Monetary Policy (management of money supply and interest rates)

This week was relatively quiet in terms of monetary policy in Europe. However, there are some important points to emphasize in this matter. As many of you probably know, the intent of cutting interest rates is to spur loan demand, thereby giving a boost for the economy because of the lower costs of credit. It should also force people to save less. Currently, the deposit rate in Europe is at a negative -0.50% level. No wonder then why bond yields have followed and have also dropped (when bond yields drop then the price of the bond rises). In the case of 10-year German bonds (bunds), yields have fallen to -0.3%. And yet, people instead of saving less and take more credit, they actually save much more as you can see on the chart below.

Since the beginning of 2018, despite the dramatic drop in Bond yields, the households saving rate in 28 European Union countries have substantially jumped, diverging from the 10 year falling trend. It looks like we have reached the point where cutting rates simply do not make sense anymore (although there has been a moderate pick up in lending as well). To be clear, this is the consumer who knows when it is a good time for spending or investing and when to save money not the central bank, and the chart exactly shows that.

Maybe Economists will finally realize that savings are not bad for the economy and economic growth rises with saving. More about this in the article:

Meanwhile, the European Central Bank (ECB) reiterated that the Asset Purchases Programme will be continued until a 2% inflation target (on average) will be reached.

As it is shown on the chart, bringing inflation to the target has been a real struggle for the EU policymakers. Thus, it will not be a surprise at all if inflation will not pick up for the next several years.

In the end, I would like to refer to the ECB Vice President Luis De Guindos speech who said that the data shows the European Economy is not going to fall into a Recession. Remember Folks, Central Bankers never forecasting recession. It simply would mean admitting a failure of their job and also they do not want their words to become a self-fulfilling prophecy. The reality is that Germany, the biggest EU economy barely avoided a recession (we still have to wait 3 months for the data revision). And Italy, 3rd largest EU economy is in stagnation, growing 0.1% in Q1, Q2, and Q3 of this year. More about Germany in the Global Economy Section.

United States

In terms of monetary policy, this time more was happening in the U.S., as we had 2 awaited testimonies of Jerome Powell, Federal Reserve Chairman. One on Wednesday to the Congressional Joint Economic Committee, and second to the House Budget Committee on Thursday. Investors were expecting that Jay Powell will not surprise market participants and confirm the current stance of U.S. Central Bank policy.

Before summarizing significant points of Powell’s testimonies it is important to note that the U.S. President Donald Trump again expressed his opinion about the Fed, this time in a surprisingly calm tone. In a speech to the Economic Club of New York, Trump said that Stocks would be 25% higher if the Fed had not raised rates, adding that all make mistakes. He also said that they increased rates too fast and decrease them too slow (interest rate the U.S. are currently between 1.50% and 1.75% target). President also told the Economic Club that he would like to see negative interest rates in the US.

In my opinion, we will never see negative rates in the U.S. because it would crash the entire financial system. George Goncalves, a bond market strategist with more than 20 years of experience, wrote in one of tweets that the main reserve currency (U.S. Dollar) should never do negative interest rate policy. It would create a deflationary doom loop which shreds bank capital over time (reduces lending) and force capital shifts to precious metals. Fully agree, also all valuation formulas of assets would be distorted creating a real mess in the financial system.

Let’s summarize then the most important points said by Jerome Powell. Apart from saying that the US economy is in a good place, with a strong labor market and inflation near their 2% target which makes the case for not cutting rates unless it changes. He also said that their involvement in the repo market (where banks lend money for themselves) is not a change in monetary policy (it is not Quantitative Easing or Massive Scales Asset Purchases made to fight the last financial crisis) but technical operations. And yet, the Fed Balance Sheet increased $270 billion since mid-September (fastest pace since the beginning of 2013, and 2nd QE program).

The most important part, however, was about the federal government debt that fiscal policy (government spending) is unsustainable and could limit the ability to respond to an economic downturn. Thus, he addressed concerns about the high level of debt in the U.S. and that it is growing too fast. He also told the Congress that the Fed is not considering negative rates in the U.S. Peter Boockvar, Chief Investment Officer of Bleakley Advisory Group and CNBC contributor in one of his tweets (screen below) compared Powell to a bartender serving drinks and then asking why everyone is drunk. Fair point, the Fed has cut rates 3 times this year (by 0.25%), lowering the cost of debt.

