Great Week of News…With a Few Warning Signs- Trade Deal

Great Week of News…With a Few Warning Signs

The country lost a war hero this week.  Senator John McCain finally succumbed to the brain cancer he was fighting for some time.  He suffered unimaginable torment at the hands of the communists during the Vietnam War.  His bravery and heroism during that time is representative of the legendary greatness exhibited by the American war fighter, and we are all grateful for his service and what he went through on behalf of all of us.

His politics were quite combative with his own party, and to a significant degree with President Trump.  That conflict headlined some of the news media this week, along with the convictions of former Presidential campaign Chair Paul Manafort and Trump attorney Michael Cohen.

But if you search deep into the Google pages, or watch a number of cable news shows, then you can find some very positive and quite intriguing news stories that are good for the country and for the economy!

 I. Top 5 news headlines for this week:

5.“Deregulation leads to expansion of energy access and rare-earth minerals”:  It should be well-known now that the energy industry, coal mining, fracking, and much more has been deregulated.  These industries are required through numerous laws and regulation to be protective of the environment, but the regulatory regime had led to restrictions in market access and profitability.  The Administration’s deregulation initiative has spurred economic growth, jobs and innovation.  In addition, restrictions on the mining of rare-earth materials have been lifted.  Everything from clean energy batteries to advanced weaponry that the Pentagon relies upon were being imported from sources abroad because mining for them in the US had been restricted.  This upside-down, dangerous threat to national security has finally been lifted.   This is a win for capitalism, and a win for national security.

4.“Mexico and the United States agree in principal on a new trade deal to replace NAFTA”:  Much of our political unrest can be attributed to many factors.  Most agree social media has exacerbated or even served as the root cause.  But the primary reason has been economic:  free trade and globalization has driven corporations to search for cheap labor, and that has negatively impacted blue collar employment in the US over the last 25 years.  The free market was only working in one direction:  if you pursue cheap labor across state lines, then you cannot have protected markets or the theft of intellectual property, or you get trade that is neither free nor fair.  The result is a populist revolt.  President Trump rode that wave and his primary target – going back to the early 90s – was NAFTA.  The trade deal between Mexico and the US this week probably means the end of NAFTA as we knew it, and that drove the market surge this week.

3.“Canada rushes to get a deal before its too late”:  Sound and fury, signifying…nothing.  Europe, Mexico, now Canada…everyone wanted to stick their chest out and say how they weren’t going to let the Americans dictate terms – and then we dictated the terms.  The Canadian Foreign Minister literally got on a plane to come to Washington after the President and Mexico announced their new trade agreement.  Simply put – apparently lost on the establishment and the elites of the last 26 years – no one can afford to NOT have a trade relationship with the country that has the largest economy, the freest economy, the most innovative economy, the fairest rule of law (although weakened), the largest multi-national banks, and the deepest capital markets.  Simply put – apparently lost on the establishment and the elites of the last 26 years – pursuing a strategy of economic confrontation with the United States has always been suicidal and self-defeating.  Canadian Prime Minister Justin Trudeau will be on TV claiming they prefer no deal to a bad deal…and shortly will sign a good deal for everyone that puts the American worker first.

2.“Nasdaq 8000”:  For the first time in the tech-index’s history, it broke 8000 on the big board.  While previous tech high’s scare investors – such as the bubble – the technology market has matured since that time, with larger and a more diverse set of companies which drive valuations.

1.“Growth revised upward”:  Not 4.1%, but actually 4.2% GDP growth in quarter number two.  This growth is predicated on actual deregulation, tax reform, and strong dollar policies.  It is based upon wage growth (2.8% year-over-year, first time since 2007) and actual economic activity as opposed to printing money or zero interest rates.  What goes up must come down, but the growth we are seeing is positive business expansion, it represents a healthy economy.

Not everything is rosy or hunky dory – the Mueller investigation never ends….China shows no signs of relenting in this trade war…Russian warships are back in the Mediterranean for the first time since 1990…the Congress remains incapable of addressing our debt problems nor even passing a regular budget…hopes for a deal in North Korea are waning…and, we are due for a market correction.

But America’s economic vitality and strength, and our role as the “indispensable nation,” is allowing the capitalist engine to power on as we near the end of 2018.

