It’s not exactly “blood, toil, tears and sweat,” but just “a little pain.” And it’s unlikely anybody thought President Donald Trump was channeling Winston Churchill as he spoke on drive-time New York radio on Friday about the impact that his proposed tariffs could have.
While Churchill sought to rally the British people at the outset of World War II, Trump was taking a different tack regarding the escalation of tariff threats with China. He had proposed tariffs on an additional $100 billion of goods from there the prior evening, on top of the levies on $50 billion of Chinese products the administration previously had announced and which Beijing had countered with equal levies.
The soreness to which Trump alluded was what has been felt in the stock market recently. “I’m not saying there won’t be a little pain, but the market has gone up 40%, 42%, so we might lose a little bit of it. But we’re going to have a much stronger country when we’re finished,” he maintained.
What that 40% or 42% represented is unclear. According to Wilshire Associates, as Trump spoke on Friday morning, the U.S. stock market had climbed 16.31% since his inauguration on Jan. 20, 2017, and by 24.6% since Election Day, Nov. 8, 2016. But that was before Friday’s 2.08% tumble in the Wilshire 5000, which was paralleled in the widely watched averages.
That day, the Standard & Poor’s 500 index lost 2.19%, the Dow Jones Industrial Average fell 2.34%, and the Nasdaq Composite, 2.28%, amid escalating concern over a trade war.
For the week, however, the declines were more moderate, owing largely to pronouncements from Lawrence Kudlow, the newly installed National Economic Council chair. In his unofficial role of Trump bull market spokesman, as he was dubbed here, Kudlow sought to assure investors there was no trade war under way after the initial $50 billion U.S.-China tit-for-tat tariff threats. Nothing has been enacted, Kudlow said on the cable networks, and nothing may be enacted.
Those assurances apparently were good for a rebound of about 1,000 Dow points from the blue chips’ early-week low to their midweek peak. That the S&P 500 managed to close above the key 200-day moving average provided technical support, just as it had after previous swoons in February and March. Whether that’s a self-fulfilling prophesy resulting from traders (human or computer) being programmed to buy at those technical levels isn’t certain, but it is observable.
But the public-relations campaign to assuage fears over escalating threats of tariffs against China failed after Trump doubled down by threatening to place levies on an additional $100 billion of imports. With term limits having been eliminated in China, Xi Jinping effectively is president for life and needn’t worry about a backlash from trade tensions. In contrast, Trump and the Republicans must face the voters, with midterm House and Senate elections looming in November.
It seems no coincidence that China targeted soybeans for tariffs, given the legume’s importance to farmers in Middle America, who voted Republican in 2016. And, as our colleague Brett Arends detailed on Barrons.com during the week, stocks tracked soybeans’ reaction to the tariff threats, falling on Wednesday after China’s proposed taxes, and recovering as trade tensions eased.
So far, however, soybean farmers in the heartland don’t seem fazed by the prospect of heightened tariffs. That’s the intelligence from Renee Haugerud, who heads Galtere, which manages several hedge funds concentrating on global commodity themes. Galtere maintains a 700-acre “research facility,” as she calls it, in the Midwest to keep her ears close to the ground, literally.
From those contacts, Haugerud found that despite the drop in soybean futures on Wednesday, farmers are sticking to their planting plans. The reasons are political as well as agricultural. Her contacts think that if China does levy tariffs on beans the U.S. government would make up for losses with subsidies. Before the November midterms, of course.
Even so, the specter of a trade war still looms over the agricultural sector, not just farmers, but also equipment dealers and banks in the Farm Belt. Indeed, lenders had become stricter, even before the trade flap arose, she adds.
More generally, tighter credit looms, with the Federal Reserve still on course for two more quarter-point interest- rate hikes, which wasn’t changed by the weaker-than-expected payroll gains in the March employment report, released on Friday. In a speech that afternoon, Fed Chairman Jerome Powell didn’t indicate that there were risks to the outlook from the trade tensions or financial-market volatility.
As for the jobs numbers, nonfarm payrolls increased by 103,000 last month, short of the 180,000 average guess from economists. But that followed a strong February and downwardly revised January, which combined made for a sturdy average monthly rise of 202,000 in the first quarter. More importantly, average hourly earnings were up 2.7% from the level a year earlier, which was as expected. You’ll recall that the initial estimate of a larger-than-predicted 2.9% year-over-year jump in the January data touched off the upsurge in market volatility and the drop in the stock market.