Jerome Powell in one of his answers also concluded one essential aspect that low rates, inflation, and economic growth are a ‘new normal’. Probably he should say about extended economic cycles (due to central bank interference). It is all confirmed by the chart below showing the longest US economic expansion but at the same time the weakest.

Current expansion has been lasting 125 months so far, with 2.3% annual GDP growth on average.

On Thursday, before the House Budget Committee, he basically reiterated remarks from yesterday. You can find a brief summary here:

In the meantime, Boston Fed Bank President Eric Rosengren also said that the Fed is unlikely to cut interest rates below zero (negative) to battle a recession. Rosengren together with Esther George were the only Fed members who opposed all three rate cuts during the Fed meetings this year.

The last thing in U.S. monetary policy context was Fed twice-yearly “Financial Stability Report” released on Friday. In the report, policymakers emphasized that prolonged period of low-interest rates harm the profitability of banks, insurers and other financial intermediaries which may lead them to “searching for yield”, which means looking for profitable activities in riskier areas, or piling up more debt. More risk taken by financial institutions might threaten the country’s financial stability.

Fed also addressed liquidity issues in repo, bond and equity futures markets noting that it has deteriorated. In my opinion, liquidity is a very important part of the equation because this was the biggest driver of the markets over this business cycle. In the end, the Fed mentioned that stock prices are high relative to corporate earnings but consistent with the low level of interest rates. Thus, as you can see they do not see any bubble, despite many market participants claiming that there is a bubble in almost every market.

Looking at corporate profits after tax vs S&P 500 on the chart below we can see a huge divergence between both measures. Just saying. 

Trade War between the U.S. and China

The Sino-U.S. trade dispute is a real roller coaster. While researching this topic, I found a great chart on Bloomberg describing how this conflict actually looks like.

source: Bloomberg

It seems like true, right? This week was no different. Let’s thus find out what happened over this week.

1. During highly awaited speech at the Economic Club of New York on Tuesday, Donald Trump said that ‘phase one’ deal should be made soon, but if it is not then he is going to substantially increase tariffs.

2. On the same day, before the stock markets closing bell White House Economic Adviser Larry Kudlow told CNBC that there will be no tariff adjustments until deal is finalized and there is a possible rollback on tariffs as part of the ‘phase one’ deal.

3. On Thursday, Wall Street Journal (WSJ) reported that ‘U.S.-China Trade Talks Hit Snag Over Farm Purchases’. In essence, Trump has been repeating that China has agreed to buy up to $50 billion agriculture products (soybeans, pork, etc.) but China has never confirmed that. U.S. also wants China to limit the forced transfer of technology for companies wanting to do business in China, but China resists.

4. Also on Thursday, Gao Feng, the Chinese commerce ministry said that the Middle East Kingdom is holding “in-depth” discussions with the U.S. on ‘phase one’ trade agreement, reiterating that canceling tariffs is an important requirement to reaching a deal.

5. During the day, Global Times (daily tabloid newspaper under the auspices of the Chinese Communist Party's People's) posted an article saying that the White House should allow U.S. companies again supplying Huawei, Chinese telecommunication giant if they want to end the trade war.

6. United States Department of Agriculture secretary said on Thursday that US, Chinese negotiating principals will hold call on Friday and there is more than 50% chance of signing a deal.

7. Likewise on Thursday, Edward Lawrence, Fox Business correspondent tweeted that both sides held another call and “the talks are progressing as the two sides try to get a Phase One trade deal on paper”.

8. Similarly like WSJ, Financial Times and CNN reported that China and the U.S. struggle to finalize ‘phase one’ deal amid issues over intellectual property provisions, agricultural purchases and tariff rollbacks. Some say that China delay a truce, not offering enough concessions.

