Happens fast. Welcome to protectionism (aka retaliationism) built upon the doctrine of trade deficits. I was hoping that the Trump administration was, at least, smart enough to posture some kind of pokersim regarding implied tariffs. However, today Gary Cohn resigned after refusing Trump’s ultimatum to support the tariffs. Cohn resigning is a big red flag that shouldn't be ignored. With Cohn out of the White House, economic policy of ‘America First’ will replace globalism over the next three years.
It was just yesterday we saw the market rally within the first few minutes until Steve Mnuchin announced he supports the Trump trade tariff’s. Tariff’s reflect the opposite of peace and cooperation; they produce trade retaliation, divisions, and economic contraction forced by higher prices. The latest research report from Goldman Sachs referred to this economic plan as ‘draconian’. In his Congressional testimony, Mnuchin couched his words by suggesting tariff’s are warranted but the country is ‘not looking to get into trade wars.’ Is this idealistic outcome possible? Not if you listen to Europe, Canada, Mexico or China who have each threatened retaliation. Unfortunately, it’s small-minded to assume this ideal outcome. Gary Cohn staged a last ditch effort to convince Trump to abandon this protectionist policy by inviting a group of CEO’s to the White House who will lobby to avoid steel and aluminum price hikes. The anti-tariff meeting is scheduled for Thursday. This meeting, along with comments from Paul Ryan, gave the market hope that Trump won’t follow through. We’ll see how it plays out now that Cohn has resigned.
The U.S. trade deficit climbed 16% year over year in January to $56.6 billion. During Trump’s first year in office the trade gap rose to $566 billion. Balancing this deficit is now Trump’s top priority. The current form of globalization in which the United States consumes and the rest of the world exports has been in place for decades in a world that is naturally an uneven playing field. The U.S. consumes because of its wealth. Other countries can’t support a consumption economy because they lack the wealth. The system works for this reason. Trade deficits have always been viewed as a joke because of this wealth discrepancy that favors the U.S. Yes, the U.S. carries a trade deficit but it’s a good deficit because we utilize the entire world as a marketplace. It’s for this reason that the United States has always acted like the adult in the room when lesser economies enact tariffs. Our lack of trade retaliation is what has kept globalization humming. This form of economic maturity/restraint by the United States has now changed. We expect steel and aluminum tariffs to be the first of many. Rumors are already swirling that a broad based ‘border tax’ is being discussed to include thousands of additional tariffs. Wilbur Ross now has the support of the president and treasury secretary to balance the trade deficit . We see three potential scenarios unfolding:
Scenario #1 ‘The Obvious Correction’:
Relevant statistics are filling the airwaves… 99.9% of the world believes U.S. tariffs will lead to trade retaliation which will produce higher prices which will result in economic contraction. Fear and panic will soon replace confidence. Especially when you throw rising interest rates into the equation. The very intent of tariffs is to incentivize domestic production and kill the growth of globalism. It’s a painful transition from globalism to economic nationalism that will take many years to implement. At the very least, it makes sense to forecast a 30% correction to Dow 17,400 by October 2018 similar to the 2002 precedent caused by George W Bush’s steel tariffs. Why is Trump implementing tariffs now? Perhaps the threat of China’s petro-yuan is greater than most think. China’s act of economic aggression is being countered. The U.S. debt machine is unsustainable in a world of de-dollarization. This trade war threatens to demolish China’s export-heavy economy before petro-yuan gains traction. Another theory for why now? Trump needs a war to create a diversion away from Mueller’s investigation. If there was no Mueller investigation, would Trump still be doing this? It’s a legitimate question that we don’t have the answer to.
Scenario #2: ‘Positive Sentiment via Market Manipulation’:
What if the market doesn’t drop? What if the market rejects this risk like it did during the lowest volatility period in history between February 2016 and February 2018? What if the plunge protection team is able to manipulate sentiment by shorting the VIX and buying the S&P 500? Very likely what would happen: President Trump would claim his greatest victory. That’s how powerful the stock market is. Trade wars could decimate global growth but if the stock market goes up, Trump gets to cherry pick minority data such as rust belt manufacturing or Pennsylvania steel growth to declare victory. It seems impossible that the stock market could withstand trade wars but we live in an era of unprecedented central bank intervention that didn’t exist in 1929 or 1987. The lesson of the past two years is this…we can do whatever we want as long as stocks are stable. It's largely for this reason that the stock market has largely always riddled the bears and smoked short bets.
The problem with this scenario is that the financial sector will be hit with a barrage of defaults if economic growth contracts anywhere in the world. Defaults lead to runs on the banks which causes contagion in our global financial system of derivative risk. The other problem would be rising p/e ratios if stock prices fail to reflect corporate earnings declines. It’s difficult to manipulate forever before the bubble gets in the way. Since January 26th/Davos, central banks have been willing to let free markets act as free markets.
Scenario #3: ‘The Negotiator’s Bluff’
Rather than an actual trade war, the bluff of a trade war could open the door to renegotiate trade deals around the world. This renegotiation could remove a majority of existing tariffs which would improve the United States’ competitive advantage. Under this positive scenario, the stock market would boom as our economy participates in globalization like never before. Immediate portfolio rebalancing would occur here & exposure to longs would take place under this scenario.
The problem with this scenario is that the U.S. has the highest labor costs in the world which keeps us at a competitive disadvantage. The other problem is that Gary Cohn did in fact resign which implies this is more than a negotiation tactic.
Which scenario do we expect to materialize? 60% chance of a correction. 30% chance of market manipulation. 10% chance of improved trade. The next six months have opened up a massive window of opportunity. Our bias is negative but we may utilize hedges knowing that market manipulation could occur. The bottom line is that it’s not a good sign that Gary Cohn resigned. We’ve seen this trade war movie before. We’re about to repeat the mistakes of past generations. Nobody wins with a tariff. Trump is hiking the cost of goods at a time when discretionary income is already under pressure because of weak wage growth. He’s doing it at an overvalued market top. This is likely to get uglier and uglier with each announcement of retaliation.
Our next momentum points are to add to our $SPY puts below $270, our $XHB puts below $40, and are now considering the $XLF (Financial sector ETF) puts below $28. We may also add further exposure to the GBTC. MGTI is fleshing out a long awaited bottom and the next bull cycle is likely right around the corner. MGTI is waiting largely on Bitcoin to make it's move. Bitcoin breaking out above $11500 - $12,000 range will catalyze a reactionary chase on Bitcoin and give it the energy to retest the $16500 area. We're sue to see MGTI run with it. Our $TLT puts might need to be sold if TLT rises above $119 as investors seek relative safety in bonds. Furthermore, we plan to soon be entering a short trade on Apple. Dare we do ...we're going to lay out the full technical trade setup showcasing evidence for why Apple's next cycle is gearing for a downwards trend. You remember when we were laying out the inverse thesis getting long on Apple in several areas in a combination of common & options trades since $96 $104 $108 $119 and so on. That bull cycle took time to materialize but when it did, it was one of our most rewarding trade setups in 2016 & early 2017. Now we're going to highlight the bear thesis as it starting to make itself known due to a ripening confluence of technical & fundamental weakness which we will address. Between MGTI & AAPL, I wouldn't be surprised
New Setups are being cultivated. We will be striking hard once we get clarity on market direction contingent upon fundamentals syncing with price action. Right now there is no need to play cowboy and make any earnest bets until this unfolds. It will resolve itself inevitably.