Quotidian Investments Monthly Commentary – May 2019
Following four consecutive months of substantial recovery from the 2018 correction it is in the nature of equity markets to then pause for breath with another short-term correction. In the middle of May and from a clear blue sky, therefore, global equities suffered a markdown in prices which has taken some of the gloss away from the sizeable upward momentum that had been generated since the start of the year.
It is blindingly obvious that market analysts simply do not know how to interpret the ongoing negotiations between China and the USA in pursuit of a comprehensive trade deal. It is equally clear that in the absence of intelligent and reliable analysis, simply negotiating their way across the road unaided seems to stretch market maker’s ingenuity and imagination to its limits and so they find it much easier to simply put a red pen through equity prices across the board until a greater degree of clarity emerges.
As a consequence of that we are currently seeing exceptional levels of volatility once again but, as has been re-inforced historically (and particularly reasserted over the past six months) equity markets inevitably bounce back and resume their upward momentum. That assertion is supported by the fact that (despite market-makers inate pessimism) the last two quarterly earnings seasons in the USA have indicated that its strong economic progress continues. The best US companies have produced brilliant corporate results which provide proof positive that, in the real commercial world, they continue to show growing sales and increasing profits.
This latest spat in trade discussions between the USA and China was triggered by a series of tweets from President Trump threatening to impose another range of tariffs onto Chinese goods. This blatant negotiation tactic simply follows a well-trodden and familiar path and is becoming rather tedious to observe. The retaliatory tariffs then imposed by China fall mostly onto the US agricultural industry. For example, the highest in the Chinese range of tariffs (25%) are being applied to peanuts, spinach, sugar, wheat, coffee, chicken and turkey. The Chinese equivalents of Charley Brown and Popeye will clearly be in the van of those who will suffer worst!
The rest of us look skywards for divine inspiration and, on earth, to the Dalai Lama for guidance in the skills of patience and the control of exasperation! One of the largest US market making operations at least had the grace to admit that equity pricing during this month’s correction has been nothing more than guesswork.
On 31st May 2019 the FTSE100 index closed the month at 7,161.70, a fall of -3.46% in the month of April itself and it now stands at +6.44% for the 2019 calendar year to date. By comparison the Quotidian Fund’s valuation at the same date shows a fallback of -9.71% for the month of May and the Fund is now up +12.67% for the 2019 year to date.
Analyst’s reports are jam-packed with ‘if, could and possibly might’ which serve to illustrate their lack of certainty and inate preference for negative pricing. It is often just guesswork with a bias towards negativity.
By a process of thought that raises more questions than it answers about the inate negativity and self-interest of the investment industry’s highly esteemed market makers, it obviously makes great logical and economic sense to them in that the most severe markdown in equity prices have been applied to the technology sector.
We recognise, of course, that the revenue exposure to China of companies like NVIDIA and Broadcom (who earn 50% of their revenue from that market) leaves them exposed to the possibility of further retaliatory actions. The situation with Huawei and the major US chipmakers being under Presidential diktat not to supply it with hardware or software is also concerning the stock-market but we simply don’t yet know if China will make any additional retaliation and, if so, what form that retaliation will take.
Following Trump’s latest round of tariff increases Chinese negotiators made a particular point of saying that China would not ‘weaponise’ its financial holdings in the USA. That statement is, of course, a shot across the bows and a thinly veiled threat of the economic damage that might be caused to the US if China so wished. For the moment that is just a negotiating stance…..but it could give Trump pause for more profound thought and a modification of his tactics. Rarely, if ever, has Trump had to negotiate with an adversary who has at least equal, if not greater, financial power than himself.
Thus the financial incompetence, economic illiteracy and sheer commercial idiocy of Obama’s years in power still acts as a brake on the US economy today. Obama’s spendthrift regime was financed to a large extent by the issuance of Treasury Bonds (the US version of Gilts in the UK) and which are essentially cheap and seemingly “risk-free” loans to the government from bond investors. China now holds the eye-watering sum of $15.9 trillion in T-bonds which (in addition to its huge equity holdings in US stockmarkets) gives it enormous financial leverage in current trade negotiations. As ever, there is eventually a price to be paid for the Obama regime’s period of deliberate gross over-expenditure.
On the positive side of that both parties are fully aware that a comprehensive trade deal will be in the best interests of both countries and so I have little doubt that a fair and reasonable trade deal will ultimately be agreed. However, Trump needs to understand the vital importance in Chinese culture of not losing face. China’s response to Trump’s standard approach of bullying tactics will be key to whether an early resolution of this ongoing dispute will be agreed. The Chinese simply will not be humiliated or forced to back down. Our view is that the current bout of equity market weakness will actually put US/China trade talks back on track.
On the more pessimistic side, there are differing economic views on how serious a long period of dispute would be and the current stock-market turndown is based entirely on the easy option of just marking down prices. Against that, Goldman Sachs research believes that the effect on economic output of an extended trade argument would be less than 1% in both countries and therefore would not be drastic.
Another positive signal is that a cut in US interest rates in 2019 is now rated by currency markets at over 80% and that would provide a very constructive boost to equity markets.
Less tangible but more interestingly, Trump is obsessed with the strength of the US stock-market as a proxy and measure of his success as President. He knows that his chances of re-election in next year’s Presidential election will largely depend upon the US markets being much higher than they are today and there is little doubt that he will seek to secure the support of Wall Street with that aim in mind.
The final trading day of May added insult to an already poor investment month. Another surprise tweet from Trump gave advance notice of tariff sanctions to be applied to Mexico (despite a recently executed free trade agreement) if the Mexican government do not do more to restrict illegal immigration to the USA. The usual Trump tactics and no doubt they will facilitate the velocity of Mexico’s compliance. But the immediate knee-jerk reaction from market-makers was to create another round of equity price reductions in all global markets.
We remain of the opinion that this a a time to keep clear heads and hold our nerve. May’s nonsensical market action and unnecessary price reductions will pass and equity valuations in the US will return to a point where they properly reflect the reality of growing corporate profits and increasing future sales.