9. South China Morning Post and Politico reported that the U.S. likely to extend by 6 months waiver (expires on Monday, 18 Nov) for US rural telecoms firms limited transactions with Huawei.

10. All of a sudden Larry Kudlow said on Friday that a deal is in Final Stages and they are ‘coming down to the short strokes’, communicating every single day. At this point, it is worth to remind The Trade War Cycle invented by StockCats.

11. Another positive tone was expressed by U.S. Commerce Secretary Wilbur Ross who said on Friday that there is ‘very high probability’ of reaching ‘phase one’ agreement, “The devil is always in the details. And we’re down to the last details now” he added.

12. Interesting thing said Jack Ma, the co-founder and former chairman of Alibaba Group for Bloomberg that the trade war may even last for 20 years if trade disputes aren't solved in a timely fashion.

13. As we previously have seen, China does not want to confirm the number of agriculture purchases. South China Morning Post reported on Friday that buying $50 billion of U.S. farm goods a year is simply impossible to reach. Some agriculture analysts pointed out that with the African swine fever there is not enough demand for those products because half of the Chinese pigs died and there is even a question whether U.S. is able to produce that many goods.

14. Finally the last thing. On Saturday, Xinhua News Agency reported that U.S. and Chinese trade negotiators held ‘constructive discussions’ in anticipated phone call amid ‘phase one’ trade deal.

I have mixed feelings about this whole trade dispute. Looks like officials from both sides try to keep a positive tone about the ‘phase one’ agreement, while insiders or people familiar with the discussions bring us concerns about unsolved issues which are basically the same as it was in Q2 this year. At the beginning of the month Anthony Cheung, Head of Market Analysis at Amplify Trading in London tweeted that the whole deal blows up. 

I cannot disagree with this statement. I think that there will be no deal this year at all and we will be informed about that in December.

Stock Markets – correction ahead?

S&P 500, Dow Jones Industrial Average, Nasdaq, all stock indices in the U.S. have recorded fresh all-time highs on Friday, pumped by US-China trade headlines, and also the Fed liquidity. The Dow crossed 28,000 for the first time ever. Meanwhile, the S&P 500 rallied for a 6th consecutive week, longest streak since November 2017. 

It is worth to note that, it is all happening since the new program of money printing or the so-called "No QE" (QE = Quantitative Easing) has been announced by the Fed. Let’s look then at the chart below.

S&P 500 is now 211 points above its 200-day moving average and the Relative Strength Index (RSI) has been in overbought territory (above 70) for the entire week, now at the highest level since February 2018 and the so-called ‘Vixplosion’ event. I think it is a time for a negative week for U.S. stocks. Here is why:

1. I think that over the next week we will be receiving more negative signals about the U.S.-China trade war which will bring more anxiety to the market.

2. Apart from RSI being in overbought territory, there is also a high sentiment among investment newsletters which Equity exposure is almost 80%.

Above 70% means greed, which historically has been proven as a good moment to escape the market in the short term.

3. There is a very high divergence between Sentimentrader’s Smart Money Confidence and Dumb Money Confidence indicators. Smart Money are the most aware and most informed market participants, Dumb Money is the less informed. You can see that the confidence of the former is really low. Also, the gap between those two indicators is the widest since 5 years.

When the S&P 500 (grey line) within 1% of multi-year high like today, over the next 3 months only 15 days were positive (23% of time), the rest were negative.

4. CNN Fear & Greed index is still at levels unseen since 2017. 

Source: CNN

The index measures stock price momentum and strength (how far it is from 125-day average and number of stocks hitting 52-highs and lows), put/call options ratio (put options is a bet for a stock decline, call option for stock increase), VIX (volatility index), among others.

5. Record net speculative VIX short positions (shorting means that someone bets that the asset will fall in price). VIX index is a volatility index, or fear index, low levels representing the market's expectations for low volatility over the coming 30 days. If there is no fear then stocks rise.

Source: zerohedge

In this case, record shorts may be perceived as a contradictory indicator. If many people bets that the market will stay calm and there will be some negative event (news) it will cause a cascade of short positions covering on VIX which will trigger the index to jump, and consequently the S&P 500 index to fall. Meanwhile, the VIX index is nearly at a two-year low.

