By David Rosenberg, originally published by the Financial Post in August 9, 2019
From the Fed to bonds to tariffs to all the global uncertainty, it’s time to make some major portfolio changes — now.
1. Tariff Man
We know what the recent past has taught us, which is that the stock market corrects hard in the aftermath of these Trump tariff threats and actions. If you recall, the initial round of tariffs came in early 2018 and that touched off a major correction in the market. The next round in September 2018 (10 per cent on US$200 billion) triggered a near-20-per-cent slide. And after the tariff boost to 25 per cent, we saw a 6.6 per cent setback in the S&P 500 in May. This latest threat to raise tariffs 10 per cent on the other US$300 billion of Chinese exports to the U.S. is a real game-changer because, unlike the previous 25 per cent hike on US$250 billion, this move will affect consumer products that U.S. households buy — the consumer was largely immune before. The notion that only China will pay for this is either a misguided comment from the White House or just another in the long list of outright untruths. Despite what the likes of Donald Trump and Larry Kudlow say, both economies are getting hurt.
2. The Fed’s flip flop
The Fed has constantly bungled its communications with the market and has flip-flopped in a manner I have not seen in more than 30 years as a market economist. After Jay Powell did everything to convince investors this was not going to be anything more than a mid-cycle policy adjustment, Mr. Market is saying, “Sorry, but you’re wrong once again” — and pricing in 100 per cent odds of a September move and a 90 per cent chance for two more cuts by year-end. There is this growing view among economists that the Fed shouldn’t be cutting rates because rate cuts are no antidote for the effects of rising trade tensions. It is a totally ridiculous argument because no central bank is going to maintain the same policy when its base-case GDP projection is hit with a negative demand shock. That said, “pushing on a string” has been a pervasive theme of ours and has already come to fruition since such credit-sensitive aggregates as housing failed to respond to the bond-induced slide in mortgage rates.
3. Rolling the dice has become policy
The administration in the U.S. is making some major miscalculations, and rolling the dice now seems to be the favoured option. I’m not sure comments that “we will be taxing the hell out of China” are going to work because the Politburo fully realizes that without a deal, President Trump’s election chances take a hit — irrespective of who he ends up running against.
4. Beijing has more cards to play
China, in turn, is threatening retaliatory measures of its own. This is where the second-round negative economic impacts take hold. I cannot believe it when I hear pundits say that the U.S. has the upper hand because China has fewer imports it can raise tariffs on. That misses the point. China can ban tourism to the U.S., as it is doing now with Taiwan. China also can step up what it’s already doing to American companies with toeholds there — surprise inspections, shipment delays, licence rejections — and then there’s the big bomb: a boycott of American goods, or directing state-owned enterprises to cease their purchase of U.S. inputs. Think it through — China has plenty of options. There is no winner from a global trade war, period.
… it is not just a trade war, but a probably currency war we all have to take into account
5. The weakening yuan
One of these options, already in motion, is sanctioning a weaker yuan. This is the sort of “stimulus” or “antidote” that Beijing is willing to pursue, and remember what happened the last time this happened in late 2015 and early 2016. In two words: risk off. And keep in mind that the president has denied rejecting the prospect of foreign exchange intervention to weaken the greenback — so it is not just a trade war, but a probable currency war we all have to take into account.
6. Bad news bunds
The global bond market is begging the equity markets to take profits. When the German 30-year bund yield moves to negative terrain, as it did last week, it is not a “TINA: message (There Is No Alternative) but rather a clarion call to turn defensive.
7. A U.S. cooldown
The U.S. economy is losing momentum in a major way. The slide in June construction spending, the falloff in the ISM manufacturing PMI in July and the contraction in the workweek, factory hours and overtime are signalling a sizeable cooling off from that 2.6 per cent first-half real GDP growth performance. As an aside, looking at the sector components of the Q2 data, the median GDP growth rate was a mere + 0.7 per cent annual rate, the slowest in six years — and tied for the weakest pace since the Great Recession. So put that in your pipe and smoke it! Meanwhile, the U.S. budget deficit through June of the current fiscal year surged to US$746 billion from US$607 billion this time last year — clearly on track to break a not-so-cool US$1 trillion.
8. Global concerns
We also have to bear in mind that this is a global trade war. Look at the escalating tensions between Japan and South Korea — lost in all the other commotion last week was the move by Tokyo to remove more Korean-made products from the preferential list. And South Korea is planning retaliatory measures of its own. What does all this do? It impairs supply chains in the tech sector, that’s what. If the Trump attack on China (which many do support) isn’t enough, he also took a swipe at the EU with renewed threats of auto tariffs. All the while, this new North American trade deal that was signed ages ago is still sitting in limbo in the U.S. Congress.
9. Bullion’s big rally
The dollar is rallying and so is gold — at the same time, the latter to fresh six-year highs against the greenback. Not usually a good sign when bullion is firming against all currencies — it is for gold, and precious metals in general, but it’s a sign of heightened risk aversion. All the more so when buyers of German 10-year bunds are willing to pay 50 basis points a year just to have their money stored. When bonds are being treated as safety-deposit boxes, you can take this as a warning sign for those that are invested in asset classes that are deemed “risky” (such as equities). So we have now seen the “Japanification” of Germany, and if long bond yields can go to zero there — this isn’t some minor fixed-income market like Sweden or Switzerland — then it could happen in the U.S. too. In two words or less: buy bonds!
10. An era of uncertainty
Time to bone up on history. Maybe pre-First World War would be a start as the world turned inward. Or how about the early 1930s, when devaluation and tariffs were all the rage? Whatever the comparison, historians will not treat the period we are living in very kindly. The world is splintering before our eyes, and here we have such people as Bob Shiller, who I respect, saying last week that his index isn’t showing a market that is terribly expensive. But who really knows what the appropriate valuation is in such a period of heightened economic and political uncertainty? Insofar as economists call themselves social scientists, and of course they are because this profession is all about explaining or predicting behaviour in one way or another, I have to say that last weekend’s shootings in El Paso and Dayton are signals of something that is going awry at a broad social level. Is it a sickness related to social media? Or maybe it’s the ability to spread “alternative facts” so easily on the Internet, to the point that people can’t discern what is fact and what is fiction. To boil it down to an investment level, this is not an era in which multiples on risky assets deserve to be above their historic norms, given the high level of uncertainty. And while one can argue that valuations can be sustained because of these ultra-low interest rates, it’s the reason they are so low that should cause some reflection.
A more in-depth version of this article was published in the Financial Post.