By David Matias
August 5, 2019 – As we’ve stated in recent months, the economies here and abroad are in a fragile state. Growth has not accelerated in the U.S. despite massive tax cuts, people are leaving the labor force in droves, and our administration insists on governing via tweets drafted on an ill-informed, infantile platform.
The intricacies of the global economy are vast and impossible to fully understand. The attempts to reduce that complexity to simple mantra, phrase, or tweet only create unforeseen carnage. The events of the past week are a case in point. The Fed announced a small rate drop — the first in over a decade — and Trump complained that it isn’t enough in a further attempt to bully the Fed. Next, the announcement of unilateral tariffs on China in addition to the existing tariffs, only reinforces the point with our largest trade partner: best not attempt to negotiate with Trump… better wait unit the next president arrives.
The problem with that scenario is that our markets are extremely myopic. Stock traders and retail investors are continually looking for a quick profit and ignore the larger trends. [As we have noted, the bond market is far more metered in their views and heavily focused on long-term trends.] China, on the other hand, can afford to wait a few months, years or even a decade. Chinese tradition is for the long play, as they have done time and again throughout history. That perspective, with the harsh realities of their control over our financial well-being, does not bode well for an impetuous strategy of bullying and pandering to populist rhetoric.
Chinese control of our economic levers is extensive. We depend on cheap Asian imports to keep our consumption economy sated while avoiding damaging levels of inflation. We need China to buy our agricultural products in order to avoid a further expansion of our trade imbalance. Like it or not, we have already handed over much of our industrial intellectual property — sometimes deliberately and sometimes not. And finally, China is the largest single holder of U.S. debt — over $1 trillion of it. In a sadistic twist, we depend on China to loan us money, to pay the subsidies to the farmers who now cannot sell their product to Chinese consumers. Well done.
The final irony in this trade war with China is the choice of imports to place a new tariff on. Namely, consumer goods ranging from iPhones to children’s clothes are what have kept America’s economy growing this year. With a 10% tariff on consumer goods, Trump not only angers our most important trade partner, but risks pulling the last leg out from under the economic expansion.
Populism is a very dangerous tact. It rarely creates long-term stability, yet often brings out the worst in a society. As we saw from horrific violence this past weekend, some individuals will take populist words literally and act on them without regard for human life. Once the pandora’s box of domestic terrorism is opened, there are few tools to halt that type of violence without widespread suspension of civil liberties, a slippery slope that has created many dark histories.
That said, this particular market volatility is not unusual, nor worrisome. As you can see in the chart below, we are still holding levels that were as recent as May. If you recall, it was four years ago in August 2015 when China also devalued the Yuan in an unexpected move that rocked the markets, and ultimately generated a 10% drop in U.S equities. In the past week, we have experienced a 6% drop as of this writing, a well justified correction given the economic fundamentals and the bond market yields over the past few months. With equities finally catching up to the rest of the world, the real risk is what our leader decides to tweet about next.
– DBM
Chart – S&P 500 from May 8 until August 5, 2019 showing the daily trading ranges. While the market is down 6% in just four trading days, it still sits above the last set of lows in May. For this decline to continue we would need to see further erosion in the economic data. Source: Bloomberg