This is going to be a longer read, but the circumstances call for it. There’s a lot to cover and we think it’s extremely important. The cross currents below the Market surface have picked up speed, in cyclone fashion. It’s part of the corrective cycle. The headlines are concerning. That’s not new. But there’s been a twist in topics. The global economy is being threatened. Let’s break it down to 3 issues for simplification. That said, there’s nothing simple about what’s going on.
#1. Interest Rates and the Fed
New Fed Chair Jerome Powell hosted his first meeting at the helm. Another interest rate hike was the result. That was expected. Markets sold off, not necessarily because of what he said. His message was clear. The landscape has changed. It’s changed rather dramatically in fact.
Powell’s predecessors Ben Bernanke and Janet Yellen, presided over the Fed at a time when growth was anemic, inflation threatened to slide into deflation, and bond yields were persistently declining. They kept interest rates near zero trying to kickstart economic growth. Congress was in gridlock. Mr. Powell faces a completely different situation. The economy, both at home and abroad, has accelerated and inflationary pressures are on the rise. The Stock Market started the year hitting new, all-time highs. Powell’s job now is to take the foot off the gas pedal and in time, tap the brakes on an accelerating economy. The Market is sniffing that out. It continues to recalibrate the faster growth and the rising price of money. This is what’s new. A lot of the good stuff had been priced in already. The Market tends to get ahead of itself at times. That’s where corrections serve a purpose.
#2. Tariffs and Threat of a Trade War
This is not about steel and aluminum, though it is a factor. It’s all about free and fair trade and the White House continuing to shake things up. Now that’s been a theme. Let’s focus on China. China has been known to copy and repurpose American goods. Cheap Chinese knockoff products have been around for decades. It’s moved way beyond toys and t-shirts.
China has invested mightily and has become a leader and innovator in science and medicine. The big concern today is intellectual property and high-tech. The U.S. is ready to take a harder line against China where intellectual property is concerned. China, historically, has violated IP rights. If it plans to be a world leader, it will need to change that. The 2 global economic titans are clashing. This holds significance, both short-term and long-term. President Trump is pushing hard and forcing the issue. China has not traded freely nor fairly for a long time. No doubt, the Chinese will push back. Is this merely tough talk from the Oval Office in search of a better deal? That seems to be the modus operandi for President Trump. The Market looked past it for over a year. But the stakes have escalated. Nobody wins in a Trade war. Global Trade is threatened. The Market doesn’t like that.
#3. Digital Dominance
President Xi has secured power for the foreseeable future. He seems focused on taking the lead in technological innovation, namely Artificial Intelligence and machine learning. He saw an opportunity with the Trans Pacific Partnership, and asserted his leadership on the global stage. The race for 5G has begun. The prize is substantial. Many believe China cheats and spies, and a growing digital presence threatens the West. Qualcomm has recently been tagged as too important to fall into foreign hands. China is focused on the long game and they’re in it to win it.
Silicon Valley has become extremely powerful over the years, and in the case of the Facebook privacy incident this week, that power has been abused. The Digital Age has grown these large Titans of Tech. Amazon knows what you buy. Google knows what you search. Facebook knows what you share. It doesn’t cost you much, at least in monetary terms. The greatest expense: your privacy. There are growing outcries for regulation and perhaps breaking up of the Tech Titans. Microsoft had a similar situation a decade ago. Facebook is in the hot seat now. The US government could weaken these powers. Tech stocks have been super powers too. The Market is getting rattled with uncertainty.
China plays by a different set of rules. They aren’t concerned about privacy and don’t even pretend to be. China has their own set of Tech Titans. And they are sort of hybrid companies that are very powerful with state backing. Their names are Alibaba, Baidu and Tencent, among others. These are China’s versions of Amazon, Google and Facebook. They are innovating like Silicon Valley start-ups with the strong backing of the Chinese government with ideas of a digital space race for dominance in the 21st century. This matters.
It is a Critical Time on Planet Earth
The correction is about short-term issues, and recalibration of price. It’s still going through the process. We said in our 2018 Outlook that the quick rapid correction from late 2014 could be a good example of what we could see in 2018:
“The 2014 correction re-set valuations, triggered some fear, tested proper technical support, and allowed for prices to have the energy required to rally and achieve much higher levels into 2015. Make no mistake we still see higher prices well into 2018. A quick selloff would correct the excesses, before resuming the uptrend. The setup is there for a well needed breather. We are prepared.”
We just didn’t know what the headlines would be, now we do. Where we are headed long-term is what’s most important. The prospect of a Trade War is not just about aluminum. For the first time in decades, there is an economic rival to the US on the global stage. China has asserted its leadership. The rules are changing. The Market is paying close attention. So are we. We are looking out way beyond the horizon.
We’re on it. We remain in defense mode with substantial hedges to help offset declines within this corrective phase. Gold has come to life too. Corrections are normal and healthy. But these new developments around trade add to the complexity.
Have a nice weekend. We’ll be back, dark and early on Monday.