With bond yields up and trade war raging, Trump’s the chump to blame
The fact that the US sharemarket had a convulsion this week and sent an angst wave around the world is not surprising — corrections are a natural part of equity markets, and happen all the time.
This one has simply involved the US playing catch-up with the rest of the world, which has been grappling with a bear market this year — in virtually everything, as I’ll explain. What brought the bear market roaring into the US like Hurricane Michael was the trade war and rising bond yields.
Markets had been going along in the belief that we were dealing with a trade war that would lead to a deal, but as I pointed out here earlier this week (“US declares cold war on China”), Vice-President Mike Pence’s speech last week put paid to that idea. That was trigger No 2. No 1 was the 10year bond yield going back above 3 per cent three weeks ago, and hitting 3.26 per cent on Tuesday.
So Donald Trump is 180 degrees off the mark with his comment that it’s all the Fed’s fault, and that it has “gone crazy” by putting interest rates up too much, almost as off-beam as he was with the remark that he knows more about this stuff than they do.
If anything, the US President himself is to blame: the trouble with starting a trade war designed to heap pressure on China is that the world is fully intertwined these days, whether he likes it or not. China is now big enough that if it sneezes, the world catches cold, including America.
And Trump is largely responsible for the rise of the bond yield as well.
He managed to insulate the US from the global bear market for a while with tax cuts last year, but the cost of that is a ballooning of his Treasury’s borrowing needs, up 70 per cent from a year ago. And there is insufficient demand to clear the US bond auctions at yields of below 3 per cent, especially with China standing out because of the trade war and Japan out of the market as well.
There was always going to be a payback for stimulating the economy at this point of the cycle, and here it is.
And finally, the reason the US sharemarket completely out-
paced the economy over the past year or two is that the Fed has been behind the curve, not ahead of it; if it’s been crazy, it’s for having interest rates too low, not too high.
Perhaps the most surprising thing is that after the twin dumps of February and March, the world suddenly couldn’t get enough American tech stocks, sending the Nasdaq on a five-month 18 per cent surge between April and September, despite clear evidence that both long and short interest rates were, and are, heading higher.
True, the 10-year bond yield, having briefly touched 3 per cent in May, had retreated like a snail antler by June and stayed beneath that mark for three months. But Federal Reserve dot plots kept coming out forecasting much steeper hikes in the Fed funds rate than the market was pricing, and US cash futures have been progressively moving higher all year.
And then finally in September the 10-year bond yield moved back through 3 per cent as Trump’s bond auctions started to bite, and kept going, peaking at 3.23 per cent earlier this week.
A higher bond yield means a higher discount rate for future cash flows, and the further out those cash flows are — as with technology stocks that don’t actually have cash flows yet — then the bigger the impact.
But what’s been going through punters’ minds since April? The FAANG stocks (Facebook, Apple, Amazon, Netflix, Google — plus Baidu and Alibaba), and with them Australia’s high-priced “fangs”, such as CSL, Cochlear, Afterpay, and WiseTech, have been outperforming everything else in the world for five years, but after the March correction this year they really took off. In fact, apart from them and a few other US tech stocks 2018 has been a terrible year for investors.
The global ex-US equity market is down 10 per cent since late January. The German market is off 15 per cent; emerging markets are down 17 per cent on average, including a 27 per cent collapse by the Shanghai Composite.
Before the October correction, the Australian market had returned a 2 per cent capital gain for the year to date, and the banks — into which most Australian investors are crowded — were minus 7.5 per cent.
Australian real estate is now 12 months into a fairly gentle, but persistent, correction. Gold is down 12 per cent, silver 20 per cent and copper 10 per cent. Debt securities everywhere are minus 5-10 per cent.
And currencies have been hammered — the Argentine peso down 50 per cent versus the US dollar, Turkish lira 50 per cent, Indian rupee 15 per cent, Australian dollar 10 per cent, euro 5 per cent, and interestingly, even the Chinese yuan has devalued 10 per cent since April.
So the best way to look at this week’s correction is that a rolling global risk asset bear market has finally caught up with the US.
The bear market has been caused by a combination of two things: the rising oil price and tightening liquidity as central banks end, and start reversing, quantitative easing programs and/ or increase interest rates.
And now there is the added threat of economic cold war between America and China.
Whether that’s justified by China’s behaviour is moot — we learned this week that it’s going to be painful for all, not just the bovver boys of Beijing.
US President Donald Trump