Alternate Universe

"Stay Short My Friends"

Trump's tweet last week;

"...We look forward to continuing our positive dialogue with China on a comprehensive Trade Deal, and feel that the future between our two countries will be a very bright one!"

You have to ask yourself - in what alternate universe does Donald Trump live?

The cause of the recent market melt-down can be fully laid at his feet. In a vain attempt to gain an advantage over China, increased tariffs have become his policy tool-du-jour. In defiance of the advice of his own hand-picked minions (chief among them the previously espoused free-trader and current eunuch-in-chief, Larry Kudlow) Trump has launched an escalated threat against China. He tries to portray this as an attack on China's economy when in fact the consumer ends up footing the bill.

He was obviously not expecting what came next. What part of 'Vix spike' did you not see coming? But not succumbing to urges, however self-damaging, has never been 'The Don's' strong suit.

In Game theory, the ultimate outcome is determined by who blinks first. But if both antagonists are equally prepared to fight to the finish, both parties ultimately lose. For its part, China is unlikely to voluntarily hand the U.S. administration a 'great victory' easily. So far, I'm not seeing any eyelid twitching on either side of the U.S. - China trade war. "I'll match your tariff and raise you a depreciation in the yuan" said the poker faced Xi Jinping.

In last week's note, I stated that a catalyst for a sell-off in risk markets was lacking - that was until the Trumpian tweets of last Thursday. Thankfully, I was out of the U.S. market entirely, (actually net short). It was a market asking for trouble, and trouble it got aplenty.

We have seen a stabilization in equity and currency markets this morning, (Tuesday at 11, but in Frankfurt not New York). The relief rally makes sense in the short term sense. I actually got a buy signal yesterday courtesy of my 80 year old neighbour who worriedly asked me about the market action. Cab driver effect still lives! He shouldn't be in equities anyway.

But don't get sucked in by this bounce. The core issue - the decline in investor confidence - still persists. In the face of the complete lack of coherent policy formulation, both in monetary and fiscal terms, risk premia will continue to rise. Secular stagnation is real. Cyclical forces have failed repeatedly to assert themselves. The Keynesian string pushing, haphazardly being attempted by the Global monetary authorities has been exposed for what it is - a dismal failure.

The efforts of the central banks to generate inflation are constantly being thwarted by things not in their control. Secular declines in demographics and disruptive technologies have dominated cyclical forces for ten years now. Add to that counter-intuitive policy mistakes of populists lawmakers who occupy positions of power in England, Italy, the U.S. and latelyJapan and the recipe for reflation that worked so well in the past has been rendered obsolete.

These amateur economists who got themselves elected by promising gold from straw, have uniformly acquiesced to the low-brow quick fix world of beggar-thy-neighbour policies, offering costless quick fixes. The most powerful impulse in human nature - fear - is driving the agenda. Rational thought and objective analysis seemingly do not apply.

How else does one explain the dichotomy of labelling China a currency manipulator - all facts to the contrary? The dirty-float managers at the PBOC have actually spent five years supporting the Chinese currency during a prolonged period of weakening fundamentals. Talk about fake news.

The implications of Trump's bald-faced politicization of the United States Treasury Department, while chilling, have not been lost on the world's central bankers. In an extraordinary WSJ commentary, former Chairs, Greenspan, Yellen, Volcker and Bernanke yesterday strongly decried the risks of the dangerous interventionist approach to the independence of the Fed now being posited by President Trump. His vociferous meddling is now emboldening copy-cats. Leftist politicians in Congress have proposed a currency bill that seeks to weaken the dollar, potentially emasculating the role of the central bank as protector thereof.

So play this bounce at your peril. The commodity markets have had it right all year. My hopes for a triple bottom in the chart of Copper have now been dashed. Oil can't even hold its rally with a full-blown crisis in the Strait of Hormuz. It remains a 'no-touch' until after the seasonally vulnerable October-November time frame. Agricultural sector prices are in disarray after the tariff news hit hard. Deflation rules.

Gold (the metal that protects both risk tails on the deflation/inflation curve) has joined Treasuries, Utilities, Reits and perversely, Bitcoin, as strong risk-off candidates. They are all over-bought in the short term, so be wary. But they all continue to exhibit bull market leadership. When defensives dominate, downside risks inevitably flare up. The weak seasonality, combined with a high potential for negative headlines from political leaders the world over, argue for a cautious stance.

While waiting for a bounce here, I will be looking for short ideas now. Risk-off behaviour should continue to be rewarded until Trump sees an opening to reverse course and save the (election) day. He will desperately need a positive spin for his 2020 stump speeches. A "really great deal" is in our future, if the Trump art of the deal playbook is to be followed closely.

But that alternate universe seems a long way off for now.

Risk Model : 2/5 - Risk Off

The single most damaging chart is the ratio of copper to gold (below). If the success or failure of monetary policy is to be judged, the markets for these two commodities have spoken - loudly! The ratio is in free-fall, seemingly headed for the dismal lows set during the last economic cycle correction level seen in 2016.

This is clear visual evidence of the pushing on a string fallacy in current monetary policy. The Fed is firmly behind the deflation curve.I will not beta-up until Powell admits defeat and lower the funds rate to something with a "1" handle. Four cuts in the Fed Funds rate is not yet in many forecasts. A renormalization of the front end of the yield curve with a Ten Year at 1.50% would do the trick. Dr Copper, my favourite market strategist, has just said so.

Copper/Gold - 2013-19