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THE DAILY EDGE: 30 NOVEMBER 2018: Puts!

Wednesday we got the Powell put, now the Trump put?

U.S., China Explore Deal as Leaders Meet at G-20 Summit Washington could hold off on further tariffs through the spring in exchange for new talks looking at big changes in Chinese economic policy.

The U.S. and China, looking to defuse tensions and boost markets, are exploring a trade deal in which Washington would hold off on further tariffs through the spring in exchange for new talks looking at big changes in Chinese economic policy, said officials on both sides of the Pacific. (…)

One offer, according to Chinese officials: in return for the suspension of U.S. tariffs, Beijing would agree to lift restrictions on China’s purchases of U.S. farm and energy products.

Such a deal would follow the model of partial agreements the U.S. has cut in recent months with the European Union and Japan, U.S. officials said. In those deals, the U.S. agreed not to levy more tariffs—in those cases, tariffs on automobiles—while the two sides negotiated over specific areas. With Japan, for example, Tokyo agreed that any deal would increase automobile production and jobs in the U.S., while Washington agreed not to press Tokyo for more concessions on agriculture than Japan had previously allowed free-trade partners. (…)

The president, before boarding Marine One in Washington to depart for Buenos Aires, said the two sides were “very close” to a trade deal with China, but added: “I don’t know if we want to do it. I’m open to making a deal, but frankly, I like the deal we have now.” Confused smile (…)

(…) The Federal Reserve Bank of Minneapolis recently reported that farm bankruptcies are rising sharply in Wisconsin, Minnesota North Dakota, South Dakota and Montana following declining prices for soybeans, milk, beef and other farm products that face retaliatory tariffs from China, Mexico and other countries hit by Trump tariffs. The Chinese market is now essentially closed to U.S. soybeans, leading many farmers to simply let crops rot in the field.

Dairy farmers are having an even more difficult time, especially as retaliatory tariffs from Mexico close down a critical market for U.S. cheese exports. Mexico has said it will not remove the barriers until Trump removes steel and aluminum tariffs, something he did not do even after agreeing to the new U.S. Mexico Canada Agreement.

“The impact at the farm level is very real and declining prices are the difference between surviving and not surviving,” said Rick Naerebout, CEO of the Idaho Dairymen’s Association. “Dairy farmers are having to sell off their family businesses because they can’t make it. Tariffs are not the sole factor but they are a main factor. We’ve seen drops in cheese exports of up to 20 percent in some of the latest numbers that have come out. Those are big numbers and they are real numbers.” (…)

(…) While the new export-order subindex ticked up to 47.0 from 46.9, the new import subindex fell to 47.1 from 47.6.

Other measures for production and new orders pointed down too. Outside of manufacturing, weakness in construction outweighed strength in services, dragging the official nonmanufacturing purchasing managers index to 53.4 in November, from 53.9 in October—the lowest level in 15 months. (…)

“The market is cooling down a lot,” Ms. Wang said. “Naturally, a lot of loss-making players will exit the market.” (…) Nasdaq-listed Ctrip commands around 62% of the Chinese travel market, according to estimates provided by the company.

(…) According to the people briefed on the preparations, Mr Liu’s December trip would go ahead if Mr Trump agreed to a pause in any further tariff measures in return for the Chinese government’s willingness to negotiate possible changes to its industrial policies. (…)

Fed Minutes Signal Likely December Rate Increase, Less Certain 2019 Path A few officials on the monetary-policy panel expressed uncertainty about timing of further tightening

(…) Officials, however, discussed changing their postmeeting policy statement to emphasize their flexibility to respond to fresh economic developments as they weigh their rate moves next year. (…)

Since January, the statement has said officials expected that “further gradual increases” in short-term rates would be necessary, and the central bank has raised rates by a quarter-percentage point every three months over the past year.

At their recent meeting, officials debated whether they should change that key phrase to stress their next few moves would depend more on the most recent data, a subtle but important shifting of the Fed’s policy-planning gears.

“Such a change would help to convey the committee’s flexible approach in responding to changing economic circumstances,” said the minutes. (…)

Officials placed new attention on developments that might lead the economy to slow more than forecast, a sign of budding caution.

They flagged concerns about rising uncertainty related to trade and fiscal policy as well as the lagged effects of their own policy tightening moves over the past, the minutes said. They also cited a possible slowdown in global growth. A couple of officials pointed to softening inflation data.

Some worried over rising levels of corporate debt, which could make the economy more prone to a sharp pullback if slowing growth triggers more defaults and bankruptcies. (…)

U.S. Leveraged Loan Market Is Showing Signs of Sputtering

(…) These debts have weakened with the broader leveraged loan market, which on average is priced at its lowest level since 2016. And there are other signs of cooling in loans too: the percentage of new deals that had to increase pricing spiked earlier this month to the highest of the year, according to data compiled by Bloomberg. Loan offerings are getting pulled at the fastest rate since July. And U.S. leveraged loan funds are seeing some of their biggest outflows in nearly three years. (…)

Whose Line Is It Anyway?

Emerging Markets can be fascinating to many, particularly to those who make a living trying to analyse them. In my Nov. 12 post, I wrote about UBS recommending emerging markets “now trading at 11 times future earnings, a discount to the 30-year average of 13 times, according to UBS”, pointing out that, since 2000, the P/E on the MSCI Emerging Markets has ranged between 8.0 and 13.0.

