The Fed is not the cause of the current stock market drubbin

What to Worry About Today: Principles and norms.
The absence of principles and norms in the behavior and statements from the White House is more than worrisome—it's horrendous. We pretend that we like mavericks and those who think outside the box, but in practice our mental health depends rather a lot on the normal and customary outcomes. We'd like to ban the phrase "thinking outside the box" permanently from American usage. All too often it means doing the unconventional because the actor is pig-ignorant.
Thus nobody told Trump he had to attend the French cemetery ceremony and Arlington on Armistice Day. Trump, of course, lied about the Secret Service not permitting him to go. And just as Trump favored Putin over his own intelligence community in Helsinki, yesterday he disregarded the CIA report (cleverly leaked ahead of time) and favored the Saudi story that the Crown Prince was not behind the murder of a US resident and journalist in Turkey. Trumps' explanation is that the Saudis are more important for business reason than a single murder and angering them would send the price of oil too high.
Trump also insulted the leader of the Osama bin Laden raid, the 4th or 5th case of denigrating well-respected military leaders, not only factually wrong but triply awful from a draft-dodger.
Nobody expects a coup, of course, but the old talk about whether the military would obey a Trump war order has to be on a few minds. Again. And a foreign entanglement is just what dictators do when domestic conditions get uncomfortable. Creating a common enemy creates some unity at home. Luckily, this time we have the US-China trade war instead of a shooting war and that should keep the Liar-in-Chief busy for a few more weeks.
Trump's behavior is shameful. It's hard to imagine the voters would re-elect him. In a few weeks the campaign for the 2020 presidential election will begin. The world will not forgive us if we re-elect this monstrous man. He is worse than a buffoon and boor. Now we need a guy in a bow-tie who goes to church every Sunday and wore the uniform.

 

Outlook:

The data calendar is full today and includes jobless claims, durables, existing home sales, consumer sentiment and the Baker Hughes rig count.

What we should be pondering is not the data, but two developing stories. First is the sense that the current expansionary cycle is ending. It's not, but we can't say conditions will clearly be even better next year. The risk of the Fed going through with three more rounds of tightening on top of the December hike is too high, though. The Fed is not the cause of the current stock market drubbing, but it can be made the villain if Trump keeps saying so. Yesterday he said he'd like the Fed to cut rates, a strange thing in the context of a plan to hike four more times. If anyone else were saying such a thing, we'd laugh at the crackpot.

As for the expansion ending, the OECD pulled one of its dumb stunts and said the world should start coordinating fiscal policy stimulus. The OEC has cut its forecast for global growth for the next two years to 3.5% and warned that "an interaction of downside risks would reduce that pace further."

What bilge. Name any time in all of history when countries coordinated fiscal policy. And who says we need stimulus? After all, we are a bit worried about over-indebtedness, if not in the US, in other places as widespread as Italy and China. Stimulus pretty much always entails higher debt, as we are seeing in the US. At the same time, we have no reason to suppose the US economy is overheating and the Fed needs to step in. In fact, the US economy could roll along in fine fettle with just the one last hike this year. At this point, we need the extra hikes next year only to preserve the reputation of the Fed.

It's not Goldilocks, but it's not a crisis, all 30 Dow components aside. It's normal if outsized stock market volatility. Corrections come and corrections go. Interfering with them is hardly ever done for the simple reason that the unknown consequences really are too scary. Stock market interventions are rare and usually confined to truly existential problems. For the market to imagine Trump interfering with the Fed to interfere with the stock market is not only abnormal and unconventional, but too awful to contemplate. All the same, that's exactly what we have been predicting. China first, probably.

The meaning for the dollar is not clear. If the Fed is forced to retreat, presumably the dollar slides downward. If the trade war with China gets super-scary, presumably the dollar benefits from risk aversion. Take your pick. And remember, when in doubt, head for the cross-rates.

Investment Advice: Avoid complications.
We liked the KISS principle the first time we heard it—keep it simple, stupid. The world is already complicated enough that we don't need to invent complications. Unnecessary complications include covering every single factor before making a decision. For example, the European Commission could agree to the Italian budget with one—just one—structural reform. In return, Italy could give up one—just one—of its ambitions. Nobody has a crystal ball in economics, anyway. The EC doesn't know for sure that Italy's debt will lead to catastrophe, just as the Italian MoF doesn't know for sure that offering support to the long-suffering will spark growth. The benefit of simplification accrues to both sides. The EC looks less hidebound and Italy looks less reckless.
Earlier this week El-Erian had a piece in the FT saying investors have to pull up their socks to get through the upcoming period. Normalization would be a lot better for equity investors if we had solid economic growth and not the slowdown and divergence we are starting to get. El-Erian is warning that what was rare indeed was last year's synchronized growth.
Now we return to more ordinary conditions. The world has long lived with divergence in growth rates. The world has long lived with EM's getting overindebted in hard currencies they cannot always repay. Oil prices go up and oil prices go down, in part as an adjustment to those same growth rates we worry about.
El-Erian's focus is on what the investor should do now. First would be to reduce over-exposure to certain sectors like tech, some of which was inadvertent. People forgot to rebalance, or got greedy and stuck with tech too long. He calls this a "technical" response. Second is to cut exposure to EM's, which he calls "behavioral." Third is to get out of index-driven or passive investing, which are the most vulnerable to panic over-selling.
"Outperforming in the latest period is likely to require a greater amount of active investment, a significant degree of patience and resilience as well as a sharper focus on upgrading liquidity and credit quality." And more contingency planning for tail events.
El-Erian doesn't say so, but this feels a bit like 1999 to us. People with almost no investing or trading experience made fortunes buying stuff that had no return at all and sometimes no earnings, just a thrilling idea and a well-told story. These newbie traders thought they were smart doing "momentum investing" when really they were just lucky enough to get on manic bandwagon. We made some sarcastic comments at the time about momentum going both ways. And sure enough, in early 2000 we got the tech wreck. El-Erian is not predicting another tech wreck, at least not in this article, but the inference is clear—easy days are over. To make a decent return, you have to be active and very, very careful. We say a lot is going to fall by the roadside. ETF's, for example.
And as usual, currencies are going to take more of the blame than they deserve. It's the fault of the dollar being too high (or too low). Or the yen, or sterling. This is a cheap shot. It's also not true. While currencies may be the pinnacle of high finance, they are also the same buy low-sell high money grubbing as any other speculative endeavor. Currencies do not cause crises in other financial classes--they reflect them. And well nigh perfectly, too, since they tend to follow crisis-reflecting yield spreads fairly closely and otherwise respond consistently to a handful of other factors. Don't get tangled up in complicated narratives that link causes and effects in seventeen asset classes and ten economies eighteen ways from Sunday. Keep it simple.

Note to Readers: There will be no reports tomorrow or Friday. Tomorrow is a national holiday in the US and conditions will be knifeblade thin on Friday.

 

 

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