Inching Closer to a Major Market Top
Another day, another step closer to 'war'... What will China do next?... Checking in on our major 'get out' warning... A lesser-known recession indicator is now 'flashing yellow'... Inching closer to a major market top...
Last week, we warned that the U.S. could be just days away from a full-blown 'trade war' with China...
Just before the Independence Day holiday, we noted the White House was planning to roll out new 25% tariffs on up to $50 billion of Chinese imports on Friday. (It did.)
We noted that China had already said it would immediately respond in kind. (It did.)
And we also said that President Donald Trump had promised to respond to any retaliation with further tariffs on hundreds of billions of dollars' worth of additional Chinese imports.
Last night, he did just that. As the Wall Street Journal reported...
The White House said it would assess 10% tariffs on a further $200 billion in Chinese goods, deepening the dispute with Beijing, while sending a message to other trading partners that the U.S. won't back away from trade fights...
The new tariffs hit a multitude of products including consumer goods, which could produce a reaction against the trade fight. The consumer products include tuna, salmon and other fish, luggage, tires, dog leashes, handbags, baseball gloves, furniture, apparel, mattresses, electric lamps and television cameras and well as components in telephones and flat panel displays.
The administration has tried to limit the impact on consumers, but the scale of the imports subject to tariffs makes that next to impossible.
To no one's surprise, China has once again promised to retaliate. However, it's next response won't be further tariffs on U.S. imports, for one simple reason: It doesn't import enough. As the Journal noted in a separate report this morning...
The Trump administration's announcement that it plans to clamp 10% tariffs on a further $200 billion in Chinese goods – from tech gear like routers to furniture and handbags – stoked anger and hand-wringing among Chinese officials on Wednesday.
China doesn't import enough from the U.S. to match Washington dollar for dollar as it has in previous rounds, so Beijing is reviewing plans to hit back in other ways, said Chinese officials familiar with the plans...
A Commerce Ministry statement on Wednesday described Beijing as "shocked" by the U.S. action and said China "has no choice but to take necessary countermeasures."
So what could China do next?
The options range from the relatively benign to the potentially severe. The Journal notes the former includes measures such as blocking licenses for U.S. companies in China, delaying approval of mergers and acquisitions ("M&A") deals involving U.S. firms, and increasing inspections of U.S. imports at borders.
But if push comes to shove, China has more powerful options at its disposal.
First, it could devalue its currency, the yuan, against the U.S. dollar. Weakening the yuan would make Chinese imports even cheaper, essentially negating the effects of the president's tariffs. But this move could have negative consequences for China as well.
If China were to allow the yuan to fall too far or too quickly, it could cause capital to flee the country. Longtime Digest readers may recall this is exactly what happened in the summer of 2015... And it ultimately helped trigger a sharp correction in both U.S. and Chinese stocks that fall.
In fact, despite the risks, China may already be doing this. The yuan has been quietly falling versus the dollar since April, but the move has been particularly sharp over the past six weeks.
And of course, China still holds more than $1 trillion of U.S. Treasury debt. Under a worst-case scenario, it could choose the "nuclear option" of dumping this debt and potentially crashing the U.S. bond market.
We don't believe this is likely. It would likely hurt China as much as the U.S. But we also wouldn't underestimate how far China might go to "save face" if it believes it has no other options.
Now, it's possible China could reconsider...
It could decide the costs of a trade war are simply too
We've been critical of the president's high-stakes tactics to date, but we would love to be proven wrong in this case.
However, China appears no more likely to back down than President Trump does at this point. This skirmish could easily escalate from here... And both the U.S. and Chinese economies could suffer as a result.
Trade war or not, we're already seeing some warning signs for the economy and the markets here in the U.S...
Regular readers know we've been keeping a close eye on the U.S. Treasury yield curve.
Normally, long-term yields are higher than short-term yields. But occasionally, this relationship
This is called "inversion," and it has historically been one of the most accurate predictors of recessions and major bear markets in stocks.
As we've discussed, the most widely followed measure of the yield curve is what's known as the "2-10 spread." As the name implies, this is the difference between the yields of the benchmark 10-year Treasury notes and two-year Treasury notes. And this spread has been falling nearly nonstop since
When we checked in on this measure last month, it had fallen to a new multiyear low of just 0.35%. But it hasn't stopped since, and as you can see in the following chart, it just hit a fresh low of 0.28% on Tuesday...
At this rate, this spread could invert (cross 0) before September.
Again, this would be a bad sign for both the economy and stocks...
