Wall Street and the New Cold War

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The stock market seems to rise or fall almost daily based on the latest news from the front lines of the trade wars.

When Trump threatens new tariffs and China threatens to retaliate in kind, stocks fall. When Trump delays the tariffs and China agrees to resume negotiations, stocks rise. And so it goes. It has been this way since January 2018 when the trade war began.

The latest dust-up came late last week when Trump threatened tariffs against Mexico if it doesn’t do more to curb illegal immigration to the U.S. Markets sold off on Friday as a result, bringing a terrible May to an end. Largely due to the trade war, the stock market had its worst May in seven years.

From the start, Wall Street underestimated the impact of the trade war. First they said Trump was bluffing. Then the analysts said that Trump and Xi would put their differences aside and make an historic deal.

All of these analyses were wrong. The trade war was problematic from the start and is growing worse today.

China will lose the trade war. The reasons are obvious. Foreign trade is a much larger percentage of Chinese GDP than it is for the U.S., so a trade war was always bound to have more impact on China than the U.S.

And if China tries to match the U.S. in tariffs dollar for dollar, they run out of headroom at $150 billion while the U.S. can keep going up to $500 billion and inflict far more pain on China.

Other forms of Chinese retaliation are mostly nonstarters. They cannot dump U.S. Treasuries without hurting their own reserve position and risking an account freeze by the U.S. China cannot turn up the pressure by stealing intellectual property because they’re already doing that to the greatest extent possible.

China’s latest threat is to ban exports of “rare earths” to the U.S. and its allies. Rare earths are essential for the production of plasma screens, fiber optics, lasers and other high-tech applications. Electric vehicles, mobile phones and telecommunications systems would be impossible to build without them. China is responsible for 90% of global production, which makes them a potent weapon in the U.S.-China trade wars.

“Rare” earths aren’t actually that rare. They are plentiful in quantity. The problem is that they are found in extremely low concentrations. This means a huge amount of ore and expensive mining processes are needed to extract even a small amount of these vital substances.

So rare earths are one weapon China possesses.

But over time, Western powers can replace rare earths purchased from China. There could be major manufacturing disruption in the meantime, it’s true. But it would not be the end of the world.

The U.S. will win the trade war and either China will open its markets and buy more U.S. goods or the Chinese economy will slow significantly.

But while the trade war is important, it’s not the main event.

The trade war is part of a much larger struggle between China and the U.S. for hegemony in Asia and the Western Pacific.

They are locked in a new cold war being fought on many fronts. These include trade; technology; rights of passage in the Taiwan Strait and the South China Sea; and alliances in South Asia, where China’s Belt and Road Initiative is promising billions of dollars for infrastructure development.

The U.S. is responding with arms deals and bilateral trade deals to counter Chinese influence. Even if a modest trade deal is worked out with China this summer, it will not put an end to the larger struggle now underway.

What are the implications?

If the Chinese view the trade war as just one step in a protracted cold war, which I believe they do, then we’re in for a long period of contracting growth that will not be confined to China but will affect the entire world.

That seems the most likely outcome for now. Get set for slower growth and perhaps stagflation. It could be like the late 1970s all over again.

Slowly, Wall Street is taking the trade wars seriously. But it is still missing its larger implications of a new cold war.

This new cold war could last for decades and it will affect the entire global economy. Let’s just hope it doesn’t turn into a shooting war.

Below, I show you why it could. Read on.


Jim Rickards
for The Daily Reckoning

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Why the Stock Market Bounced Back in January

This post Why the Stock Market Bounced Back in January appeared first on Daily Reckoning.

The president appeared before the American people last night.

Markets waited for good news — or bad news  — to come issuing from his mouth.

Would he announce a pending China trade deal?

Conversely, would he threaten another shutdown if Congress won’t fund the wall… or announce a state of emergency?

Markets could swing in either direction, depending.

But nothing sensational was forthcoming…

No chum went into the water, no dog’s bone went tossing onto Wall Street.

Nor was any blood drawn, and no fang broke any skin.

The president instead ladled out a pot of porridge… as is typical of State of the Union addresses.

Dow futures held steady throughout… as did S&P futures.

But a draw goes to bulls, says Paul Donovan, global chief economist at UBS:

There was no escalation of tensions — at least not meaningfully. There was no talk of using commander in chief military powers to build the wall, for instance. That might be considered a win for investors, who prefer it when things do not escalate.

Today the collective shoulder shrug continued.

The major averages ended the day lower… but slightly.

“How Hard Is It to Be a Stock Market Bear Right Now?” asks a MarketWatch headline this morning, pointedly.

Rather hard is its answer — and for cause.

After December’s near-bear market, the stock market put in its best January in 32 years.

And so the bulls have regained their jaunty bounce.

But why the counterswing?

Have market conditions brightened measurably? In one month no less?

The jury reaches a mixed verdict…

The January unemployment report trounced expectations.

Nonfarm payrolls surged by 304,000 — the most in nearly one year.

A Bloomberg survey only projected a median estimate of 165,000.

On the other hand, the fourth-quarter earnings season is in swing. And results to date have been mixed.

Moreover, the earnings outlook for 2019 appears dark.

Morgan Stanley chief U.S. equity strategist Mike Wilson:

Earnings are deteriorating even faster than we expected. The earnings revision… over the past month has been even more negative than we expected, leading us to think our earnings recession trough in the U.S. could be later than [the first quarter] and deeper.

Markets are said to look ahead — not back.

Shouldn’t markets be choking on a possible earnings recession?

If you seek true explanation for the market’s rapid January recovery, perhaps you needn’t look further than the central banks…

In early January Jerome Powell lifted his foot from the monetary brake pedal.

He said a wait-and-see approach would govern him. And at the end of the month he issued markets similar assurance.

He further suggested he is prepared to lay off the balance sheet.

Is it coincidence then that the stock market turned in its best January in 32 years?

But above we referred to central banks — plural.

Consider, for example, the People’s Bank of China (PBoC)…

The Chinese economy is slowing to a crawl. In response the central bank has reopened the liquidity taps.

Over one January week alone, the bank emptied some 1.1 trillion yuan of liquidity into the market.

If you think Chinese liquidity has no impact on U.S. stocks, you might have another guess…

“Just to demonstrate how critical to U.S. stocks is ‘China-sponsored’ liquidity to the global market,” says Zero Hedge:

Look no further than the below stunning chart of PBoC open market operations… relative to the key value/growth ratio for U.S. stocks. If there was ever any doubt that the relative performance of U.S. stocks — and especially FAANGs/growth names — is a function of Chinese liquidity, it can quietly be put to rest.

The FAANG stocks are of course Facebook, Apple, Amazon, Netflix and Alphabet (Google’s parent company).

These stocks are heavily exposed to China. They in turn weigh heavily in U.S. indexes.

Each, incidentally, is up on the year — some of them substantially.

Here is the referenced chart:


The correlation is not precise — but the chart certainly gives the flavor.

Can you therefore expect the present rally to continue if Chinese liquidity flows?

Not according to Maleeha Bengali, CEO of MB Commodities Capital.

Not without a resolution to the U.S.-China trade war, at any rate. The fundamentals remain negative:

This break above [S&P] 2,600 could be a red herring… This liquidity boost seems to be temporary. Once the sugar rush is over, equity shall return to its path of least resistance. For now, that is down. After the squeeze from December lows, it is teed up perfectly to perhaps retest the lows of December. At least that is what the fundamentals are saying.

But which side will win the battle, the fundamentals — or the central banks?


Brian Maher
Managing editor, The Daily Reckoning

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