Focus on the forest

Wednesday, 23 January 2019
Melbourne, Australia
By Murray Dawes

  • A strange state of affairs
  • Trade war swinging towards Trump

The argy bargy continues between the US and China as deadlines approach for a trade deal. Last night saw a big fall in US markets after the Financial Times reported that the US had turned down a preparatory meeting with their Chinese counterparts. 

Stocks tanked and then of course the denials came out and stocks attempted to rally again. But at the end of the day we saw the daily sell pivot in the S&P 500 that I have been discussing over the past few days. After such a huge rally from the lows and with the market butting its head up against some pretty stiff resistance I wouldn’t be surprised to see this daily sell pivot turn into a short-term downtrend.

I don’t have much of a view on how the US–China trade spat will play out, but my colleague Lachlann Tierney has a better grasp of the ins and outs of the current situation so he will be filling you in on what to expect below. My own view is that as the deadline approaches there will be plenty of positive and negative reports flying around as each side attempts to get the upper hand in the negotiations. But at the end of the day they will find some sort of middle ground and something will get done. China certainly has plenty of reasons to be getting a deal signed with the economy coming off the boil so rapidly at the moment.

The US government shutdown is another piece of news that could get markets rallying again if only for the short-term. They must be getting close to wrapping things up there in one way or the other, so a good announcement about that will probably get a few bulls excited. My own view on that is that it’s small cheese in comparison to everything else that is going on, so a spike on good news in relation to the shutdown will probably be short lived.

More after the markets…


Overnight, the Dow Jones Industrial Average closed down 301.87 points, or 1.22%.

The S&P 500 lost 37.81 points, or 1.42%.

In Europe, the Euro Stoxx 50 index finished down 12.27 points, or 0.39%. Meanwhile, the FTSE 100 lost 0.99%, and Germany’s DAX closed down 46.09 points, or 0.41%.

In Asian markets, Japan’s Nikkei 225 is up 8.9 points, or 0.043%. China’s CSI 300 is up 0.048%.

In Australia, the S&P/ASX 200 is down 22.6 points, or 0.39%.

On the commodities markets, West Texas Intermediate crude oil is US$52.77 per barrel. Brent crude is US$61.53 per barrel.

Turning to gold, the yellow metal is trading for US$1,283.68 (AU$1,798.36) per troy ounce. Silver is US$15.37 (AU$21.53) per troy ounce.

One bitcoin is worth US$3,589.48.

The Aussie dollar is worth 71.38 US cents.

A strange state of affairs

The only big piece of news that you need to worry about is whether or not the US Fed will continue to tell the market that it is now in a more dovish stance. The catch 22 is that the higher the market rallies the more inclined the US Fed will be to keep raising rates which will hurt the market and thus cause the US Fed to back off. It really is a strange state of affairs. More akin to a game of cat and mouse than an objective management of the economy.

Any signs that the US economy is on the way to overheating will cause the FOMC to continue raising rates from their very low level. If employment continues to surprise to the upside or inflation starts to increase (hard to do with weak oil prices), we should expect to see the market reacting to good news as bad news because it lowers the chance the Fed will remain dovish.

A market like this one is incredibly hard to analyse objectively. You just have to roll with the punches and react to the situation as it evolves. 

I used to spend a lot of time poring over economic data and trying to trade the announcements if they were above or below market expectations and I worked at building up a big picture view of the macroeconomic setting so I could search for sectors of the economy that I thought were under or overvalued.

That process is so much harder than you could ever think and in the end can lead to ‘paralysis by analysis’. So much data comes out at such a steady pace that you end up with 52 positive bits of information versus 48 negative. Data is usually so volatile from month to month that inferring any big picture view from the data is a lot trickier than it sounds. Long-term trends are needed and they can give many false signals. Add to all of that the fact that the Chinese might announce a huge stimulus package tomorrow which would completely change the data going forward and you quickly realise that searching for tradeable information within daily announcements is a bit of a mugs game.

The news services love to baffle you with BS by constantly referring to each data announcement or twist and turn in the market. You need to actively switch off from all of that nonsense if you are to see the forest instead of the trees.

Investment decisions have to be based on something concrete, but when you look at how bombarded we are every day by news and how mind bogglingly complex price action is, you soon realise that there is a whole lot of grey out there. If you’re not careful you will end up chasing your tail.

That’s why I’ve decided to trust the charts because they contain a huge amount of information if you are willing to spend the time to understand them. There is no holy grail in trading or investing and you will get into lots of trouble if you think reading charts means you can predict the future. Instead if you see them as a way to manage risk and to create concrete trading plans that will override your own ego they can come in very handy.