As you can see, each time the yield curve has inverted, the economy has predictably dipped into recession within the next 12-18 months (indicated by the gray bars).
However, these events have tended to weigh on stocks much sooner. As you can see by the red stars in the chart, the market has peaked within a few months or even weeks of each of the last four inversions.
This is why both Porter and Steve Sjuggerud consider an inverted yield curve a major "get out" warning for stocks.
But this isn't the only early warning signal we're following right now...
Earlier this week, Jim Paulsen – chief strategist at investment firm Leuthold Group – noted that another lesser-known recession indicator is also "flashing yellow" today.
The following chart shows the Baa corporate-bond spread. This is the difference between the yield on corporate debt rated Baa by
Over the past 50 years, every time this spread has jumped above 2%, a recession has followed within several months (or in the case of the 1990-1991 recession, a recession was already underway). And as you can see, this spread briefly touched exactly 2% last month before pulling back...
To be clear, neither of these signals is a reason to panic and sell all of your stocks today...
The yield curve hasn't
Likewise, the Baa spread is getting close to crossing above 2%, but it has not yet done so either.
And perhaps most important, as we noted recently, four out of five of Steve's market "vital signs" remain solidly healthy today.
Until these things change, investors would be wise to give this long bull market the benefit of the doubt.
Stay long, but stay "hedged"... And keep an eye on your trailing stops just in case. We'll keep you posted.
New 52-week highs (as of 7/10/18): AllianceBernstein (AB), CBRE Group (CBRE), New York Times (NYT), and Sysco (SYY).
In today's mailbag, a subscriber sends encouragement for paid-up subscriber Gail H... and several others respond to our colleague Dan Ferris' excellent Digest on key investment metrics. Send your notes to feedback@stansberryresearch.com.
"Dear Gail H... I believe Porter had some extremely sound advice on his Stansberry Investor Hour podcast. I can't remember the episode. First off... save, save, save. You can't build assets without first learning the behavior of not spending them.
"Next, Stansberry offers TONS of free info on its website. Learn the basics of investing, how to buy a business.
"When ready to actually invest a bit, buy a basic subscription. Though Porter may hate me [for] saying it, don't fall for the promos. You're not likely to hit the lottery by buying any subscription service. The most important thing to learn is asset allocation; as you build your assets, learn how not to lose them.
"I am a Stansberry Alliance member, the most expensive subscription to Stansberry, but I've gleaned the most valuable lessons from the daily free subscriptions. Best of luck to you Gail. You're better off than most just by reading and keeping yourself open to learning." – Paid-up Alliance member B.R.
"Dan, as a small business owner, it's quite basic. The key metric is demand." – Paid-up subscriber Ed E.
"In wholesale plumbing distribution, [the key metric]
"[Dan wrote:] 'And for those who won't take the time to learn the key metrics of the businesses in their equity portfolios, we're grateful. The more ignorant they remain about key metrics, the more of an advantage we'll have in the stock market...'
"When you consider those more ignorant than yourself are rubes to fleece, then I'll pass on doing business with you." – Paid-up subscriber H.W.
Ferris comment: I can almost see how you'd feel that way, H.W. But I meant nothing sinister by it. I'd urge you to re-read the rest of the passage you quoted, which reads, "and the better our readers will fare when they take our advice."
As always, my goal was to give our readers the advantage they need to make money and not lose it in the stock market. And rest assured, you must have an advantage in the stock market, or you will get trounced.
The old saying goes that the stock market is like a poker game. If you look around the table and can't identify the patsy, it's probably you. It makes me cringe to think that our readers might be at a disadvantage, and I'm grateful for the opportunity to write in the Digest and reach every one of you. Understanding key metrics will help you gain the advantage you need to master the stock market.
I hope that the overwhelming majority of our readers understood the value I was trying to provide on Monday. And I was on the fence about responding to your e-mail, but I figure if you re-read that Digest, maybe you'll understand the message I was trying to relay. In fact, if the only outcome is that a small percentage of Digest readers go back and re-read my essay, I'll consider that a resounding success.
Finally, I'm sure you'd benefit from reading Extreme Value (though it's not for everyone). I'd strongly encourage you to buy a lifetime subscription and read every word of every monthly issue and update we publish. I'll bet you every penny that you won't regret doing so. Click here to see how you can get lifetime access to Extreme Value for the cost of a typical one-year subscription.
Good luck, and be careful out there.
Regards,
Justin Brill
Baltimore, Maryland
July 11, 2018