There are four major factors driving the market. The factors are growth, trade wars, geopolitics and regulation of technology.
Each of the four factors has its own internal contradictions, in effect a binary outcome for each. This means there are 16 possible paths the market might follow (24 = 16). No wonder the market acts confused.
With regard to growth, the bulls expect a boost from the Trump tax cuts. They are also anticipating inflation due to strong job creation, rising labor force participation and a low unemployment rate. They expect interest rates to rise but consider this more a sign of economic strength than a cause for concern.
Strong growth is good for corporate earnings, and a little inflation is usually good for nominal stock prices, at least in the early stages. The bull case for growth is a curious mixture of the Phillips curve and the Laffer curve.
Bears point to an economic slowdown in the first quarter (most projections are around 2% or less). This is consistent with the dismal average of 2.1% growth since the end of the last recession in June 2009.
Stronger growth is impeded by demographic and debt head winds and the impact of Chinese labor and technology on global pricing power. Tax cuts are not expected to help, because the drag on growth caused by increased debt will outweigh any stimulus from lower taxes.
The Fed is giving a weak economy a double dose of tightening in the form of rate hikes and the unprecedented destruction of base money as they unwind QE. The Fed will probably push the economy to the brink of recession before they get the message and pause on rate hikes.
This bearish view combines the Reinhart-Rogoff thesis on debt death spirals with a return visit to Fed policy blunders in 1929 and 1937.
To some, the trade wars are another conundrum. There is little doubt that a true trade war will reduce global growth. But many are wondering if we’re facing a trade war or just a series of head fakes by Donald Trump as he pursues the art of the deal?
For example, Trump imposed Section 232 tariffs on steel and aluminum imports and then almost immediately carved out exemptions for Canada and Mexico pending progress on NAFTA. Then the president trumpeted a trade deal with South Korea that imposed quotas on steel imports but almost immediately said that deal was conditional upon South Korean help in dealing with North Korea.
Trump threatened over $50 billion of Section 301 penalties on China for theft of U.S. intellectual property, but within days China and the U.S. calmed market fears by announcing plans for bilateral trade negotiations.
So is it really a trade war, or just a set of negotiating tactics?
I believe the trade war scenario is more likely.
Yes, Trump offered relief to Canada and Mexico on the steel tariffs. But that was only so he could gain negotiating leverage on the NAFTA talks that are ongoing. If Canada and Mexico fail to give Trump the concessions he wants on NAFTA, those steel tariffs can bounce back to hit Canada and Mexico as they already hit China and Brazil.
Meanwhile, Trump will wait to see if China is willing to make concessions in the intellectual property area. If not, he can easily double or triple that $60 billion figure.
My take is that this trade war is not going away anytime soon. It will last for years, get much worse and be a major headwind for stock prices (click here for an urgent trade war update).
But I admit that Trump has left enough wiggle room to indicate he could back off the trade wars if he can exact enough concessions from China and the NAFTA countries.
Geopolitics are another on-again, off-again market driver. A strong case can be made for a coming war with North Korea.
Decades of North Korean development of nuclear weapons and ballistic missiles and a rapid increase in the operational tempo of tests in the past year reveal that North Korea is determined to build an arsenal of nuclear-armed ICBMs that pose an existential threat to the U.S.
For its part, the U.S. has made it clear that North Korea will not be allowed to acquire or possess these weapons. These two views are irreconcilable and point toward war.
- Source, James Rickards
