Financial Markets Weekly: March 23rd

April 3, 2018

Here’s your financial markets weekly report for March 23, 2018.
Beware the Ides of March.
The VIX volatility index (AKA the Fear Index) began last week at 16.59. By Friday, it had careened to a lofty 24.02. Jumping nearly 39 percent during the week. The S&P 500 declined 6 percent. The technology sector alone slid 7.9 percent. And Friday's volatility alone brought the S&P 500 lower by 2.1 percent.
As stated in previous missives, we believed equity indices might revisit their February lows. Even break through them. Registering as customary market behavior now that volatility has returned to the fore. Yet, we don't believe the market has finished its bullish ways. Evidenced by this week's Monday bounce after having double tapped the February lows. It is obvious, however, that stocks will no longer be providing such returns gratis. As they did last year. When we were given a risk-free taste of the good life. Enough to get us hooked. Now the market will make us pay for such munificence. By dialing up volatility. And forcing investors to sweat it out.
We are 21 percent of the way through 2018. With the S&P 500 down 2.75 percent year to date. If the market year were a baseball game, we'd be in the bottom of the second inning. With the bears holding a one-run lead over the bulls. Zero outs. Bases loaded. But the advantage still resides with the big bats in the bull's dugout. Who, since 2009, have managed to rally whenever they've been pressed. We believe, at least this time, they will do so again.
Because taxes, regulation and monetary policy currently serve as wind in the sales for economic growth. Things aren't perfect. Government spending and the new tariffs could threaten our tranquility. But the fundamentals don't signal major economic problems ahead. The current volatility in markets is not a warning. It's just volatility.
Speaking of tariffs, the global punditocracys' heads are aflame over the Trump administration's recently enacted tariffs. And would have you believe that the same mistakes that led to The Great Depression are being repeated.
The astute observers at Pantheon Macroeconomics agree. Stating that everyone needs to take a deep breath. This is not 1930. Nor a Smoot-Hawley redux. That was a time when global trade flows plunged by 66 percent in the four years after the U.S. greatly increased tariffs on a wide range of goods. The subsequent collapse in trade flows, shown in the following chart, from a U.S. perspective, was a global economic disaster. And trade did not return to its pre-Smoot-Hawley level until the early 1950s.
That was then. This is now.
The Trump administration's tariffs on selected imports from China amount to only about $15B per year, some 0.08 percent of U.S. GDP and less than 0.02 percent of global GDP.
Markets, therefore, spent last week reacting more to the threat of further, more aggressive actions on the part of the U.S. administration, than to the real impact of tariffs. Assuredly, the signal sent by the administration was not welcomed. That it is prepared to ignore WTO procedures. Prepared to turn away from decades of incremental global trade expansion. Nor will low value-added manufacturing be returning to the U.S. There will always be a cheaper producer elsewhere.
But, the administration's actions also reflect the growing, consensus frustration with the inability of global trading mechanisms to force the Chinese to play by commonly accepted rules of engagement.
Many developed nations believed that China's entrance into the WTO would align its trade practices with those of other members. That has not been the case. As the Chinese have repeatedly forced foreign businesses to sell ownership equity to Chinese interests just to gain toe holds in Chinese markets. And the Chinese have made an art form out of pirating the intellectual property and research treasures of foreign firms, universities and governments. And while the Chinese have paid lip service to mending their ways, they've done nothing about it.
Accordingly, China's alleged trading partners have every reason to be upset.
Pantheon Macro believes the market's reaction to the tariffs, as they currently stand, is overdone. Because the fundamental story in the U.S. has not changed. Economic growth has been increasing since mid-2016. GDP growth this year will be close to three percent. And considering next year's even larger tax-cut impact, robust growth seems assured for some time. So long as the equity markets perturbations don't degrade into a sustained bear market.
Pantheon further forecasts that the 19 percent consensus for corporate earnings growth this year is too low. They expect something closer to 30 percent. Which will be manna to markets. Further, Pantheon's analysts expect a decent increase next year, as well. Though faster wage gains will mean that earnings can't rise as fast as they likely will this year.
At this point, we view the recent volatility as a buying opportunity. Not as the catalyst for something more sinister. So long as the administration's capriciousness does not roil markets too much, the U.S. economy has attained too much momentum to be slowed by only allusions to a more serious threat.
Globally, Brazil is the year's leading country index thus far. Up 10.1 percent. Thought it's down 5.7 percent from its January peak. Also faring well thus far are Russia, +7.5 percent, and Italy, +6.9 percent.
Domestically, much has been made of Facebook's 17 percent smackdown. Having recently come under attack for its lack of regard over consumer privacy. And its alleged ties to a voter analytics firm that worked closely with the Trump administration leading up to the 2016 election.
Questions over how Facebook manages third-party access to user information comes at a difficult time. As the U.S. tech sector draws fire from the European Union. Which is preparing to unveil legislative proposals to increase taxes on tech giants as part of an escalation in trade tensions between the U.S. and other countries.