Trade War: Advantage Trump

Trade War: Advantage Trump

The politicizing of the criminal justice system aside – trade war: advantage Trump.

We have discussed trade several times over the last few months (read more here, here, and here), as well as the pros and cons of the confrontational approach the President has taken towards trade.  While President Trump’s communication and style may not be what we are used to, and pundits can fall on either side of an issue, trade is one area of policy where the advantage is decisively with the United States.  Can we blow a great hand that we have been dealt?

Sure.  But not so far.

Who is losing the trade war if America is winning, and should we be cautious in how we manage the “Trump Trade Policies?”

Who is losing, badly, in the Trump Trade Response?

1.“Turkey, Iran and those not playing nice in the Middle East”:  Cozying up with NATO enemy Russia … not letting our planes fly from Incirlik during the Iraq War … purchasing Russian S400 SAM systems … and, to top it off, imprisoning a US pastor.  Not the best way to endear yourself to Trump.  Iran has had US sanctions slapped back on after withdrawing from the Joint Comprehensive Plan of Action Iran deal and their currency the rial has collapsed in value compared to the dollar.  Both countries can continue to defy America and probably survive, but it won’t be fun or pretty on the streets for their citizens.

2.“Our friend Europe is also feeling the squeeze”:  Euro is down against the dollar … Germans fearful of trade negotiations hurting their primary industry – automobiles … Europeans wanted to prove they could go it alone and stay in the Iran deal – until ALL of their major corporations said it is more important to do business with America.  Having saved Europe from two world wars, rebuilt them after the war on our dime, protected them from communism for almost 50 years on our dime, allowed their corporations and industries to have free access to our market – while allowing them to protect theirs from US competition so they would not be weakened next to their Russian neighbor … the only position for the EU to take should be one of thanks.

3.“China finds global doors closing fast”:  European companies have cancelled multiple projects with China this past year – part of a security review that is tightening access to Western technology.  While China so far has responded tit-for-tat to Trump tariffs, their currency is down against the dollar and their economy has been slowing.  Trump banned Huawei’s attempt at purchasing Qualcomm to prevent further gains for China’s 5G research and development efforts.   China’s “Belt and Road” initiative looks to link supply chains around the globe – only so far it has been debt riddled with investment in non-productive regions … much like the Soviet Union’s investment in the far reaches of Siberia.  Mal-investment in China has led to hundreds of ghost cities – literally vacant cities which no one lives in.  The trade war can be a costly game if this keeps going, but costlier for China than the US.

Trade War: Advantage Trump

What could go wrong for America in this current global trade conflict?

1.“What goes up always comes down – so can King Dollar”:  While the dollar has been up against major currencies during the Trump Presidency, and it remains the only currency which can be used in all global transactions, it does not have to stay that way.  The dollars usage has actually increased during the last 2 years from 61% to 63.9% of all global transactions.  That is still lower than the high of 84% in 2009 (not counting the early post-war period when the dollar was one of the few currencies even in print).  Nonetheless, countries can and could in the near future require trade to occur in other forms of currency.

2.“The response could be asymmetric”:  Turkey doesn’t have to care about trade – they could leave NATO and join the Russian-Iranian axis … Iran has Hezbollah sleeper cells in Latin America and it is believed in the US ready to strike … Russia could continue to tamper with elections … everyone could join China in dumping US treasuries (although that would hurt them as much or more) … the Chinese already steal intellectual property and could ramp up espionage in the US … bottom line – the response to losing a trade war to the US could be very expensive for US interests over the long term if not confronted head on.

3.“Economic downturn would change the calculus”:   Trade conflicts helped exacerbate the great Depression.  There is little doubt that you should not increasing barriers to competition during an economic downturn, so a recession or modest dip in the GDP would not be a good time for picking fights.  But right now the United States is simply trying to level the playing field that has been unbalanced against us for decades.  There is not mush risk in the current policy of trying to make current trade fair trade.

Trade conflict is not welcome, but we didn’t start it.  For decades countries have taken advantage of easy access to US markets, while being hostile to American access to their home own markets.  Trump is simply leveling the field.  Everyone can lose in a trade war, but if there is a winner, it will be America.

Part II: Ten Years Ago, The World Changed

Part II – Ten Years Ago, the World Changed

This is part II in our three-part series remembering the 10th Anniversary of the 2008 Financial Crisis (view part I of the series here).  This week, we look at the month of August of that year and the big events which represented the closing days of the real estate boom.

