The U.S. will head to the election polls on November 6 for the Congressional mid-term elections. One third of the Senate and every seat in the House of Representatives is up for grabs. Polls so far are showing that the Democrats have a good chance of taking over the House, but the Senate may still be under Republican majority. In a final push to keep the House with the GOP, President Trump is using every single trick up his sleeve ahead of tomorrow. Why does this matter for markets?
U.S. markets had their worst month ever in October, falling 8% on the month alone. Given the impact of Trade Wars and the global economic slowdown evidenced in most emerging markets -- including China -- it was only a matter of time until U.S. markets would fall prey to Trump's latest measures, as global supply chains are disrupted and companies face margin pressure on higher raw material costs.
But there is another concern. If the GOP lose majority of the House, there is a worry that President Trump's tax stimulus measures and policy may be unwound by the Democrats. Don't forget the S&P 500 is still up 27% since Trump's election and announced measures in November 2016.
The market, especially Chinese-exposed names and sectors, experienced a vicious rally last week as November started. Stocks nearly unwound all the damage of October in just three days, especially the miners and copper-focused names. It made sense, given copper had held $6200/tonne, but stocks had fallen about 15% on equity market liquidations. That has now been normalized.
The yuan rallied from 6.97 all the way up to 6.85 vs. the dollar. China-exposed tech stocks and markets bounced about 5%-10%, as the market was convinced that a trade deal would ensue, given Trump's apparently positive phone call with Jinping going into the G-20 meeting.
Call me a cynic, but the timing seems a little too perfect to announce some "positive" headlines going into the mid-term elections and stage a market rally right before the voting polls open. The devil is in the detail, and President Xi Jinping, in his speech at a Shanghai Trade Expo, defended the global trade system and how "practises of 'laws of the jungle'" are not going to help. China has promised to further cut import tariffs, making it easier for foreign companies to access China, showing that it is opening up its economy more. It lacked timing details -- and more importantly, did not address key U.S. demands about Chinese trade, including Intellectual Property theft from U.S. firms.
The market rally last week seemed pre-emptive. Being long China and Chinese-exposed stocks, like miners or techs like Alibaba (BABA) , requires some sort of resolution between the U.S. and China. An actual agreement, not just tweets and false handshakes.
The market is extremely fickle and jittery. Any headline causes violent moves up and down, as traders find themselves chasing their trades, scared to have their heads ripped off. Fun times.
We all know what the fundamentals are telling us: There is still value in commodities and physical markets are tight in copper, iron-ore and steel. The first round of tariffs just kicked in on September 24, we have yet to hear on company conference calls about the damage of trade tariffs in full effect (the 25% to be carried out in January 2019).
Now, 75% of S&P 500 companies have reported earnings for the third quarter so far. Despite another stellar quarter of earnings (EPS up 26% Y/Y), the earnings season has been disappointing, as investors focused on peak earnings and margin pressure into 2019. Increasing price pressures and disruptions to the supply chain represent real risks for companies going into 2019.
Sunday night, the Chinese Caixin October PMI came out at 50.8 vs. expectations of 52.8 -- the weakest print since June 2016. New orders tumbled down to 50.3. Consumer staples was hit hard overnight and the offshore yuan gave back its gains from last week, trading back at 6.92 from highs of 6.85 last week. China stocks are giving back Friday's bounce and Hang Seng closed down 2% Sunday night.
If China shows no signs of backing down, there is a risk that yuan breaks the 7 level vs. the dollar, which will cause another wave of selling. All shall reveal itself after the U.S. elections, as China is probably waiting to see what sort of majority Trump will have post mid-terms elections. There is no bullying the red dragon for now.