Blowing a Big Hole
… in Arguments and Clichés
In a week that finally witnessed a smoking gun from Trump’s lawyer Cohen, the collapse of Chinese trade talks, FOMC and Jackson Hole statements from Fed Chair Powell, we saw a momentary new high in SPX, and the worst week for the dollar since February as Turkish fears unwound. Everything seems linked to this mercurial President.
A familiar refrain of the last 18 months and possibly much longer. Commentators have been quick to draw a parallel between Dean’s testimony in Watergate in 1973. The trade war of 2018 continues to follow a similar pattern to the previous 1929 and 1987 crash years. The liquidity crunch for Turkey may be symptomatic of an emerging trend with 1998 Asian overtones. And yet Powell’s possibly ironic reference to Greenspan’s stewardship in the 1990s highlights how a strong Goldilocks economy with low inflation, strong earnings and growth can shrug off these threats—in the short but not medium term.
The market was momentarily shaken this week by the conviction of Manafort, Trump’s former campaign chairman and his personal lawyer Cohen’s guilty plea. Indeed the man who exposed Nixon in Watergate, John Dean said Michael Cohen just did the same to Trump.
And yet the market soon recovered. Why?
FIrstly It did this before in 1973 as it expanded its out way of initial trouble. Just as the stock market duly broke to new highs last year following Comey last year so this maintains the prospect of our projected blow out in stocks in 2018.
Similarly the US 10 year yield broke to new highs just as it did last year:
Having matched the Watergate bond move with the 10 year spike above 3% it calls for a larger correction before a further blow out new high.
So too the Dollar is still following the Watergate template and coincidentally the 1987 projection.
Why would these markets move so counter-intuitively?
Firstly, as we explained in our articles on news, this is the classic reaction to possibly significant but not substantiated news. That is the market sells off, traps shorts, and then takes them out with a squeeze to new highs as we have seen this week with SPX’s reaction to Manafort/Cohen.
Secondly, substantiation comes from evidence and not doubt as shown in our comparison of Watergate, Monicagate and Russiagate last year.
We may have seen another smoking gun this week. But the damage is not done by the trigger of doubt but by the bullet of evidence. There is as yet no substantiated evidence that Trump colluded with any wrongdoers.
Thirdly, when markets are being driven by other factors, unless news derails those factors, they will continue to prevail. That is, the US and global economy remain in a Cinderella state of strong earnings/growth and subdued inflation.
That was the clear message from Wednesday’s FOMC minutes and Friday’s Jackson Hole testimony from Jay Powell where many markets appear to be following the standard (average) template.
The US Fed will continue on a gradual rate hike path given ‘strong’ growth in income and jobs. Many have taken this to imply quarterly rate hikes in order to balance the risks of hiking too quickly based on the low unemployment rate alone and pausing/getting behind the curve based upon on-target inflation alone.
There doesn’t appear yet “to be an elevated risk of overheating” with “no clear sign of an acceleration above 2%”. Although this has been interpreted as marginally dovish compared to previous speeches, it ironically could be seen as leaving the Fed more vulnerable to any surprise jumps in inflation. But the greatest irony we believe in “Monetary Policy in a Changing Economy” is that he denigrated most of the indicators available to the Fed and highlighted what should prove to be the greatest risk of all. In his speech he referred to previous instances where excessive reliance on the natural rate of unemployment and the neutral real rate of interest led to misguided policy in the 1960s 1970s and mid 1990s.
Given the theme of this year’s Jackson Hole symposium (implications of growing concentration by a few superstar (disinflationary?) firms such as internet based Amazon) Powell correctly cautioned against placing too much weight on inflation as a key signal of overheating. Rather he flagged “destabilizing excesses appeared mainly in financial markets rather than in inflation” in the run-up to the previous two recessions”.
And this is rub. Powell suggested his own policy of moving ‘conservatively’ would be inappropriate in a financial crisis or “when inflation expectations threaten to become unanchored.” In this instance the “FOMC would resolutely ‘do whatever it takes.’ But without a clear idea of which indicators will flag these, the Fed will only be able to act too little be too late.
As it did in 1987. Back then a fall in liquidity created an increasing large hole for a rising stock market that was simultaneously undermined by international tension. With balance sheet reduction now drying up liquidity, potentially destabilising currencies such as the Turkish Lira, and international tension growing while the stock market enters its last blow out phase, the hole is ominously getter larger.
Jay Powell is right to praise Alan Greenspan.
Next week we will explore the impact of falling liquidity as more companies continue to buy back their own stocks—or not. It’s a Musk read after this weekend.
Here’s to making the very best.
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