7. Risk Appetite Momentum indicator, the measure Goldman Sachs uses to calculate market optimism or risk appetite also known as “Euphoria Meter” has reached all-time highs. Thus, it can be said that markets are experiencing euphoria which has never been seen before.

8. Statistics. The S&P 500 has recorded 29 sessions without back-to-back declines or avoided falling in consecutive sessions, the longest stretch since 2005. The index has also rallied for a 6th consecutive week, longest streak since November 2017. Time to stop this record.

8. As reported by Bloomberg "A majority of rich investors expect a significant drop in markets before the end of next year and 25% of their average assets are currently in cash, according to a survey of more than 3,400 global respondents." Those are investors with more than $1 million in investable assets.

I think that a healthy correction of 5-7% over the next couple of weeks would be reasonable.

Brief Look at Bitcoin

Bitcoin is currently worth roughly 8500-8600 dollars. These 2 big green candlesticks at the end of October when BTC reaching almost $10600 came after Chinese leader Xi Jinping said China should "seize the opportunity" offered by blockchain. Most cryptocurrency investors know that China has banned initial coin offerings (ICOs) and shut down local trading cryptocurrency platforms in 2017. No wonder then why Bitcoin rose more than $3000 in just 2 days.

After that South China Morning Post report that “Chinese state media People’s Daily has published a commentary stressing that while blockchain can help provide the breakthroughs needed to overtake competitors it should not be compared to cryptocurrencies, which China banned in 2017.” And Bitcoin 2 days euphoria has started to fade.

At this point, it is worth to note that China’s central bank, the People’s Bank of China (PBOC), has been working on its own digital currency but there is not much information about these developments. 

For the next couple of months, I see two scenarios for Bitcoin. I drew a descending channel and assigned arrows in each of scenarios.

1st scenario (green) is when Bitcoin brakes up descending channel, will come back to the line as a support and at this point I see a good entry to consider.

2nd scenario (red) is when bitcoin brakes down the channel, will come back to the line and then it could be a potential point for shorting.

I would also watch cryptocurrency/blockchain-related news, any positive or negative developments could also trigger a substantial move.

Global Economy

1. At the beginning of November Financial Times reported that decline of motor industry drags down the global economy quoting the International Monetary Fund:

“The IMF believes this fall in output accounted for more than a quarter of the slowdown in the global economy between 2017 and 2018.”

As you can see, the global demand for cars has dropped substantially during this year. It is mainly driven by Chinese slowdown where Auto Sales are expected to fall by 12% in 2019.

It directly translates to companies’ profits. For instance this week, Nissan Motor Co reported a 70% FALL in quarterly profit and cut its full-year forecast to 11-year low, amid dropping sales. Expect more news like that in the future.

2. As I already pointed out in the previous Market Wrap, China has been the biggest driver of this economic cycle. Bloomberg reported that China’s credit growth slowed more than expected in October and was at the lowest level since at least 2017 due to weak demand for credit.3

I found in Yardeni’s data that Bank Loans in October have been the lowest since mid-2016 and over the last 10 years there have been only 3 months with a slightly lower amount of loans.

This drop-in credit is also related to the fact that China is deleveraging its shadow banking sector (non-bank financial intermediaries that provide services similar to traditional commercial banks but outside normal banking regulations). China Shadow Banking loans dropped by 234 billion in October, the second biggest one month fall this year, and the 7th drop in a row as well as 18th of the last 20 months.

Source: zerohedge

If there is no demand for loans, how to spur economic growth then?

Forecasts for Q4 2019 China GDP growth are between 5.8%-6.0%. Honestly, I do not think that they will manage 6%. Why? Recent economic data confirms my thoughts:

”Industrial production in China rose 4.7% YoY in Oct, below the median forecast of 5.4% growth and slower than September's 5.8%

Retail sales rose 7.2% year-on-year in October, missing expected growth of 7.9% and matching the more than 16-year low hit in April.

