China Indicates It Won’t Retaliate Now on New U.S. Tariffs

(…) “China has ample means for retaliation, but thinks the question that should be discussed now is about removing the new tariffs to prevent escalation of the trade war,” Ministry of Commerce spokesman Gao Feng told reporters in Beijing on Thursday. “China is lodging solemn representations with the U.S. on the matter.” (…) Gao said that both sides are discussing the previously announced trip in September by Chinese negotiators to Washington. (…)

Gao also repeated Vice Premier Liu He’s comments on Monday that China is “willing to solve the problem through consultation and cooperation with a calm attitude, but firmly opposes escalation of trade war.”

If Chinese officials go to the U.S. for talks next month, the two sides should work together to create conditions for talks to progress, Gao said. Both sides are currently discussing the trip, and information on that will be released in a timely manner when available, according to Gao, indicating that the schedule isn’t set yet. (…)

Reuters’ adds this quote which sums it all up: the ball is in Trump’s court to postpone the new September 1 tariffs.

“We hope the United States will show sincerity and concrete actions,” Gao said.

• US business group urges Donald Trump to delay new China tariffs coming ‘at the worst possible time’ Americans for Free Trade, comprising 150 industry associations, wants US president to delay levying 15 per cent duties on US$300 billion of Chinese goods

• National Security Concerns Threaten Undersea Data Link Backed by Google, Facebook U.S. firms and Chinese partner have sunk hundreds of millions of dollars into Los Angeles-Hong Kong cable project

U.S. officials are seeking to block an undersea cable backed by Google, Facebook Inc. and a Chinese partner, in a national security review that could rewrite the rules of internet connectivity between the U.S. and China, according to people involved in the discussions.

The Justice Department, which leads a multiagency panel that reviews telecommunications matters, has signaled staunch opposition to the project because of concerns over its Chinese investor, Beijing-based Dr. Peng Telecom & Media Group Co., and the direct link to Hong Kong the cable would provide, the people said. (…)

If the U.S. rejects Pacific Light’s application, it would be the first time it has ever denied an undersea cable license based on national security grounds, and it could signal regulators are adopting a new, tougher stance on China projects. (…)

This next piece dates from Aug. 6 but still has significance in my view:

• Pence signals openness to sanctions over China’s human rights abuses

Vice President Mike Pence has signaled that the Trump administration is open to using the Global Magnitsky Act to sanction top officials in Xinjiang, China, where more than 1 million Uighur Muslims are being held in internment camps, according to a Chinese religious freedom advocate who met with Pence at the White House Monday.

Bob Fu, founder of ChinaAid, said that Pence also told him that he planned to give a second speech about China in the fall to address religious freedom issues. Beijing has been paying close attention to Pence’s plans for a second speech, as the vice president has been at the forefront of the administration’s confrontation with China. So hawkish was a speech Pence gave in October that the New York Times framed it as a portent of a “New Cold War.” (…)

While the Trump administration has condemned the internment camps, it has taken no specific action against Beijing for the human rights abuses. Magnitsky sanctions — if imposed — would be a significant step. (…) Magnitsky sanctions have never been used against an official of the Chinese Communist Party. (…)

Mnuchin Says U.S. Doesn’t Intend to Intervene on Dollar for Now

INVERSIONS INVASION

Investors are really focused on recession risks:

The Daily Shot has a few interesting charts about the negative mood:

• While the economy is slowing, there is scant evidence that it’s headed for a recession in the short-term. However, economists are boosting their probability estimates of an economic contraction within the next twelve months.

Source: @WSJ; Read full article

• Also, according to the Quinnipiac Poll, more households now see the economy worsening.

Source: @bpolitics; Read full article

• On June 13, I posted that

Nearly half (48.1%) of US CFOs believe that the US will be in recession by the 2nd quarter of 2020 and 69% believe that a recession will have begun by the end of 2020. CFOs are even more pessimistic in most other regions of the world.

Could it be that if most economic actors believe a recession is coming, a recession will come? We know that CFOs are curbing capex and deleveraging. So far, the American consumer has shown little concern for economists’ warnings. Fortunately, the latters don’t directly influence the economy.

Back to the survey of economists plotted above, remember that equity markets (and interest rates) weakened in the fall of 2011 (-17%), in the spring of 2012 (-9%) and in the fall of 2016 (-13%) but proved false alarms.

Perhaps an actual yield inversion makes the current high probabilities more credible. Perhaps.

However:

• It took one to three years for the economy to go into recession after the previous episodes of yield curve inversion.