"This potential backlash is all part of this building trade war that's beginning to emerge," said Michael O'Rourke, chief market strategist at JonesTrading, to the WSJ. "It's something people should be concerned about."
We've long held Facebook in portfolios. Allotting a premium to the means by which the company pioneered the monetization of mobile advertising. But, given the recent missteps, and the increasing questions of the company's trustworthiness - which remains paramount to their business model - we've trimmed positions and placed the company on a very tight leash.
Geopolitically, Mike Pompeo was tapped to replace Rex Tillerson as Secretary of State. Changing the status quo in the Middle East.
Secretary Tillerson was a moderating influence in the administration. That moderation included supporting the Iran deal. A deal about which President Trump has been very vocal in expressing his dislike. So, perhaps it was only a matter of time before Secretary Tillerson left his post. Yet, the timing is interesting. Prime Minister Netanyahu just visited the U.S. Echoing President Trumps' displeasure with Iran. So, when the new SecState begins his job, expect to see a different view of how the U.S. deals with Iran.
May 12th is the next opportunity for President Trump to nix the Iran deal. We believe he may do so. And then ratchet up pressure on Iran in order to get a better deal. This President has proven that everything is a deal. So, we don't expect the Middle East to burst into conflagration just because the U.S. exits the current arrangements with Iran.
And now, Russia. Who has attempted to assassinate three former Russian citizens on British soil over the last month. And while the western media feigned shock, perhaps we should not be so surprised.
A friend who lived in Russia recently told me that Russia is simply behaving as it always has. That Russian behavior has not changed. Only the west's perception of how Russia should behave.
Russia has long projected power outwardly in order to bolster its defenses against foreign encroachment. Consider, after all, that Russia does not have a single river that originates in Russia. All flow through Russia after beginning elsewhere. Moreover, Russia resides within a nest buffeted by foreign powers with whom it has been forced into repeated conflict. Europe to its west. Asia to the south. Accordingly, Russian expansion and foreign aggression reflect the nation's effort to bolster its borders. The security cushion between the motherland and her potential enemies. Leading to such conflicts as the Crimean invasion. The attack on Georgia. Or the assassination of the homeland's perceived traitors abroad.
Anyways, back to the lethal attacks in Great Britain.
What Russia did, if they were the perpetrator, was to use a WMD in the UK. The UK responded by kicking 23 Russian diplomats out of country. Russians probably respond in kind. Steps conducted largely for public consumption.
But now NATO is involved. And rightly so. Against this backdrop, the upcoming World Cup in Russia will likely be boycotted by some countries. Or, we may even see Putin cancel the World Cup. Which would signal that a bigger response from the West is coming. Or has already occurred. One that requires Russia's full attention.
The threat of retaliation by both sides will grow. One of the UK's economic weaknesses is on the energy front. Where the United States will likely step up its efforts and flex its growing energy might.
But what if Russia's attack served a dual purpose?
Higher energy prices help Russia. The increased political tensions building across Europe and the Middle East, should push oil prices higher. As might the potential squeezes on supply due to geopolitical maneuvering. Which occurs at a time of peak global demand. Oil and energy shares, which have underperformed for months, may begin to outperform in the months ahead. All of which provides salve to Russia's economy. And global energy investors. Sure, it's a bit conspiratorial. But Russia is no stranger to the cloak and dagger. And when a predator is cornered, it rarely sits idle. But prefers to initiate the attack.
Brackets busted yet?
In the history of the NCAA Basketball Tournament, a 16th seed has never, ever, beaten a one seed. Until this year. A week ago Friday, the University of Maryland, Baltimore County (UMBC) beat the University of Virginia - which wasn't just a number one seed, but the top ranked team in the tournament.
Nobody saw that coming. But we rarely expect or prepare for the unexpected. One of the major Achille's Heels of most investors.
Ten years ago, nobody could have foreseen the bankruptcy of the world's largest toy company. Operating in an industry that does around $90 billion in annual sales. But, the death knell for Toys "R" Us likely began in 1998. When Walmart began to sell more toys than Toys "R" Us. Then along came the Internet. For which Toys "R" Us was wholly unprepared. Compounding its problems. And placing all those equally unprepared rivals on a collision course with obsolescence.
Last week the company took its last breath. Having announced that it couldn't find necessary financing. That it would be forced to liquidate assets. Leaving the bonds worthless. The company will close all U.S. stores. More than 30,000 people will lose their jobs.
Shumpeter's gale, also known as creative destruction, remains extant in every facet of the economy. Today, Toys "R" Us. Tomorrow? Who knows. But the tides of technological and societal change will continue to unexpectedly crash upon the shoreline of our realities. Forcing us to adapt to everything left in its wake.
Stay tuned for your next financial markets weekly update…
Financial Markets Weekly Recap
Major indices finished lower last week. The DJIA lost 5.67%. The S&P 500 fell 5.95%. The Nasdaq dropped 6.54%. While small cap stocks lost 4.79%. 10-year Treasury bond yields fell 3 basis points to 2.81%. Gold closed at $1,347.25, up $32.90 per ounce, or 2.5%.
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