It was real estate, and the government’s intervention into that market, that drove the collapse of the banks in that year.  It was not too little government, but too MUCH!  President Jimmy Carter signed, and President Clinton extended, a law known as the Community Reinvestment Act (CRA).  This law required banks to loan sub-prime into communities which had bad credit, eliminating the bank’s risk calculus and making the government liable for the debt when Fannie and Freddie bought the paper, or in general, as banks have FDIC insurance to cover accounts.   Failure to loan into bad credit neighborhoods, and the government could revoke your bank charter.  With implicit government guarantees on the debt, the banks happily extended loans to people who would not be able to repay them.

This, by itself, was just one of many issues that had deformed the real estate and bank lending markets.    The one regulation which may have helped – Glass-Steagall – had been repealed by Clinton with Republican support in 1999.  This allowed bank traders to use regular bank depositor funds to trade in the stock market.  Resourceful capitalists that they are – Wall Street began bundling bad credit loans, known as subprime, with good loans in what was known by few as “mortgage backed securities” (MBS Bonds).

When the bad credit loans’ adjustable rate mortgage adjusted upward in the early to mid-2000’s, these people stopped paying.  The bad debt was mixed with the good debt in the bonds as stated above, and Wall Street began to sell them….rapidly.  Those holding the notes – banks and the government – began to see massive losses.  Those who insured the bonds began to receive massive claims they could not cover……you remember what happens next, we cover it in the final Part III next month.

So how did markets and money look in August 2008 – not pretty:

The 4 BIG events in August 2008 which headlined the ongoing financial crisis of that year:

4. “Global Banking Giant HSBC announces 28% drop in profits”: As earnings reports were released that first week of August, HSBC was hemorrhaging money and suggested in a note to clients that the economy was projecting to be the “…worst we have seen in decades.”

3. “Another global bank announces a suspension of withdrawals”: August 10th BNP Paribas announces in a press release that they were suspending all account withdrawals “…because it cannot value the assets in them, owing to a complete evaporation of liquidity…” in the market.  While the biggest shoe to drop to date – the first withdrawal suspension of the crisis – the markets were rather melancholy in response.  They would trade in a 200 point range the remainder of the month.

2. “Geo-political crises are rampant across the globe”: Russia has invaded Georgia … President Musharraf resigns in Pakistan, setting off protests in the streets … the Baltic States – Latvia, Estonia and Lithuania – enter a steep recession which begins migrating through eastern Europe … Al Qaeda launches simultaneous attacks in Afghanistan and Iraq … the financial crisis was one of many that were striking at the confidence of Western society.

1. “Nationwide Insurance reports real estate prices slid 10% just in the month of August”: In one of the steepest declines of the on-going crisis, Nationwide reported a 10% drop on August 28th.  It appeared to be what would force the water over the dam, and it was one of the many factors that would – on 8/28 we were less than two weeks from the Lehman Bros. collapse.

America’s Democratic party would nominate Barack Obama as their nominee this month 10 years ago, and the American team was on their way to winning another overall medal count at the Summer Olympics in China.  The economy was struggling, but we were completely unaware of what was coming soon.

Or were we?

As has been well documented, many traders had been forecasting doom for over a year – Michael Bury, Gregg Lippman, Steve Eisman and Ben Hockett were preaching for well in advance that the system was corrupted and the banks were over-extended.  They were ably portrayed in the hit 2015 movie titled “The Big Short,” based upon the book of the same title.  They were not the only ones – our firm’s “safety first” clients experienced ZERO losses, and started the climb back up with their portfolio 50% ahead of those who remained in risk associated assets.

New clients in the months that followed were often represented by the money manager in the home being dragged into the office by the ear, and when asked if they were ready to get into a principal protection product, they would offer some resistance – the remnants of the “I know better” mentality of the easy money era, only to receive an immediate “Shhh!” from the other spouse.  This was the classic spousal refrain you could see in each couple sitting at the table in the days and months that followed the collapse:  “…You screwed things up listening to Wall Street, now I am making sure we don’t lose the rest of it.”

 August 2008 had some precarious moments, but was really the calm before the storm.  Part III will follow in September with our examination of what would become the biggest financial crisis in recorded history.