Are You Bullish or Bearish on the US Stock Market through 2018?

At the risk of curbing anticipation over what Fed Chairman Jerome Powell might say at next week’s annual symposium in Jackson Hole Wyoming, it is unlikely he’ll say anything that you can use to trade the markets over the balance of this year. Why? It’s not clear that the Fed knows what’s likely to happen nor could it tell us if it did without running the risk of bursting the global financial bubble that it, along with other central banks, has blown since 2008. Secrecy and uncertainty have been instrumental in keeping the market “bears,” most notably the “short sellers” away.

Most informed observers know that the global economy is slowing and that Mr. Powell’s policy to continue raising interest rates, ostensibly because growth is strong and inflation is rearing its ugly head, is making matters worse. Higher rates strengthen the US dollar, which is deflationary to our own economy and exacerbates the woes of most emerging markets. I believe the real reason the Fed is continuing to raise short term rates is because financial institutions, especially insurance companies and pension funds, desperately need higher rates to function properly. Also, raising rates will provide leeway for the Fed to lower them and offer some relief to the markets when (not if) the next financial crisis occurs.

Mr. Powell has the financial markets exactly where he wants them right now, completely uncertain as to what’s actually going on or what action the Fed might take in the weeks ahead. And there are plenty of reasons for the market to sell-off and plenty for it to rally into the New Year.

The bad news is that while many are concerned about inflation, there is still tremendous global deflationary pressure demonstrated by the more than half of commodities, and most notably gold, that are in “bear” markets (i.e., greater than 20% decline), and the fact that almost all have had at least a “correction” (i.e., greater than 10% decline). Many emerging markets have declined and some are on the brink of financial crisis, and with the exception of the US stock market, most global markets are performing poorly. Making matters worse is that the global yield curve (which compares long to short term interest rates) is inverted and copper prices have tanked recently, both signs of bad economic times ahead.

Those poorly performing international markets, and the fear they could worsen, is one good reason the US market might continue to rally, as a steady inflow of offshore capital keeps our markets afloat. Corporations flush with offshore cash liberated by this year’s tax reform could also keep the party going as major corporate buybacks continue this fall. And, if all else fails, history has shown that Q4 is critical to the entire year’s economic welfare, so don’t be surprised if the Fed provides some “unexpected” interest rate relief to goose the markets into year-end, assuming a major crisis doesn’t occur, in which case all bets are off.

Just be aware that even if the US market rallies into year-end, it could severely correct before, perhaps during the next several weeks. So, are you bullish or bearish?

Is it Possible to Negotiate Fair Trade Practices With China?

I applaud the aggressive approach that the Trump Administration is taking on trade with China and it is difficult to argue that the effort is not only fair but long overdue. China has notoriously flouted long standing trade agreements by engaging in unfair trade practices. Most egregious among them is the stealing of intellectual property from foreign companies, and the least of which is the raising of trade barriers and the manipulation of its currency, the yuan, to protect its domestic industries and boost its trade exports.

The debate over whether the USA or China stands to lose the most in a trade war is really beside the point. The USA is still the stronger, more diverse economy, and the envy of the world because of its transparency, rule of law, depth and liquidity of its capital markets, and the fact that it still possesses the world’s reserve currency, a major advantage for conducting world trade. So, clearly the USA has many more tools at its disposal to wage a trade war than does China. However, the real question is which country is likely to succeed in getting its way as the trade war becomes more protracted and entrenched, which appears to be the case currently. In that regard, it would appear China has the upper hand. The USA must balance the long term benefits of achieving fairer trade, with the short term fallout and criticism from opposing political factions, the media and its citizenry. China is better positioned to present a unified resolve, even if it means sacrificing the welfare of, and suppressing the will of, its citizens to do so. China has the luxury of taking its time, completely unfettered by challenges posed by periodic elections and from opposing political factions.

With the recent abolishment of term limits, Chinese president Xi Jinping is defacto China’s leader for life, which confirms his status as the most powerful Chinese leader since Chairman Mao Zedong. President Trump is midway through a four-year term, and Congress, now controlled by his party, faces a midterm election this fall that could jeopardize that majority; these are political realities he must balance with his desire to negotiate a satisfactory trade agreement for America.

President Xi has the luxury of presiding over a state-controlled and censored media, in sharp contrast to our President that must contend with a biased mainstream media that ridicules him, undermines his strategies, and voices a consistent lack of respect for him and his office.

The real advantage for China is its ability to negotiate freely without regard for the welfare of its own citizens, compared with America where government is responsible to its citizens and must answer for its actions at every turn. As blunt as that statement appears, few developed nations in the world would argue that individual liberties are respected in China. That ability to sacrifice the needs of its citizens could give China the advantage in a trade war of attrition and could mean the difference between success and failure in those trade negotiations.

Knowing these facts, if you were President Xi, would you give an inch in these negotiations, or would you sit back and wait to see if President Trump loses either house of congress in the upcoming November elections, thereby further advantaging China in those negotiations? Regardless of the outcome in November, if you were President Xi, wouldn’t you wait to see if Trump is re-elected in 2020, knowing that if he loses the election it is likely that his successor will not have the fortitude and courage of conviction to continue to wage a Trade War? After all after decades of jawboning about the need to negotiate with China, heretofore there has been no real attempt by America’s politicians to remedy that injustice. All good negotiators like to let the negotiations come to them and in the meantime, President Xi can bide his time and watch America’s divisive and ineffectual political leaders win the battle for him.

Is Treasury Secretary Mnuchin’s Move to Reduce Capital Gains Taxes Naïve or Genius?

When I heard the news yesterday, I nearly fell off my chair, not because it’s a bad idea, but the timing in my humble opinion could not be worse. The Treasury Secretary is studying the ramifications of reducing capital gains taxes on investments like stocks, bonds and real estate, by taking into account inflation before levying taxes on investors selling those assets. Capital gains currently are figured by subtracting original asset purchase prices from current sale prices without adjusting for inflation. Obviously, such a move would be seen as favoring the rich who have more assets to sell and would thereby benefit most from such a proposal. In addition, at least in the short run, naysayers contend that the move would further increase our already obscene and growing Government debt, which nobody thinks is a good idea. However, proponents of the proposal would argue that reducing capital gains would in the medium to longer term increase economic activity and ultimately lead to an increase in tax collections by the Government.

Notwithstanding the economic merits of such a proposal, the politics of doing this and doing it now seem to be ill-advised. The Democrats already depict this administration as favoring the rich, there’s all the noise about Russia, world trade and tariffs, immigration, not to mention there’s a midterm election coming in a few months. Why would the GOP propose something like this, that is likely to inflame the media and has NO chance of happening any time soon? It would seem like a bone-headed move, right?

Or perhaps it’s a stroke of pure genius. Stock market followers sensing pending doom in the markets for months may now believe that the recent tanking of market stalwarts like Netflix and Facebook is signaling the imminence of a market correction. If history is any guide, August is a good time for a stock market sell-off. The GOP knows that the only hope of sustaining the heady economic growth recently reported (and give them a fighting chance in the midterm elections) is to delay a stock market sell-off until at least next year. What better way to keep folks from selling their stocks now, but by holding out even the possibility that if they wait until next year, their tax bills will be lower? The genius part of the move is that such a “bluff,” if you will, won’t cost taxpayers a dime and isn’t that a better idea than spending trillions propping up the market by getting the Fed to lower interest rates, print money or restarting quantitative easing again?