With bond yields up and trade war rag­ing, Trump’s the chump to blame

The Weekend Australian - - BUSINESS REVIEW - ALAN KOHLER

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

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