Cumberland’s David Kotok observes, among other things, that

• Almost all of the world’s major countries’ sovereign debt now trades with a yield below the overnight risk-free rate of the United States. I cannot find an historical precedent for such a global financial construction. 
• The abruptness of the August 2019 decline in US Treasury bond rates has been matched only six other times in more than three decades – in October 1987, June 1989, February 2000, November 2001, December 2008, and August 2011. These dates were all during or close to recessions. (Bianco Research)
• Meanwhile, the US annual inflation rate rose to 1.8% in July 2019 from a four-month low of 1.6% the previous month and above the market consensus expectation of 1.7% (https://tradingeconomics.com/united-states/inflation-cpi). Also note that some measures of inflation are now above 2% and trending higher when recent time periods (rather than year-over-year comparisons) are examined.  Essentially the gap between inflation and interest rates is near zero which means the use of money (by a borrower) is essentially free.
• While US Treasury note rates have declined, junk bond rates have not; thus the spread has widened. Compare yield on HYG to GT10 (Bloomberg) to obtain a market-based spread. It is now about 350 basis points. On January 1 it was 314 bps. Before the tariffs and trade war it was about 250 bps. Conclusion: Trump tariffs are raising credit risk premia, and the higher risk premia explain weaker sectors of financial markets, slowing economic growth, and rising volatility.
• Meanwhile, the Trump federal deficits are now set to cross $1 trillion annually. The US Treasury is examining issuing longer maturities. In my view, Trump should stop bashing Powell and start directing his administration to issue 100 year TIPS. The world would buy a lot of them and the United States could achieve remarkable low cost permanent financing for its many needs and wants. 

David then wonders:

• How and when will the Trump Tariff War stabilize?  Will it? Are we headed for global fortress regions and will we permanently reverse the benefits of a half century of globalization and economic integration? Trump has just threatened a new tariff level of 30% for the first time. Tariffs Revenue to the US Treasury has doubled since this trade war started and is still rising and accelerating up. At 30% on all China sourced imports, the federal revenue would grow to about $200 billion annually. The tariffs amount to a sales tax imposed on American consumers and businesses.  For a metaphor, This amount would be roughly equal to a national increase in the gasoline tax of about $2 per gallon. That is the trajectory of the present thresholds of Trump-Navarro trade war policy.
• Will Trump use the Exchange Stabilization Fund (ESF) as a supplemental weapon in the trade war? In our opinion this move would significantly undermine the long-term stature of the US and of the US dollar as a world reserve currency. The mere fact that Trump has alluded to using the ESF (and to wanting a weaker dollar) makes it now an unpredictable issue and raises risk premia.
  3.  What will the Federal Reserve do, when will they do it, and how will they explain it? Trump’s bashing of the Fed is likely to continue and intensify. They make a convenient political target, even though the economic issues and financial stresses originate in Trump’s protectionist policy and not in Fed policy. Any creditworthy borrower can obtain financing easily, and any refinancing is happening or has happened. There is not a lot left to “milk” out of the system. The problem is not with low rates; the problem is in weakening economics and rising uncertainty premiums that are resulting from Trump’s inconsistent and ill-advised behavior.
• Lastly, there is a developing body of research that estimates how much damage negative rates and even very low rates are doing. Torsten Slok has published a partial list of those papers. Essentially, negative-rate policies and very-low-rate policies eventually become counterproductive and act as contractionary forces. See Brunnermeier and Koby, “The reversal interest rate,” January 30, 2019 (https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&ved=2ahUKEwiM5JCwjJzkAhUQVd8KHVFiDgsQFjABegQIABAC&url=https%3A%2F%2Fscholar.princeton.edu%2Fsites%2Fdefault%2Ffiles%2Fmarkus%2Ffiles%2F20p_reversalrate.pdf&usg=AOvVaw0F9ZkQPUlLbzTjXedY-YzE). Also see NBER working paper 26040 by Sims and Wu, July 2019, entitled “Evaluating Central Banks’ Tool Kit: Past, Present, and Future” (https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=2ahUKEwjz_emnjZzkAhVmZN8KHTZGCE0QFjAAegQIABAC&url=https%3A%2F%2Fwww3.nd.edu%2F~esims1%2FSW.pdf&usg=AOvVaw2dJTpeNxHCREsdw_ovQtwD).