Fixed asset investment, a key driver of economic growth, rose just 5.2% from January-October, against expected growth of 5.4% and the weakest pace since Reuters record began in 1996.

3. Meanwhile, global business slump to the lowest levels since the last recession:

“"The IHS Markit global business outlook—which surveys 12,000 companies three times a year—fell to the worst level since 2009.

The Ifo world economic outlook, which surveys 1,230 people in 117 countries, fell in the Q4 to the worst level since Q2 2009."

4. Germany has avoided recession (in my opinion, till data revision comes – in 3 months). Economic expansion in Q3 2019 was just 0.1% (forecast was -0.1%). Q2 2019 was revised from negative -0.1% to negative -0.2%

Euro Area GDP Growth for Q3 2019 was reported at 0.2%.

5. Hong Kong was not that lucky as the biggest European economy (Germany) and fell in a first recession since a decade (Two-quarters of negative GDP growth) amid anti-government protests, global economic slowdown, and accelerator in the form of U.S.-China trade war.

Q3 GDP shrank by -3.2% from the previous quarter

From a year earlier, the economy contracted 2.9%

This is the worst crisis since HK reverted from British to Chinese rule in 1997.

6. In the United States' expectations for Q4 2019 GDP Growth have significantly fallen. According to 4 tracking estimates, Q4 Real GDP is expected to growth 0.83%, drop from 1.25% in just 7 days. 

That means nothing else than quick deterioration in economic data of the world's largest economy. Interesting to see what is going to happen over the next 1.5 months.

7. Global debt has reached a new record. Few days ago the Institute of International Finance reported that global debt has now hit $250 trillion and is expected to hit a record $255 trillion at the end of 2019, up $12 trillion from $243 trillion at the end of 2018, and nearly $32,500 for each of the 7.7 billion people on planet. This debt accounts for 330% of global GDP.

There is nothing else to say than congratulations.

8. In the end, for your curiosity, a few charts and an example of the author's ignorance in one of the largest financial portals in the world:

Financial Times reported: "US manufacturers hit harder than China’s in a trade war"

The author concluded this looking only at Manufacturing Purchasing Manager Index (PMI) for the U.S. and China. This is lower for the U.S. The index shows general economic trends in the manufacturing sector by surveying hundreds of companies. There are at least three reasons why this is not true.

First, the trade war is just an accelerator of the global slowdown and both economies have started slowing before the dispute has begun and the U.S. is slowing faster.

Second, China has injected historically record amounts of MONEY (liquidity) into the system since the beginning of 2019 which caused temporary recovery in the data.

Third, (thanks for @head_donut), no one knows China’s actual data because they are ‘smoothed’ or to put it simply, manipulated.

a) According to Citi Bank Total Central Bank Purchases will reach as much as $1 trillion in 2020.

EM – Emerging Markets, Fed – Federal Reserve, BoJ – Bank of Japan, ECB – European Central Bank, SNB – Swiss National Bank, BoE – Bank of England

Seems like 'not QE' is actually QE.

b) Apple Market capitalization is now bigger than the entire Energy sector in the United States.
via Michael Hartnett, Bank of America

Since January 3, Apple stock price is up 86% !!

Source: zerohedge

c) We are also living in record times in terms of the stock market in the U.S.

We have the longest EVER and the best performing (since World War II) bull market.

468% total return (incl. dividends) on the S&P 500. This run has started March 9, 2009 according to
The Leuthold Group.

As of Friday, 15 November the S&P 500 brought more than 472% total return. Happy days.
In the next point, you will get to know who benefited the most from this bull market.

d) In 2016 the richest 1% in the U.S. held more than 50% of all stocks, financial securities, trust equity, and business equity, and 40% of non-home real estate. U.S.

The top 10% of families directly owned over 93% of all stock and mutual fund ownership.  
Data: NBER

This is one of the most important reasons for wealth inequality. Rich holds the most assets, central banks keep interest rates low and print money supporting inflation of asset prices and.. Tadam, inequality increases.

Another reason is financial education.

Have a great week ahead!

Disclaimer: This content includes only personal opinion and that should not be considered the professional financial investment advice.