• "Kee" Points with Jim Kee, Ph.D.


    • An Agenda at War With Itself
    • How to Think About Markets Now

     

    An Agenda at War With Itself

    Global markets continue to reflect, in my opinion, President Trump’s policy program that seems to be at war with itself. Wealth is created by production and exchange, and the tax-cut deregulation policies that Trump has implemented definitely promote the production side of this wealth-creation equation. However, Trump’s tariff threats and related actions on trade policy clearly work against it on the exchange side. That is why I consider his program to be at war with itself. Near-term, the tax/regulatory environment is pretty set, so it is the back-and-forth in the global trade outlook that explains most of the back-and-forth (ups-and-downs really) in the markets this year. In addition, we are starting to see tangible effects of this in the real (as opposed to market) data. We see it in reduced global trade (particularly in capital goods), with Japan (the world’s 3rd largest economy) declining -.3% in the third quarter, Germany (the world’s second largest exporter) -.2%, and Sweden and Switzerland -.2% (Asian Times). There are other concerns out there – see the “glass half empty view” below – but trade angst explains the most with the least, so it wins the parsimony contest (which is what all sciences strive for). Interestingly, economist David P. Goldman argues that the relative outperformance of Chinese stocks during the recent turbulence suggests that investors believe Trump will do what it takes to get an agreement with China and move on. That is my sense as well, but I know how unsettling this volatility can be.



    How to Think About Markets Now

    Keeping your head when others are losing theirs is good advice when market volatility increases. Or, said a little differently by a current institutional strategist, "What is your greatest risk in markets right now? Well, it might sound trite, but it is probably you" (Matthews Asia). I have mentioned in prior Kee Points and webcasts that the world’s experts on volatility, like the University of Rochester’s William Schwert or London Business School’s Elroy Dimson, argue that volatility is not actionable. You cannot predictably make money buying or selling stocks just because volatility has suddenly increased or decreased. As an aside, trading technology might be playing an increasing role in short-term volatility. Automated trading programs (“program trading”) may enhance short-term market volatility by increasing sell orders when markets are falling and increasing buy orders when markets are rising. This could lead to the phenomena of over-shooting and under-shooting equilibrium security prices. It should also lead to other automated trading programs taking advantage of any mispricing (by buying on big dips and selling on run-ups), which should work to reduce volatility. Anyway, global markets as measured by our (STMM) benchmark MSCI World index are down 4%-5% year-to-date, and U.S. markets (e.g. S&P 500) are roughly flat. Going into 2018 markets weren’t in wildly overvalued territory, but I felt that they had priced in the stronger growth that we’ve seen (“surprising growth, disappointing returns”). Going forward, a “glass half empty view” would see 2019 playing out like 2018, with waning confidence in global trade negotiations and in EU/Italy debt negotiations. It would tilt toward a “hard Brexit” (less amenable trading relationship between the UK and the EU) outcome. It would see a continued deterioration of global capital spending and global trade in general, increasingly contentious politics in the U.S. (and perhaps overly aggressive Fed tightening), rising geopolitical tensions in the Middle East, and it would anticipate heightened effects of all of this on emerging markets. So what’s the “glass half full view”? Well, it is simply that none of what I just rattled off is exactly a secret to global investors, and it is reasonable to assume that a lot of it is priced-in. The glass half full view would argue that each of these could go the other way, i.e. tilt towards a more positive outcome, and markets would then surprise on the upside.


  • "Kee" Points with Jim Kee, Ph.D.


