BotTrigger Trade Alert: $EEM Limit order to buy the June 2019 $45 strike PUTS @ $4.00 | 5% allocation | 9/5/18
BotTirgger Trade Alert: $BABA limit order to sell our November $180/$210 Vertical Call Spread @ $7 ( not $7.50 which was our entry, but $7). We may even sell it sooner at a lower cost pending the quality of the next bounce. We'll go over why below.
We want to catch these EEM puts on the next bounce within this larger bear trend. Right now the $EEM (Emerging Markets Index Fund) June 2019 $45 strike puts are trading around $4.90 in value. We should see that value come down on the next bounce when the EEM snaps back to the median 21 EMA (exponential moving average). Both the technical backdrop & ensuing narrative give this bear trend legs to head further south.
This emerging market collapse may have legs. Last week’s market was quiet despite the looming impact of $200 billion in Chinese tariffs and weakening currency conditions in Turkey, Argentina, South Africa, Indonesia and Brazil. If these Chinese tariffs are implemented later in the week, it should further strengthen the dollar and pressure emerging markets. The expected Fed rate hike on September 26th will also add relative strength to the dollar. After a terrible month of August, investors are unsure how much more pain these emerging markets can handle before contagion sets in. Global debt is $169 trillion, up from $97 trillion on the eve of the Great Recession according to the McKinsey Global Institute. Previous debt crisis involved households and sovereign governments, this time the concern centers on corporations in emerging markets that borrowed heavily in dollars. Turkish companies borrowed to finance bridges, hospitals, power plants, and port developments. European banks lent freely in search of higher returns in order to take advantage of low rates from the Fed and ECB. Well, those bills are coming due at a time when the strengthening dollar and sinking lira makes it increasingly expensive for Turkish borrowers to pay their dollar debts. Paying off a $100,000 loan at the start of 2018 required 379,000 lira. Now, that same loan would take more than 660,000 lira. The free money is going away. As Trump/Mnuchin/Powell/Ross continue a protectionist policy of tariffs, sanctions and interest rate hikes it is engulfing emerging market economies. Turkey is the beginning. By itself Turkey carries minimal systemic risk. But if you combine the impact of defaults from the ‘fragile five’ of Turkey, Brazil, Indonesia, India and South Africa then the derivative risk starts to become meaningful. Today’s note from the Brookings Institute reads, ‘In an era of interconnected markets and global supply chains, the current trade tensions between the U.S. and China are likely to have significant contagion effects around the world.’ As U.S. markets reject the risk of a Chinese trade war, one proxy stock being used to price a Chinese trade war is Alibaba. BABA is -$5 down to a market cap of $442 billion compared to its American counterpart Amazon which saw its valuation briefly surpass $1 trillion on Tuesday. With so much exposure to China Apple should also be trading as a proxy for a trade war, nevertheless, AAPL has rallied $11 over the last week as BABA declined $16. The market isn’t sure what to think. The proposed tariffs could go into effect as soon as Friday. It’s unclear whether the new tariffs will be set at 10% or 25%. As information is released, the market will be forced to deal with this unpleasant risk variable. Beyond tariffs, a strengthening dollar and emerging market contagion the biggest risk catalyst remains Mueller’s investigation. The timing of Mueller’s wrap up is uncertain. Rudy Guiliani had been pushing for a September 1st deadline but that obviously did not happen. In Bob Woodward’s new tell-all book about Trump’s White House, he reports that Trump’s former lawyer John Dowd ran the president through a mock interview which Trump failed. Dowd told Trump, ‘Don’t testify. It’s either that or an orange jumpsuit…You are not a good witness. Mr President I’m afraid I just can’t help you.’ Dowd resigned the next morning according to Woodward’s timeline of events. This qualifies as one more account that should make investors nervous. September promises to escalate the legal war against Trump, the trade war against China and the oil war against Iran. In order to properly sync with these three catalysts, we are adjusting the momentum purchase point for SPY puts from any price under $280 to any price under $286. For QQQ puts we’re adjusting from any price below $174 to any price below $182. Our BABA long position is now at risk of the recovery period we had forecasted for which was on the high end to stage a 13 week recovery. With today's price action breaking a below a major key support level, we have to heed that as a shot-gun warning that BABA revisiting it's $210 highs before November may be a busted trade thesis. We will be looking to sell our BABA position on the next bounce. We still have plenty of time for that bounce to occur and get out of the trade unscathed near or at break even. $GLD calls are being added to the watchlist just in case this proves to be the month when market weakness begins. GLD has dropped from the high $120’s in April to $113 today. A basket of SPY/QQQ/EEM puts and GLD calls represents a good watchlist of possible hedge allocations should market leadership falter over the coming weeks.
