The Final Stretch

We are in the final stretch for the year. 2018 has certainly been eventful. 2018 has been memorable. It’s been memorable for the good stuff as well as the bad. There’s been a lot of both.

This was a really good week for investors. It was a really important week too. This might surprise you that the month of November ended positive. That sure doesn’t tell the story. It’s been a tough year. In fact, this has been the worst year for global asset classes… ever. But the year is not over yet. I read that as of the Thanksgiving week, 90% of the asset classes around the world were down in 2018. The previous record was 84% in 1920. Think about that one for a second. The Bond Market has been in the red all year, but the continued sell-off in stocks last week sent the S&P and DOW back into the red for the year. What followed was the best weekly gain for the Stock Market in 6 years. The rally this week took them both back in the green for 2018. Make no mistake, this has been a very challenging and gut-wrenching go for investors. There have been very few places to hide amidst the selling. The volatile price action has been whipping investors around. I know you’ve been feeling it. Our portfolios have felt it after having a stellar first half. The fall in the Fall has not been fun. But we think it could be over and better days are here, and more are ahead.

Wednesday saw an explosive rally which was ignited by the Fed Chairman. But it started even earlier. Monday brought big gains, stemming last week’s sell-off, and closed at the highs. That in and of itself was important. Tuesday morning brought more losses, which at one point cut 2/3 of Monday’s gains. It seemed like, here we go again, take cover, because more selling was coming. But it didn’t. Throughout the course of the day, the losses kept eroding. Buyers stepped in and Tuesday saw the DOW and S&P both close at the highs on the day again. It was a major reversal. Significant. Then came Wednesday’s surge, which was the best day for the DOW in 8 months, tallying a 600 point gainer.

Fed Chairman Jerome Powell had a speech on Wednesday. He basically said that interest rates are close to neutrality, which means the rate hike campaign might see a pause while they reassess the situation. Powell acknowledged that there are some new signs of sluggishness and acknowledged the recent volatility. He also mentioned that the Stock Market is not excessively valued. Fed Chairs rarely comment on the Stock Market. This speech sent stocks higher.

There is an 82.7% probability of a rate hike in December. But expectations are shrinking for higher rates next year. Over the Summer, the Market was factoring 3 rate hikes in 2019. We wouldn’t be surprised if it ends up being only one. Growth rates are peaking this year and signs of a cooldown are in the air already. The Federal Reserve is still in the process of unwinding the hyper aggressive monetary policy from the financial crisis. The unprecedented level of quantitative easing eventually needed to be unwound. Remember, this has never happened before. The “whatever it takes” attitude from the Fed in 2008 and 2009 to save the financial system from failing came with consequences, and we are seeing some of them now. The Fed’s quantitative tightening campaign has had a dramatic impact on Market liquidity, which has no question contributed to the volatility. The good news is both the Stock and Bond Markets like clarity and low rates. Sensing the Fed is considering a pause in the rate hike campaign was a very Bullish sign for investors.

But the main attraction is this weekend. The Trade War is being addressed face-to-face. Trump and Xi are breaking bread in Buenos Aires. The G20 Summit in Argentina will host the meeting of the two Presidents. Expectations have risen for some sort of positive outcome, whatever that might be. A trade deal is highly unlikely this weekend, though some might have been bidding up stocks thinking one could get done. The more realistic result would be a pragmatic discussion between the two Presidents and commitment to carving out a path to a deal which is mutually acceptable. Both Trump and Xi need a win here. Nobody is winning now. They both have to know it, though probably wouldn’t admit it.

China has been very strategic in targeting its tariffs at Trump’s political base of support. Currently, China imposes 40% tariffs on U.S. automobiles. This is more than double the rate of 15% that China imposes on its other trading partners, and approximately one and a half times higher than the 27.5% tariff that the United States currently applies to Chinese-produced automobiles. Both Washington and Beijing have been methodical in their approach, though our sources say the Chinese have been quite confused in how to deal with the American President. Clearly they’re not the only ones. It’s important to note that the Chinese economy has struggled this year, certainly more so than the U.S. But the U.S. economy has shown some vulnerability.

General Motors announced a major layoff this week. This was not expected and has significant implications beyond the auto industry, which has clearly been struggling. GM’s announcement has directed attention toward the White House economic policies. The trade war has hurt the Midwestern economy. GM said Trump’s tariffs on steel and aluminum have cost the company $1 Billion. This was Trump territory in the 2016 election as the President promised better economic policies to reverse decades of manufacturing declines. The GM news was certainly a hit to the President ahead of the meeting this weekend.

Our sense is that a deal won’t get done this weekend, but dialogue is an important step to carve out a path to a deal. Both sides could walk away feeling that they won something. But the major issues are too complex and too important to resolve immediately. China will have to finally address the core issues that are important to the U.S.; namely: intellectual property protection, coerced technology transfer, subsidies to state-owned organizations, as well as cyber security and espionage. These issues have major implications for the rest of the century, and beyond. It’s that big. In an effort of good faith, China may offer to reduce its tariffs on American farmers and agree to purchase more U.S. natural gas in exchange for a suspension of tariffs. A possible scenario is that the White House will raise the existing $200 Billion in tariffs from 10% to 25% in January as planned but withhold imposing the $267 Billion in additional tariffs allowing for negotiations to occur. Would that scenario please or disappoint the Market? It’s tough to tell. Expectations have gotten higher. What is clear: Nobody wins in a trade war. Both Presidents need a win.

Expect the volatile price action to continue. We’ll be all over it.

Have a nice weekend. We’ll be back, dark and early on Monday.


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