Yesterday, I came across this chart titled “The Case for Buying EM Stocks” from Alpine Macro which claims to be “A Unique Mind On The Markets”. I like such high-low range charts, especially when they suggest that we are at the very low end of a reasonably stable long-term range. So I glanced at it for 30 seconds before proceeding…

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…to simply redraw the trend lines to see how that might change “The Case”. Not quite as trendy, is it?

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Recall that the composition of the MSCI EM Index is far from stable. For example, just in the last 10 years, China has moved from 14% of the MSCI EM Index to its current 31%. A bunch of “Others” are next in line at 27% from 39% in 2008 while Brazil went from 14% to 6% and Russia from 10% to 3%. Looking at the past may not be a good reflection of the present.

Speaking of EMs:

Commodities Drop Looks Secular, Not Cyclical From slower economic growth to chronic excess capacity, the long-term outlook for raw materials isn’t good.

Gary Shilling has identified 10 forces that explain the weakness and why it will persist.

1. Slowing economic growth globally and a possible recession in the next year.

2. The strengthening dollar is increasing the local currency cost of commodity imports in developing as well as advanced economies

3. Chronic excess capacity exists among commodity producers.

4. Slowing growth in China

5. As economies grow, proportionally less is spent on commodity-intensive goods and more on services.

6. Globalization disrupts economic growth in the West to the detriment of commodities.

7. The escalating trade wars disrupt economic growth and commodity demand as uncertain business people postpone capital outlays.

8. Mounting inventories depress commodity prices. Producers can’t be sure initially whether weakening demand is momentary or serious and don’t want to disrupt production. So inventories climb.

9. The realization that a peak in oil demand, not supply, is in the cards as rising supplies of natural gas and LNG as well as renewables replace oil

10. Real commodity prices, or those after taking inflation into account, fall steadily in the long run as efficiency, substitute and human ingenuity consistently beat temporary shortages.

Point #7 is supported by these charts:

Tax reform was supposed to boost capex in the U.S.. It’s boosting buybacks instead:

New orders are not suggesting that the boost is coming anytime soon:

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Europe looks even worse:

  • CapEx expectations point to slower business investment ahead.

Source: Longview Economics (via The Daily Shot)

Bogle Sounds a Warning on Index Funds The father of the index fund says it’s probably only a matter of time before they own half of all U.S. stocks; ‘I do not believe that such concentration would serve the national interest’

(…) Equity index fund assets now total some $4.6 trillion, while total index fund assets have surpassed $6 trillion. Of this total, about 70% is invested in broad market index funds modeled on the original Vanguard fund.

Yes, U.S. index mutual funds have grown to huge size, with their holdings doubling from 4.5% of total U.S. stock-market value in 2002 to 9% in 2009, and then almost doubling again to more than 17% in 2018. Even that penetration understates the role of mutual fund managers, as they also offer actively managed funds, and their combined assets amount to more than 35% of the shares of U.S. corporations.

If historical trends continue, a handful of giant institutional investors will one day hold voting control of virtually every large U.S. corporation. Public policy cannot ignore this growing dominance, and consider its impact on the financial markets, corporate governance, and regulation. These will be major issues in the coming era.

Three index fund managers dominate the field with a collective 81% share of index fund assets: Vanguard has a 51% share; BlackRock, 21%; and State Street Global, 9%. (…)

It seems only a matter of time until index mutual funds cross the 50% mark. If that were to happen, the “Big Three” might own 30% or more of the U.S. stock market—effective control. I do not believe that such concentration would serve the national interest. (…)

Even if present trends continue (sometimes they don’t), the enormous value of index funds should not be ignored. First, index funds provide investors with the most effective stock-market strategy of all time: buy American business and hold it forever, and do so at rock-bottom cost. Second, index funds are among the few truly long-term owners of stocks—for all practical purposes, permanent owners of capital—an enormously valuable asset to society. The long-term focus of index funds is a much needed counterweight to the short-termism favored by so many market participants. (…)

EMERGING MARKETS PMI REMAINS WEAK

imageThe HSBC Emerging Markets Index (EMI), a monthly indicator derived from the PMI™ surveys, continued to indicate only a marginal increase in output across global emerging markets in April. The EMI posted 50.4, from 50.3 in March, well below its eight-and-a-half year long run trend level of 53.9.

April data indicated falling output in the four largest emerging economies. Overall business activity across the Chinese manufacturing and services sectors declined slightly for the third month running, the longest sequence of contraction in over five years. Meanwhile, private sector output in Russia fell at the fastest rate since May 2009. Indian business activity fell for the ninth time in ten months, albeit marginally, while Brazil posted a fractional decline for the second time in four months.

Manufacturing output across emerging markets was broadly stagnant in April, while services activity growth was unchanged from March‟s weak rate. The volume of new business across both sectors rose at a rate little changed from March‟s eight-month low. Backlogs of work fell for the fourth month running while a marginal cut in employment was signalled.

Cost pressures remained subdued in April, as average input prices increased at the slowest rate since June 2013. Manufacturing input prices continued to fall in
China, South Korea and Poland, while Russia and Turkey continued to post the sharpest rates of inflation.

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