    • Quick Global Overview
    • Two Articles Worth Reading


    Quick Global Overview

    It looks like a little change in the language from Fed Chair Jerome Powell on the pace and target of Fed rate hikes, along with an agreement between President Trump and Chinese leader Xi Jinping, is all it took to put a little wind back in the sails of the stock market. This included global markets as well, and a bounce by the more interest-rate sensitive “bond surrogates” like utilities, REITs (Real Estate Investment Trusts), and even consumer staples. Clarity on global trade is needed, with continued slowing growth indicated in global measures, like preliminary data showing a slight contraction in Germany’s 3rd quarter GDP (Germany is Europe’s largest economy). Energy sensitive assets stayed pretty flat, which is understandable given lower oil prices over the past few months ($53 WTI, $62 Brent). Oil price forecasting is always tricky - on the demand side, most of the growth in oil demand has come from emerging markets, which have experienced slowing growth. On the supply-side, of course the increased U.S. production and the fractured OPEC environment have put downward pressure on prices as well. I am not sure it really makes sense to talk of OPEC as a coherent entity these days. However, crude has bounced recently with intentions of a supply cut agreement between Saudi Arabia, Russia, and Canada’s Alberta province (Bloomberg).



    Two Articles Worth Reading

    Two articles in this weekend’s Barron’sare really worth the read. The first, “Don’t Panic Over the Budget Deficits,” sounds a little like, “telling people what they want to hear.” It stressed how a few minor tweaks could improve the government’s fiscal outlook considerably. I would replace that with “major tweaks,” but I do agree with the non-doom-and-gloom thrust of the piece. If you are an aging boomer like me, you have heard all of your life how “Social Security and Medicare might not be around when you retire.” That’s silly. Some of the conditions will change (payouts, eligibility rules, etc.) but these programs are not going to disappear any time soon. Such all-or-nothing thinking dominates the internet stories but does not accurately depict reality. The other article of interest was an interview with University of Chicago economist Raguram Rajan, the former Governor of the Reserve Bank of India who stabilized the rupee, got inflation there under control, and tried to “clean up” the country’s banks (Barron’s). In my opinion, Rajan was one of the best things to happen to India, and his departure in mid-2016 was a big loss for that country. Rajan expressed concern over leverage (excess borrowing) in general, from China to U.S. corporations to the shale industry’s highly levered private equity transactions. He forecasted more stress in these areas going forward but no generalized contagion or full-fledged crisis. Rajan also expressed a concern for many entities that have stretched for yield (e.g. pensions and insurers), something we have intentionally avoided here at STMM. When asked what his biggest global concern was, he answered that it was the underpinnings of the various populist movements, because “when every country is angry, it doesn’t make for good international relations.” Well said!


  • "Kee" Points with Jim Kee, Ph.D.


    • The Current Economy and Markets
    • The Most Interesting Thing I Saw Last Week

     

    The Current Economy and Markets

    Growth is slowing a bit, with Nowcasting models like the Atlanta Federal Reserve Bank’s GDPNow (my favorite) model putting fourth quarter GDP growth at 2.5%. That will change with updated data as we move through the quarter, but it is less than the 3.5% growth rate estimated for the third quarter, and certainly below the second quarter’s 4.2% growth rate. I don’t attribute this to any “wearing off” of the business tax cuts (reduced corporate rates, favorable expensing provisions) or reduced impacts of a less regulatory tone at the federal level (or Fed rate hikes, for that matter). I see it primarily due to the impacts of trade uncertainty on business spending. Global market movements (US over Non-US, Emerging Markets down most) also seem to reflect this. But this expansion is pretty anomalous, so it is important to watch the data closely (and we do). For example, prior expansions have been driven or led by housing and autos. We’ve seen a normal, strong rebound in autos since the recession (and not the transient cash-for-clunkers blip), but housing starts are still way below prior expansion levels. And we’ve never had a series of rate hikes that followed seven years of (near) zero percent rates, so that territory (i.e. the impact of rate hikes on the economy and markets) is a little uncharted. As for markets, we’ll see if we get a strong year-end bounce, which is typical of mid-term election years (called a “Santa Claus rally” in non-election years). That’s the average pattern, but of course there’s too much variability of any given year’s market performance around the average to trade on it. If only investing were that easy!