Now over to Lachlann to enlighten you about the US–China trade dispute…


Trade War Swinging Towards Trump
By Lachlann Tierney

Hi there, my name is Lachlann Tierney and I’m an analyst for Port Phillip Publishing’s Markets & Money. I regularly write about iron ore, the Chinese economy and the Aussie dollar. I have a penchant for macro issues, and with some fascinating developments coming out of China and the US today, I asked Murray if I could take over for half of Port Phillip Insider.

Today, I will be talking about how the mainstream press regularly misleads you on the impacts of the trade war, what the prospects of a deal are, and how China has effectively been backed into a corner on the issue.

Here are three headlines I’ve picked out from the globalist-leaning Business Insider:

  1. ‘Trump is failing to achieve one of the biggest goals of his trade war, and he only has himself to blame’
  2. ‘Trump’s trade war took a stunning bite out of the US economy, and it’s the strongest evidence yet that he’s shooting himself in the foot’
  3. ‘Trump trade war: China, steel tariffs could cost US families, jobs’

Pure and simple, this kind of spin is myopic baloney. It’s all based on short-term thinking. Trump is playing the long game here, even when it’s to his own detriment.

It’s shocking how little credence the mainstream press gives Trump’s grievances in the trade war. They rattle off the stock explanation of trade-deficit, potential currency manipulation and corporate espionage. As if these were minor things!

According to research by the Center for Strategic and International Studies, it is estimated that cyberespionage (especially industrial espionage) by China has cost the US a total of $600 billion over the last two decades or more.

Meanwhile, as early as November we flagged in Markets & Money how 75% of the tariff burden would be felt by Chinese exporters.

This was based on research out of The European Network for Economic and Fiscal Policy Research which concluded that:

Through its strategic choice of Chinese products, the US government was not only able to minimize the negative effects on US consumers and firms, but also to create substantial net welfare gains in the US. The US government implemented an optimal tariff strategy.

Now granted, US markets have been taking a hit recently. But this pales in comparison to what is happening in China. When you play a game of bloody knuckles it will inevitably hurt both players. It’s just that the US seems to have the stronger arm here.

By the end of last year, the CSI 300 had lost roughly 27% of its value, greater than its closest rival in the loss-stakes, the Nikkei 225 which had lost 14%.

Given the large amount of retail investors in China’s stock market, the Chinese government has responded by cutting the reserve requirement ratio (RRR) to inject some liquidity into the market.

But it gets worse. As Trading Economics notes:

The Caixin China General Manufacturing PMI fell unexpectedly to 49.7 in December 2018 from 50.2 in November, missing market consensus of 50.1. The latest reading pointed to the first contraction in the manufacturing sector since May 2017, as new orders declined for the first time since June 2016 and new export business dropped for the ninth month in a row due to the trade frictions between China and the US.

Basically, manufacturing growth in China is starting to contract for the first time in two and a half years.

As a result, the word out of the South China Morning Post has become increasingly bullish over the past few months about the prospects of further, more significant stimulus.

It is also a sign that a trade deal is edging closer. China is feeling the heat.

The Wall Street Journal recently floated the idea that tariffs were about to be rescinded. The markets, naturally, went into a flurry.

While this was later rubbished by the Trump administration, let’s examine the latest quotes out of Larry Kudlow, Trump’s top economic advisor…

Promises are great but enforcement is what we want — things like deadlines and timetables and full coverage of the various structural issues…will this all be solved at the end of the month? I don’t know. I wouldn’t dare to predict.’

Crucially, he said a meeting between Chinese Vice Premier Liu He and US Trade Representative Robert Lighthizer on 30 and 31 January would be ‘very, very important’ and ‘determinative’.

Kudlow is the guy I listen to most on this issue. He knows the markets inside-out and knows his words carry weight. Back when the news world was losing it over trade quarrels with Canada and Mexico, Kudlow said it was a ‘family quarrel’ and subsequently the USMCA (NAFTA’s replacement) came about.

Because of these factors, I think the trade war has a genuine hope of coming to a positive end, with the US extracting key concessions from China. The mainstream media would have you think otherwise.

What does this mean for you as an investor?

Personally, I think it could mean a few things. First, be prepared for a big move in markets around 30 and 31 January. Secondly, be prepared for a sharp fall in the AUD as more pain hits the Chinese economy. I think the AUD increasingly functions as a proxy for the Chinese economy with the disproportionate impact of commodities on the health of the currency. Finally, start looking further afield when hunting for stocks to go long on. In particular, I’m thinking of mid-tier gold producers, who could see their margins blow out (in a good way) with a weak Aussie dollar and continued uncertainty about global growth.