by enough to decrease consumption of foreign goods and services

–domestic industries can voluntarily restructure themselves, with/without government help, to improve quality and lower prices so they make more things foreigners will want (unlikely to happen on a large scale)

–the government can erect tariff or regulatory barriers to imports, to try to redirect consumption to domestic goods (almost always a bad idea:  look at the US auto industry since the mid-Seventies)

None of these actions are likely to win unanimous applause from voters.  And if legislative action produces negative results, it will be completely clear who is to blame.  So politicians everywhere, and particularly in badly-run countries, tend to not to want to choose any one of them.  Instead, they most often opt for the external adjustment route.

external

–This means to encourage or embrace a decline in the local currency versus that of trading partners.  That simultaneously makes foreign goods more expensive for locals and local goods cheaper for foreigners.  Devaluation will encourage exports and inhibit imports, achieving the same end as rising interest rates, but without the sticky legislative fingerprints attached.  It’s those horrible foreign exchange markets instead.

 

More tomorrow.

 

 

 

 

 

 

yen strength a minus for Abenomics

This time a year ago $1 bought about 120 yen.  That figure was 125+ last June.  The rate was 113, however, a week ago–and 108- today.

This amounts about a 10% year-on-year gain in the yen’s purchasing power against the dollar, half of that strength during the past week.

The rise is good for consumers for whom the cost of imported items like food has skyrocketed under the administration of Prime Minister Shinzo Abe.  Not so good, though, for Mr. Abe’s grand plan to resuscitate his country’s still moribund industrial sector through massive currency depreciation.

There’s no particular reason for the yen to strengthen that I can see.  Yes, Mr. Abe did recently observe that aggressive intervention in currency markets is an imprudent strategy.  And, yes, this is the time of year when corporate cash flows back into Japan causes mild currency strength.  But the Bank of Japan recently initiated a negative interest rate policy designed to weaken the yen.  And in my view there’s no sign yet that Mr. Abe’s bet-the-farm gamble on 1980s-era export industries is paying off.

Yet the currency is going up.

This may just be bad luck.

If we assume that the US dollar has peaked, then the question for short-term currency traders is which of the two remaining majors, the yen or the euro, is a better bet.  Given renewed uncertainty about Greece and the upcoming vote in the UK on a referendum to exit the EU, traders may think they have little choice other than to shift their holdings toward yen.

Still, the biggest economic problem for Japan–and the reason Japan is a cautionary tale for the US–is that the political power structure there is totally committed to defending the status quo and retarding structural change.  It’s subsidizing industries whose heyday was in the 1980s, and it’s allowing its workforce to shrink by its anti-immigration stance in the face of an aging domestic population.  A rising currency will only make the circle harder to square.

 

 

the Chinese currency and the Chinese stock market

Throughout my financial career I’ve found that in sizing up currency markets traders from the big banks have always been ten steps ahead of me.

I’ve hopefully learned to live with this–meaning that because I’m never going to outthink them I believe my best currency strategy should have two parts:

–to avoid making future currency movements a major element in constructing my portfolio, and

–to be a “fast follower” if I can–that is, to figure out from a trend change what the banks must be thinking and to consider getting on board if I think the trend is going to have legs.

 

China has moved the price at which it will buy and sell renminbi down by 1.9% yesterday and by another 1.6% today.  Informed market speculation seems to be that another couple of downward moves of the same magnitude are in the offing.

From a domestic policy perspective, China would prefer a strong currency to a weaker one.  As I mentioned yesterday, the country has run out of cheap labor and must, therefore, transition away from the highly polluting, cheap labor employing, export-oriented basic manufacturing that is the initial staple of any developing country.  This kind of business has been the bread and butter of many Chinese companies, some of them state-owned, for decades.  Many are resisting Beijing’s call to change.  The strong currency is a club Beijing can use to beat them into submission.  In this sense, the fact that the renminbi has appreciated by 10%+ against other developing countries’ currencies over the past year, and by around the same amount against the euro, China’s largest trading partner, is a good thing.

On the other hand, the developed world has made it clear to China that if it wants to be included in the club that sets world financial policy, and in particular if it wants the renminbi to be a world reserve currency, the renminbi cannot be rigidly controlled by Beijing.  It must float, meaning trade more or less freely against other world currencies.  So China has a long-term interest in doing what it has started to do yesterday–to allow the currency to move as market forces drive it.

Why now, though?

World stock markets seem to be thinking that a severe erosion of China’s GDP growth is behind the move toward a currency float–that it’s backsliding from a committment to structural reform.

I’m not so sure.

I think what currency traders have concluded is that Beijing has enough money to prop up its stock market and enough to keep its currency at the present overvalued level–but not both.  So they’re borrowing renminbi  and selling it in the government-controlled market in the hope of pushing down the currency and buying back at a lower price.  Understanding what’s going on, and realizing the risks in defending a too-high currency level, Beijing is bending in the wind.  Doing so limits the amount of money that can be made this way, effectively short-circuiting the strategy.

Offshore renminbi, which can’t be repatriated into China, trade about 5% cheaper that domestic renminbi.  That’s where we should get the next indication of how far renminbi selling will go.

As far as my personal stock investing goes, my strong inclination is to bet that renminbi-related fears are way overblown.  I’ like to see markets calm down a bit before I stick a toe in the water, though.