    The Most Interesting Thing I Saw Last Week

    In prior Kee Points I have talked about the difficulties of measuring GDP in economies with a large non-market (i.e. government) component. That is because GDP is meant to measure “market valued” output, and it is hard to measure how much government production, which is not subject to profit and loss, is market valued. One Nobel Prize winner, Frederick von Hayek, called it the “economic problem.” Hayek described it not as a problem of how best to build a bridge, which is an engineering problem; the economic problem was whether or not to build a bridge at all given competing uses for the resources. Would society instead value an aspirin factory? Or a toy factory? How would you know? The economic problem solves itself in decentralized, price-directed market economies, but Hayek felt that centrally planned economies would be lost in “a sea of conceivable alternatives.” They would always produce too much of some things and not enough of others, and indeed centrally planned economies have been characterized by such persistent shortages of things people desire and surpluses of items not demanded. But that’s old Cold War stuff! Does it apply today? Well, a recent Financial Times article, “China’s under-used regional data centres stir overcapacity fears,” details how the Chinese government has subsidized firms (including Apple) to build data storage in remote areas (following the latest five year plan no less), resulting in a “plethora of under-used sites,” while demand outstrips supply by 20 to 25 percent in cities like Beijing and Shanghai. In the aggregate, “there’s definitely over capacity” (China Policy Research) as China continues on what some have called a “bubble in big data” there (Financial Times). Such general overcapacity interspersed with localized shortages is just Hayek’s economic problem rearing its 70 year-old head.


  • "Kee" Points with Jim Kee, Ph.D.


    • Then and Now: Comparing 1998 to 2018
    • A Quick Point on Trade


    I generally try to avoid a lot of numbers in Kee Points unless it is really interesting stuff, and I hope you will consider the first paragraph below really interesting stuff. It is just a quick look at how some things have changed over the past 20 years, based upon an article in Investment News and citing multiple sources (e.g. U.S. Department of Labor, U.S. Department of the Treasury, U.S. Bureau of Labor Statistics, etc.):


    Then and Now: Comparing 1998 to 2018

    What does the world look like now compared to twenty years ago? In 1998, the federal minimum wage was $5.14, while today it is $7.25 (a 40% increase, just below the 55% cumulative rate of inflation). The median U.S. home sales price was $153,000, today it is $325,200. That is more than double, which is similar to college tuition, which has gone from $5,020 at a public school in 1998 ($22,710 private) to $10,230 ($35,830 private) in 2018. GDP has gone from $8.8 trillion to $20.5 trillion, an increase of nearly 2 ½ times, which is similar to the stock market, which has gone from 1,017 in 1998 to 2,708 today (an increase of 2.7 times). Health care premiums have more than tripledfrom $2,100 single ($5,523 family) to $6,896 single ($19,616 family). And the national debt has quadrupled, from $5.4 trillion to $21.7 trillion. Incidentally, twenty years ago the 10-year Treasury yield was 4.77%; today it is 3.14%.


    A Quick Point on Trade 

    Wealth is created by production and exchange, so trade (exchange) is important, particularly for growth companies. That’s because growth companies and their valuations are more about the future than the present, and most growth companies in the U.S. include international expansion as a key component to their future growth plans. That is why growth stocks are so sensitive to Trump/China trade news. A lot of analysts that just look at a country’s trade (exports and imports) as a percentage of its GDP miss this insight. Having said that, we are China’s largest single country export market (though Asia is their largest export region). Not so for the U.S.; our largest export market is Europe, and the goods we sell to Europe are higher margin (more profitable) than what we sell to China. So trade between the U.S. and China is important, but probably a little more so to China than to the U.S. For that reason, I think you’ll see some near-term (next few months) agreements between the U.S. and China and their President Xi Jinping. But I also think trade strife between the two countries will be an ongoing part of the longer-term (multi-year) picture, kind of like European debt problems.


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