The Chain Sequence
Tariffs and Italy are further links
In a week that saw the end of the Winter Olympics in South Korea, the arrival of the Beast from the East in Europe, traders were left shaking by the actions of, what some outside the US may now unkindly describe as, the beast from the West. Donald Trump did what he promised and started the protectionist ball rolling with a 10% tariff on aluminium and 25% on steel.
This week is significant. In two separate articles for subscribers, we therefore highlight the potential impact of protectionism on both stocks and currencies and how it could be side-tracked or, better still, defined by the outcome of the Italian election. It is curious then that one of the potential beneficiaries of Trump’s tariffs appears to be leading the Italian Stock Market as it goes into the election.
Coincidence? Probably. Correlation does not always imply causation but causation can often help find correlation.
When British Prime Minister Harold MacMillan was asked what blew governments most off course (and by extension policy and markets) he replied “Events, my dear boy, events”. The events of this week are important and necessitated in depth analysis covered in our two articles.
Events are important to the extent they or their consequences have not been anticipated or, from a market perspective fully discounted. If they affect price action they can serve as useful points of comparison within a broader development or similar chain of events. The market’s protectionist reaction was an important confirmation our Marker Map, that has continued to nail stock indices for the last month, remains on track.
Significant events can also change what is driving a market and, in so doing, cause an intermarket realignment. Donald Trump’s tariff announcement helped finally break the Dollar’s recent negative correlation to stocks and revert to its more traditional inverse relationship. Again an important marker in the context of 1987.
Dollar – SPX Correlation
It is important to bear in mind and track what is really driving the market and not exaggerate the importance of actual events or indeed people unless they provide the evidence to do so. It is great to see increasing numbers of quality research sources rely on historical comparisons as a better guide to what will happen than any textbook or deductive argument. However, without recognising the broader context, event comparisons can easily fail.
The event of the week FITS neatly into our very long standing analogies with stocks in the 1920s and 1980s and the Dollar in the 2002-2004 period and therefore adds narrative, self-reinforcing confirmation and therefore confidence.
The reason, we believe, is the context for stocks was different to 2002 whereas 1929, 1987, and 2018 share an identical set of underlying conditions or problems.
This unique and dangerous combination with a probably similar outcome will be no surprise to any reader of our newsletters. But what is really amazing is, that despite no crash yet, the similarity continues to grow as evidenced by the Trump tariffs this week.
Protectionism and Stocks
In our article on the impact of protectionism on stocks (The Good, The Bad and The Ugly) we explain why stocks tend to react in a certain way under a protectionist regime given a certain set of underlying conditions. Often stocks (and particularly those that benefit directly from tariffs) rally in the initial phase but, as the longer term consequences of protectionist policies hit home, they suffer a much larger decline.
Protectionism and the Dollar
For the Dollar again the underlying conditions are important.
But the consequences outlined in the Unlucky $SEVEN amount to a soft dollar policy:
$ Devaluation Policy Officially Over : Tariffs obviate the apparent need for the US administration to talk the Dollar down to redress the growing trade deficit.
This is remarkably consistent with our 1987 template which we have previously outlined not least because tariffs have been introduced 2 months after Trump’s ‘stronger and stronger’ comments mirroring Ronald Reagan’s tariffs 2 months after the Louvre agreement of February 1987.
Shock. Tariffs threaten higher inflation and lower growth which is bad for the Dollar.
Escalation. We strongly doubt this is a one-off.
Vengeance. Destabilisation directly through retaliatory measures.
Evidence. There is overwhelming evidence that protectionism has led to a depreciation of the USD.
No Cohesion. Undermining global cohesiveness and raising tension
Protectionism is a misguided policy tool. It has often created more problems than it has solved. To the extent that this is ultimately reflected by both the currency and then stock markets is adequate testimony. But the seven signs are further evidence for our 1987 stock and 2003 USD views and trading strategies.
The Italian Election
The Italian General Election plays a pivotal role in financial markets. Not so much because the outcome could be tremendous or devastating. Whatever the result, it is unlikely there will be a clear decisive outcome until the political machinations (for a coalition or even minority government) are complete. And truth to be told, as a fan of all things Italian except their politics, it will not be decisive even then. As the character of Benito Mussolini said in a current Italian comedy “”Governing this country is not impossible, it’s pointless.” Once upon a time, this could have been a potential ground shaker because of Five Star’s rise and call for a EU Membership referendum. As they have dampened their anti-EU position and the election has been more dominated by immigration than EU membership, this election is likely to produce a tremor at best (or worst). Any significant move as a result will probably not be sustained for Italian reasons. The election therefore could well provide a better opportunity within what we believe will be increasingly volatile stock and currency markets.
Both the Italian Election and the Dollar’s reaction to Donald Trump’s Tariffs could well play a key role in a volatile and probably increasingly volatile stock market. The Seven signs of Dollar weakness could well be instrumental in exploiting the ‘day of days’.
Or as it says in the Book of Revelations 6:17, about the seven signs of the Apocalypse:
“For the great day of wrath is come; and who shall be able to stand?”
There are now more than enough links in the chain in the sequence before a 2018 Crash that… whenever it comes…we won’t just stand we hope to ride it in top gear.
Here’s to making the very best.
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