A deal to calm down the stock market

Yesterday we had a splendid example of the market not knowing how to interpret news and falsely deducing it was fake. At least one important FX site reported the US contemplating a cut in projected Chinese tariffs was fake news and rallies in currencies like the euro and AUD should be ignored. But the story was true. TreasSec Mnuchin told the press he favors lifting some tariffs as a strategy to improve the tone of trade talks and make some real progress.

The problem, of course, is that offering concessions is not consistent with the Trump style and Mnuchin is not the lead guy on trade. That would be Trade Rep Lighthizer, who sees compromise as weakness and will say only in response to the Mnuchin story that everything is on the table. He is supposedly under pressure from Trump to get a deal to calm down the stock market. The WSJ also reports China is sending vice ministers next week for talks with Mnuchin and Lighthizer. Oh, to be a fly on that wall. 

It’s all very murky. But it’s not fake news. Be careful what you read. To be fair, it’s improbable that the trade hawks will lose to the more reasonable and competent TreasSec. The core of the story is not credible in the context of the parties involved. But it’s also true that Trump never has a plan—he improvises everything. So, unlikely not impossible. Later various parties, including the Treasury, issued denials that the discussion about cutting tariffs even took place.

Consider the AUD, a primary beneficiary of any improved China trade deal. It spiked from 0.7170 to 0.7221 in a single hour on the story, or 51 points, almost triple the average true range. The AUD then fell back to 0.7172 twelve hours later, hanging on to a mere net two points. But off the low the day before at 0.7089, it’s was a 62% retracement. You can judge the story improbable but it’s still unwise to dismiss the simple fact that the market believed it and may return to believing it, chiefly because we want to believe it.

What to Worry About Today: Confirmation Bias.

Yesterday we saw a headline asserting “No valid reasons to buy euros.”  This got our back up, because we say the eurozone has one very big reason for folks to buy its currency—Mr. Draghi. We have no doubt he is going to dance through the minefield of tapering, shoring up zombie banks here and pushing some stimulus there (selective long-term repos, probably).

The negative-euro story named as reasons not to buy (1) China slowdown (2) Brexit and (3) final CPI at 1.6% y/y from 1.9% in Nov, implying the ECB will have to delay its first rate hike.

We say none of these pass the “so-what?” test. A key reason investors chose a currency is confidence in its central bank to guide the economy. Draghi may have said it long ago (2012) but his mantra remains in place—“whatever it takes.” The rickety and inefficient financial sector soldiers on with minor improvements here and there. The sclerotic European parliament will get a long-overdue shake-up in May.

If you want to sell euros, a better argument might be that Draghi leaves office in December. Pundits blather on about whether he will get that first hike before leaving. Bah. What matters more is what the next guy will do. 

A single data point—the inflation data—should not drive a currency. A single central bank chairman statement, yes. But not a single data point.

Where does the negative story come from? We have a theory. We didn’t see anything too terrible on the chart that accompanied the story, but the author surely did. Humans have a terrible tendency to confirmation bias—seeing what you expect to see. Charting gets some blame for inducing a conclusion and then going back to find reasons for it—the exact opposite of the scientific method, which says study the data first, then deduce. We draw a line and expect it to become support or resistance. We draw a Fibonacci retracement or pivot points or interpret a candlestick, and expect the theoretical outcome.

Nearly always you can erase the lines and draw news ones or introduce new indicators to come up with the exact opposite conclusion. Often just changing the timeframe (from daily to hourly, for example) changes the outlook. And we lack any statistical basis to suppose one line or indicator is any better than the other one. That leaves us at the mercy of commentators who hardly ever have skin in the game and lack a track record.

Just saying. Be careful what you read.

Outlook:

We get industrial production today, likely to show a slowdown, but with the manufacturing component up by about 0.3% after a flat November. For context, consider the tradingeconomics.com information that industrial production has averaged 3.73% from 1920 to 2018. In November, it was up 3.9% y/y after 3.8% in October—higher than the long-term average. See the chart.

Any negative response to today’s data should be a flash in the pan. Slowdown, maybe, but it would take a giant drop to justify any judgment of recession, yield curve notwithstanding. What triggers angst is not the data, but rather the misbehavior of the government. Bloomberg writes “Analysts expect the shutdown to end by mid-February, warning that if it drags on through March it would cause growth to drop below 2 percent for the quarter.” 

This is the kind of thing Trump needs to avoid. Is it a sufficient incentive to prod him into a change in performance? As long as the stock market is okay with the shutdown, maybe not. But if it’s true that he is shoving hard on the Trade Rep to get a China deal, maybe he is becoming more sensitive to the deeply negative effect he is having on the average voter. Bloomberg had one of its cute statements the other day, that the federal employees being forced to work without pay may not have been Democrats going into the shutdown but became Dems PDQ. Trump doesn’t care about the economy except insofar as it reflects himself. He doesn’t’ care about the Average Joe unless that person is part of the base. 

Uncertainty is high about the upcoming data from everywhere, not just the US but China and Europe. Worse, uncertainty about policy is high, starting with Britain even if the US is louder. Somewhat weirdly, the markets are taking all this uncertainty in stride. Any reduction in uncertainty is another nail in the dollar’s coffin. Since Trump wants a weaker dollar, maybe he can be incentivized to clean up his act for that reason alone. Surely Kudlow and Mnuchin are telling him that…

Tidbit: We are holding a naming contest. Our old desktops were named George and Gracie. They are going into retirement in the closet. We need a name for the new Dell. Please propose a name, not too obscure or cute. Winner gets a free copy of the 4th edition of Technical Analysis for Dummies, due in late summer. We have to revise/write it first. We will show the suggestions and readers can vote. Names of contestants and winner will not be disclosed (unless winner wants the glory).  Here are some of them. We will winnow the list over the weekend.

HAL+

Riddles; Trixie

Spot

Murphie

Gesualdo

Leonardo

Max

Sigmund

Milton, John Maynard

Compte Rendu

Mario, Nico, Marcelo, Vito, Rocco, Enzo, Bruno, Cosmo, Luca

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