And he concludes (my emphasis):

We enter the post-Labor Day period with caution about the policy outlook in the US and elsewhere. Bonds are in a barbell and avoiding a ladder. Ladders now center duration in the highest risk and lowest yield portion of the yield curve.  Stock accounts are rebalancing and deploying cash reserves. Market corrections have allowed for repricing and entry. Fear is providing those entry opportunities. Quantitative accounts have been defensive for months; they are now redeploying as indicators confirm opportunity and market based prices indicate entry.  When the inflation adjusted interest rate is zero or lower, money’s usage is free.  This is bullish for many asset prices.  Our job is to manage the investment landscape and be agnostic to a policy with which we disagree.  We don’t like the Trump policy. Dislike of, disgust with and disdain for Trump behaviors do not prevent us from seizing market opportunities.

I am all for being contrarian, when value is reasonably compelling and I can get a good enough grasp of the environment.

In the fall of 2011, the Rule of 20 P/E reached a low of 14.3 in September; equities were a bargain. It was 15.6 in May 2012, still a bargain. No brainers!

In the fall of 2016, the correction had brought the R20 P/E from 21.2 in July to 20.4 in October, very mildly overvalued. Trailing EPS had declined 4.5% from their May 2015 peak to their July 2016 trough. Earnings then resumed a strong uptrend along with the enthusiasm from the newly elected President. Stocks were not cheap but earnings were rising with promises of a more business friendly government and eventual tax cuts.

In January 2017, the Rule of 20 Fair Value started to rise again as earnings accelerated and inflation slowed from 2.5% in January to 1.6% in June. This provided a strong back wind and the S&P 500 rose 28% between January 2017 to January 2018 when the R20 P/E reached 23.5.

As things stand now (2920), the R20 P/E is exactly 20.0 (fairly valued) but the Rule of 20 Fair Value (2925) is declining (it was 2951 in June) as trailing EPS are flattening while inflation is rising.

Personally, I don’t have a good enough grasp of the environment to bravely buy without a backwind coming from rising EPS and/or declining inflation.

I note, however, that the China/USA game of chicken may be nearing at least a short term solution/truce, that the Fed wants to be market friendly and that world central banks are dovish. I also note that oil prices are down 30% from their October 2018 peak, hurting producers but providing a meaningful boost to discretionary income, a big offset to any inflation from the trade war.

TECHNICALS WATCH

The 13/34–Week EMA Trend Chart (courtesy of CMG Wealth) remains positive but both lines are weakening.

Has America’s China Backlash Gone Too Far? ‘We have a China attitude, not a China policy,’ Henry Paulson says

Greg Ip throws this weird idea that China bashing may not be the best approach.

(…) “We have a China attitude, not a China policy,” says Henry Paulson (…) No one is leaning against the wind, providing balance, asking what can we realistically do that has some chance of getting results that won’t be harmful to our economic and national-security interests in the long term?”

To be sure, much of the establishment expected China to liberalize more—and they turned out to be wrong. Yet in the rush to pivot, the new hawkish consensus ignores China’s history of increasing—not decreasing—global cooperation.

Former World Bank President Robert Zoellick, a top trade and State Department official under Mr. Bush, notes that China was once a major source of ballistic-missile and nuclear-weapons proliferation. Starting in the 1980s it began to conform to global norms on weapons exports, halted nuclear tests and worked with the West to contain Iran’s nuclear program. From 2000 to 2018, it supported 182 of 190 United Nations Security Council resolutions imposing sanctions on violators of international rules, Mr. Zoellick says.

China’s cooperation extended to the economic sphere. It eventually acquiesced to U.S. pressure to let its currency appreciate and has generally accepted adverse World Trade Organization rulings. Says Mr. Zoellick, “My point isn’t that all is well.” For example, “China has not lived up to its WTO commitment not to require tech transfer.” He says the question is how to induce better behavior and notes that China is discussing WTO reforms to meet Western complaints. (…)

China has also increased its cooperation on humanitarian and environmental causes, assisting in containing Africa’s Ebola outbreak in 2014, banning trade in elephant ivory and joining the Paris climate accord on greenhouse-gas emissions.

The experts agree Beijing has backslid on economic and political liberalization but disagree that this means China’s system is fundamentally incompatible with the West’s and that cultivating Chinese reformers is fruitless. (…)

These experts worry that if the U.S. assumes conflict with China is inevitable and thus it should decouple now, that could unleash dynamics that make conflict more likely. “If we treat China like an enemy, they might become one,” says Mr. Paulson. (…)

“The message to China should be: Let’s fix the rules of the road,” says Mr. Hadley. “But make no mistake. If we cannot work those things out and we do get into bare-knuckle confrontation, we will be prepared and we will win.”

• “OPEN SESAME!” MOMENTS

What’s in a name!!

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  Autonomy Capital lost 16% in Argentina market rout