The federal-funds futures market continues to price in a quarter-point increase in the Fed’s interest-rate target, from the recently raised 1.50%-1.75% range, at its June 12-13 meeting. An additional hike is only little better than even money at the Sept. 25-26 gathering, but a target range of 2%-2.25% or higher has a 73.6% probability, according to Bloomberg’s analysis.
Could the markets actually be roiled by the prospect of the U.S. central bank going too far? That’s the possible message from the forward markets, according to JPMorgan economists, led by Nikolaos Panigirtzoglou.
Market expectations are pricing in a rising Fed rate target until the first quarter of 2020, which would mean the forward market anticipates that the central bank would be easing policy by then. This inversion of the so-called forward curve happens only rarely; most recently in 2005, 2000, and 1998. That has typically been followed by the most popular depiction of an inverted yield curve, the spread between the Treasury two- and 10-year-note yields. Even without a trade war, an inverted yield curve is a bearish portent.
More than the return of volatility, the signal change in this year’s financial markets has been the breakdown in the yin and yang between stocks and bonds.
Volatility, after all, has only reverted to normal levels after having been artificially sedated for years. But bonds no longer are providing the “medication” that has been the secret for the bull market’s longevity, according to Doug Ramsey, chief investment officer at the Leuthold Group.
This is the “regime change” described here last month (Up & Down Wall Street, March 10). In prior upsurges in volatility and drops in equities, Treasury bonds could be relied upon to provide a shock absorber in the form of a traditional “risk off” rally.
As Jim Bianco, head of the eponymous Bianco Research, pointed out then, in February’s dramatic jump in the VIX (the Cboe Volatility Index), the paltry response in long Treasuries was the proverbial dog that didn’t bark. As a result, government bonds no longer were providing the effective hedge to equity portfolios that they had during episodes of market distress. Bonds had served a vital function for portfolio managers, limiting drawdowns during periods of market upheaval, so they maintained their equity positions, rather than being forced to sell out at market lows.
Ramsey writes in the April Leuthold “Green Book,” as the monthly is known by the firm’s institutional clients, that the yield on the benchmark Treasury 10-year note has actually climbed 10 basis points (one-tenth of a percentage point) since the stock market’s peak on Jan. 26. In contrast, in the past four stock market declines of 10% or more, yields dropped by 50 to 150 basis points. As yields fell, the prices of those bonds rose, cushioning the loss on stocks.
“To some extent, then, these corrections proved self-medicating,” he writes. The decline in longer-term interest rates provided a stimulus to the economy, while making the bonds less competitive with equities’ valuations. That dose of medication helped to extend the bull market’s life.
If Treasury bonds no longer are providing protection, it appears investors are seeking it at the opposite end of the yield curve—in cash equivalents or their close cousins. Bianco Research’s Ben Breitholtz says investors have flocked to short-term Treasury exchange-traded funds in unprecedented fashion, adding $11.4 billion in the past 90 days.
That’s a marked change from previous episodes, when investors sought protection at the long end of the bond market. Since its peak, the S&P 500 has declined 9.3%, while the iShares 1-3-year Treasury Bond ETF (ticker: SHY) provides a 30-day Securities and Exchange Commission yield of 2.15%, more than the 1.98% on the S&P 500.
For taxable accounts, short-term Treasury securities have the additional attraction of being exempt from state and local income taxes, which no longer are deductible from federal taxes. For an investor in the 9.3% California state income tax bracket, which hits at $105,224 for married couples filing jointly, a three-month T-bill yielding 1.726% is equivalent to a fully taxable 1.903% yield. For a Californian paying a 33.3% combined federal/state tax rate, the 1.31% yield on the Vanguard California Municipal Money Market Fund is equivalent to 1.964% yield.
Back on Jan. 23, Bridgewater Associates chief Ray Dalio declared, “If you’re holding cash, you’re going to feel pretty stupid.” To repeat the conclusion made here last month, cash provides no gain but a shield from the pain of losses. As Ramsey suggests, bonds no longer are the medication to keep you comfortably numb.