The S&P 500 has now given up all its gains year to date, and Asia is basking in a sea of red overnight as indices fell around 3% on average across the board. Asia-Pacific stocks are down 30% from highs, almost down to the June 2017 lows! From an extreme overbought situation, with investors considering taking profit, this has now spiraled into indiscriminate selling across the board.
Hedge funds and institutions are forced to cut their gross books down, given leverage/margin calls and "value-at-risk" (VAR) measures blowing up, and risk management 101 taking over. Forget earnings, fundamentals, top line and bottom line beats. Microsoft (MSFT) is a great example of that: Revenue up 19%, net income up 34%, earnings up 36% -- no one cares. That is a market that has just let fear and preserving capital overtake any sense of logic and rationale.
There is a lot of finger pointing going on, political lobbying of sorts. But if this market correction does indeed spiral into a recession, one thing is clear, President Trump has single-handedly caused this collapse. The global economy was growing at a comfortable 3.5% rate, inflation contained, growth robust -- it was a perfect balance of goldilocks economy, positive for risk assets and equities.
In his narcissistic desire to put "America First," Trump embarked on the trade war tariffs campaign using the one key weapon the U.S. had vs. the rest of the world - trade. After all there was no way the U.S. could allow China or any global power to supersede them in global trade or global reserve status (note gold and oil trading in yuan, taking flows away from the U.S. dollar).
Following Brexit and Trump Trade Wars, global tariffs could reach levels not seen in 15 years (according to a UBS report). Combined, these two events could add 142 bps to the average global import tariff, totally unwinding the globalization efforts of the last 15 years. We are at the late end of the economic cycle. Trade disputes and fiscal easing now could cause the next recession very easily.
Central banks should remain independent from the government and the politician's agenda. Look at Turkey, a great example of how things can turn from good to worse if the central bank is not allowed to do their job. After Trump was done coercing his trading partners all throughout the summer, he then lashed out at the Fed. It would seem absurd to try and coerce the Fed Chairperson to keep rates lower in order to boost the economy and make his presidency look successful.
Looking back at history, a lot of Trump's policies and views are as though we are stepping back in time to the Reagan era, and Trump is using his playbook. Back in 1984, President Reagan basically demanded that the Fed Chair -- at the time, Paul Volcker -- not raise rates before the election.
There is no doubt that the market had grown significantly over the years since the global financial crisis -- via monetary accommodation by various central banks to boost growth. The Fed took the right approach in taking rates higher, as the economy cannot function forever in a negative real rate environment without inflation getting out of control and the economy overheating.
The year 2018 has been all about taking the foot off the pedal. There was organic growth, companies with solid balance sheets, and the Fed was just removing the punchbowl slowly to allow markets to continue on their own. It was a smart move, as if they did not and markets collapsed, there would no buffer to lower interest rates later and boost the economy, if necessary. Everything was going smoothly until Trump started waging war on all the major super powers to increase the U.S.'s dominance and push his own agenda.
Most traders and portfolio managers today have maintained their careers during the "Buy the Dip" and the "Fed put" times. Any time any hints of a slowdown appear, the Fed has come to the market's rescue. Now, with the new Fed Chairperson, Jerome Powell, investors are seriously unsure how he will act during a time of crisis. Will he take the "economist" route and keep raising rates to take the excess out of the system (short-term pain, long-term gain)? Or will he feed the market with the opioid of free money that it is used to (short-term gain, long-term uncertainty)? It's easy for central banks to kick the can down the road and let someone else deal with the bigger problem.
South Korea exports orders this morning turned negative for the first time. There is a direct correlation between this measure and global earnings per share revision. It is signaling doom and gloom. Investors are using these broader indicators to imply much more downgrades to come, regardless of the earnings beats we see now in the third quarter reports.
There are only two things that can change the market sentiment. Either the Fed caves in and holds off on their USD interest rate hike path, or there is some settlement between U.S./China to stop the global trade supply uncertainty. The former seems more likely and plausible -- especially with U.S. markets collapsing, the Fed has arguably more justification to ease their hawkish stance. In the meantime, traders are trying to test the resolve of the Fed taking the market down to a "level" to force them to react. This is a scientific experiment, as no one knows how soon or fast the Fed will or can react.
Until then, stocks trading on high double-digit P/Es with no cash flow and extremely high growth rates will be punished, as they are more "flash-in-the-pan" in nature. Right now, one should focus on large-caps, with high single-digit P/Es, high free cash flow and solid balance sheets. Given even the latter group is down 20% from the highs, it will pay to be in quality over speculative stocks. At some point, with U.S. 10-year bond yields trading back to 3%, one can argue, the bond/equity switch will be done and equities will start to look more attractive again. The question is, when?