 

 

 

 

 

Greece votes No

Yesterday, Greek voters backed its national administration’s position of rejecting the latest EU bailout conditions in a resounding vote.  60+% of total ballots were “No,” with the nays being a majority in all regions of the country.

S&P futures fell to about -24 when the official voting results were announced shortly before 11pm eastern time last night.  As I’m writing this just before 8am, futures are off by -14; European stock markets are trading lower, but not by much, as is the euro.

Not the best, but not bad, either.

I think what Mr. Tsipras has demonstrated with this vote is that Greece simply will not accept the bailout terms on offer from the ECB/IMF.  Yes, the two sides might sign an agreement, but any Athens government that attempted to implement it would be tossed out of office and replaced by one that would not.

In many ways–and, in particular, from an investment perspective–this simplifies the situation a lot.

 

As I see it, the ball is now in the EU’s court.  It can either make enough further concessions to make a bailout deal palatable to Greek voters   …or it can walk away from the negotiating table, thereby forcing Greece to exit the euro.  The first course presents significant political risks to Brussels and Berlin.  In fact, the Tsipras negotiating style has both brought the idea of further concessions to the point of being at least thinkable and simultaneously made making them much more politically incendiary.  For German voters still paying extra taxes to rebuild the former East Germany, having Ms. Merkel so publicly bested by Mr. Tsipras’ could easily end the political careers of her and her supporters..  I can’t imagine politicians in Ireland, Spain or Portugal who accepted EU austerity regimens faring any better.

We may know which way the EU and IMF have decided very quickly.

Greek banks are supposed to reopen tomorrow, after being shut for a week.  They likely don’t have enough cash, without ECB support, to meet massive demands for withdrawal of deposits that will most likely ensue if those funds haven’t been transmuted into drachma overnight.

 

As an investor, I think Greece leaving the euro today would be the optimal outcome.  This is pure pragmatics.  That way, the Greek crisis would at least be over–for countries other than Greece.  Markets would decline somewhat, sectors would readjust to the new reality  …and then the mind of he market would be on to the next thing.

My guess is that Greece exiting the euro but remaining in the EU will actually be the final outcome.  I also suspect that the process will take longer than just to tomorrow, but that the bulk of the market reaction to whatever happens will take place over the next few days.  The creditors acceding in more than the most superficial way to demands for better terms is the biggest surprise–meaning, least likely outcome–I can think of.

 

What am I doing in my portfolio?

I’m keeping a much closer eye on China (more tomorrow).

I’m watching US trading carefully today.  I’m looking looking for stocks to buy whose prices may be depressed by worries about Greece.  If futures are any indication, I won’t have much luck.

 

 

Greece in a nutshell

Greece joined the euro in 2001.  This gave it the right to print/mint euro currency, as well as to issue Greek sovereign debt in euros.  The second is important because issuing euro debt is like having access to a giant EU credit card–payment was at least implicitly guaranteed by every member of the EU, not just Greece.

Greece probably didn’t meet the criteria of economic health necessary to qualify to join the euro. Everyone in the EU seems to have known this at the time but thought that having the cradle of Western intellectual and political history in the euro was symbolically important.

In 2009, the ruling party lost an election.  The new administration discovered, and announced to the world, that Greece had been systematically falsifying its national accounts–official reports of the country’s fiscal health and growth–for years.  Greece’s apparent prosperity during the opening years of the 21st century turned out to be a combination of lies and living beyond its means, funded by large-scale euro bond issuance.  Most observers agree that Greece run up more debt that it can ever possibly repay.

Negotiations between Greece and its creditors are at an impasse.  Broadly speaking, the EU and IMF want to see structural economic reforms (which may prevent a repeat of the country’s woes) in Greece before any debt forgiveness.  Greece, whose current government has already reversed some of the few reforms implemented over the past six years, wants debt forgiveness first, talks about structural reform later.

The EU put a take-it-or-leave-it offer on the table about a week ago.  The Greek government has decided to call for a national referendum vote on the issue, scheduled for Sunday.  In the meantime, it has shut down its banks, so no one can take their money out of the country.

There are some odd technical issues with the referendum.  For example, one political party is suing to stop the vote, saying it’s unconstitutional.  It’s also coming at the start of vacation season, so it’s not clear whether people can get home to vote, especially with atm withdrawals limited to €60 a day.

Domestic Greek polls indicate that likely voters favor accepting an EU bailout plan by 52/48–even though the administration is campaigning against it.  A “No” vote probably means Greece leaves the euro, and maybe the EU as well.

I have mixed feelings about the negotiations themselves.  On one hand, I’ve got to admire the ingenuity and determination of the Greek side in trying to get the best possible deal.  On the other, everything I’ve I’ve read and heard to make me think Greece regards negotiation as a blood sport.  The point is not to get a fair deal, but to suck the other side dry and toss the husk to the side of the road.  –even a little bit–about the needs of the other side.  It’s turned the negotiations into a fool me once, fool me twice situation, in my view.

I think the current Greek administration may have done a huge amount of damage to the country’s long-term economic prospects by trying so hard.to wriggle out from responsibility for the current crisis.

Ironically, the better outcome for the EU might be for Greece to vote to leave the euro.  The resulting damage to the Greek economy will be enormous, I think.  Seeing what happens will likely silence separatist movements elsewhere in the EU.