Of the most traded EM currencies four have weakened between 10-20% (Indian rupee, Chilean peso, Russian ruble and South African rand), one has dropped 30% (Brazilian real), and two have declined more than 40% (Turkish lira and Argentine peso). The root cause of everything we’re seeing may very well be the petrodollar. Remember last December when President Trump referred to China’s launch of petroyuan as an act of ‘economic aggression’ and an effort to ‘undermine international order’ via de-dollarization? Well, we haven’t heard anything from him since. Why? Somebody must have advised the president to stop talking about it publicly. Since that time, however, much has happened. American financial leaders are working to strengthen the dollar via tariffs, sanctions and interest rate hikes. Is this policy being put in place to lessen the de-dollarization blow of petroyuan? Perhaps. After launching in March, petroyuan is ready for its first crude oil contract delivery in September of 600,000 barrels. For the first time since we left the gold standard 45 years ago, the dollar no longer has a monopoly in the global oil trade. Countries like Russia no longer need to hoard dollars in order to purchase oil. Ordinarily, this would be a massive problem for the issuance of U.S. debt. It should be a massive problem for the value of the dollar. But…the dollar is strengthening. How?
From the perspective of a currency war, Trump is doing an incredible job of supporting the dollar. In the face of all common sense, he’s relentless on tariffs. He passed tax cuts than enabled repatriation. Buybacks are supporting U.S. stocks. PPT helicopter money is propping both bonds and stocks. He brought in Larry Kudlow to replace Gary Cohn; Kudlow built his career as a strong dollar advocate. He brought in Jay Powell as Fed Chairman who is systematically raising interest rates. What comes next?
There are three primary effects that need to be managed in a strong dollar enviornment. First, emerging markets suffer from a lack of liquidity. Trump/Powell/Mnuchin/Ross show no interest in bailing out these struggling EM’s. In fact, they’re trying to make things worse. We expect this ‘America First’ policy to continue. If EM’s no longer require dollars to purchase oil, then the U.S. needs to manufacture another reason to own dollars. How about an EM currency crisis? Sell your Argentine pesos and convert into dollars. Sell your lira and buy dollars. It’s already happening. The allure of strong U.S. employment and a strong stock market is working. The second effect of a strong dollar is the downside pressure in puts on oil prices. There’s an inverse relationship between the value of the dollar and commodity prices. Much of the world still uses petrodollar. The higher the value of the dollar, the less demand there is for oil. The only way to keep oil prices high during a strong dollar cycle is to manufacture an oil shortage. This helps to explain Iranian sanctions. The third effect of a strong dollar is that American multinationals sell fewer products abroad. To help ease their pain, Trump passed domestic tax cuts.
There are no coincidences in currency. A country is only as strong as its currency. Make no mistake, China initiated a currency war against the dollar with its launch of petroyuan. This is why Trump is on the verge of implementing $200 billion in Chinese tariffs. This is why the dollar is being supported so vigorously. This is why emerging market currencies are collapsing.
Today the Dow is +40 but BABA is down another $6 and EEM is below our momentum point at $42. Technical action is showing it’s time to enter a portfolio hedge to protect us from this currency war. We intend to purchase of a 5% allocation of EEM June 2019 $45 puts upon the next relative bounce @ $4.00 cost.