"I've Been Waiting Here to Be Your Guide
Reveal the Secrets That You Keep Inside
No One Leaves Until the Night Is Done
The Amplifier Starts to Hum
The Carnival Has Just Begun"
- Paul Stanley, Curt Cuomo (KISS) 1998
Like A Shot
Just a bit after 4 a.m. ET, Bloomberg News reported that the U.S. and China were moving closer to an agreement on just what tariffs might be rolled back in a potential Phase One trade deal (give me a break). Immediately, longer-dated yields spiked, not just in the U.S. but across much of planet Earth. Currency exchange rates ran one way, then oddly reversed. European equities moved higher on this news, or perhaps in response to better-than-expected service sector November PMI revisions across the European Union (EU), after Asian markets had sold off earlier. Finally, U.S. equity index futures spiked at first, reverted back toward the overnight mean, and then headed higher yet again, as keyword-reading algorithms played tug of war with the very concept of price discovery.
The interesting thing is that even though U.S. equities closed on Tuesday well above the lows of the regular session, the volume was indeed there, and not just in tech names. The broadest of U.S. large-cap indices suffered a third consecutive day of growing weakness on ascending volume. Yields at the longer end of the U.S. Treasury curve cratered midday. The all-important three-month/10 -year spread hit a mere positive 12 basis points on Tuesday prior to ending the day up around 15 basis points.
As you can see here, that spread now tested key October/November support. Something in the back of my head does have a problem describing the spot where these spreads rebound as support when they are simply the result of real-world resistance in the bond market. That said, for this particular spread I don't think we worry until the 50-day simple moving average (SMA), now at positive nine basis points, comes into play.
As the U.S. 10-year note met demand, this forced the Real Estate and Utilities sectors back into leadership roles across trading floors, while Energy, Industrial and of course Financial stocks took one in the teeth. Distribution? Yeah, you could say that there was some institutional distribution on Tuesday. Some folks watch the VIX, which made a run at 18 on Tuesday morning, only to finish the day below 16. I watch the CBOE put/call ratio. I think this is where one finds out just how rattled market participants might be.
The Put/Call Ratio did not hit perceived "sky is falling" levels on Tuesday, but 1.13 was the second-highest reading for this item since late October and well above the 50-day SMA of 0.98. Enough traders apparently thought it necessary to go the added expense of adding protection, which you know is one of my pet peeves. Most readers know that I would rather sell a portion of any long in order to reduce my personal level of discomfort (and buy it back later if need be) than I would do anything that increases net basis. The ability to manipulate net basis is the very cradle of profitability.
Games People Play
Everyone is playing games. Everyone is trying to get over. The Chinese say they need to see a rollback on exiting tariffs and not just a suspension of the coming dog-and-pony show on Dec. 15. President Trump declares the United States is prepared to wait until after the U.S. election... in a year. This, while President Trump expands the trade war to include Argentina and Brazil, both of which compete with the U.S. in agricultural markets, both of which are potential dumping grounds for cheap Asian steel. This, as the trade war is expanded to include France, the EU, and NATO. This, as the House of Representatives refuses to vote on the U.S.-Mexico-Canada (USMCA) trade agreement even though this deal very likely has the bipartisan support necessary to pass.
The thing the House of Representatives did do on Tuesday was pass The Uighur Act of 2019, a bill that calls for sanctions against senior Chinese officials in response to reported human rights abuses against the Muslim population in the semi-autonomous region of Xinjiang, the area from which many of the rare earth metals required for use in developed economies originates. Passage of this bill is the ethically correct thing to do. That said, this does add another layer of contention between Washington and Beijing.
Another? Yes, for those not quite focused, Beijing suspended on Monday a review of requests made by U.S. military craft (both air and sea) to make port-of-call stops at Hong Kong. That came after President Trump signed into law last week the Hong Kong Human Rights and Democracy Act that had passed easily in both houses of the U.S. legislature.
You and I are not at the table. The U.S. and China are so close to a trade deal. The U.S. and China are so close to a Cold War. Both of these outcomes are realistic. The Chinese side clearly has no interest in surrendering unfair advantages in trade enjoyed for decades. The Chinese side likely has no interest in drawing back on the theft of intellectual property, on cyber espionage, or agreeing to anything overtly enforceable.
Investors must keep mind that, on the U.S. side, decision making is most likely driven by money and time. On the Chinese side, it's power and time. China has made great strides in the fields of artificial intelligence as well as the broad implementation of 5G telecom networks. Indeed, one might say that China has taken a leadership role and is likely working on both military applications for these technologies as well as putting this edge to use in order to create regional strategic dominance and global strategic influence.
The issue is this: China's national behavior in not just global trade, but in achieving this perceived success has led to this pushback from the U.S. as well as clear concern from other developed economies such as the EU. This has at a minimum disrupted the flow of capital across borders and slowed the trade that the Chinese economy has depended on to get where it got. In short, Chinese behavior on these levels has put not just its relationship with the U.S. in peril, but has negatively impacted foreign relations everywhere.
Most of us simplistically believe that movement toward a trade deal would be a good thing and that sliding into a Cold War would be a negative. My thought is this: We are already in a Cold War. What happens from here? At some point, tariffs are curbed, hands are pressed, smiles are forced, and cameras flash. All will appear to be just what the doctor ordered, at least overtly. Covertly, behaviors will remain unchanged. Violations of anything agreed to will be denied. Trade having already been restored will provide a short-term boost to GDP on both sides of the Pacific. Long term? Do not be surprised to see both sides act to secure specific turf as what was once thought of as a global economy develops into economic spheres.
My prediction? Someone else will write a very similar column decades after they put this author in the ground.
What does a Cold War mean to financial markets? For one, should such an undeclared existence descend upon the planet, addressable markets will decrease in size. This will put a cap on equity valuations despite the clear shortage of available equity in said marketplace. This will also increase demand for sovereign debt at longer maturities, which in turn would collapse the yield curve, causing the Federal Reserve (this begs a certain level of situational awareness, a lot to ask from this crew) to reduce short-term rates aggressively. Quantitative easing? As long as it continues to focus on short-term debt. If we have learned anything, we have learned that purchasing debt at longer maturities does not do a lot for credit markets, but does severely slow an economy's potential to grow.
No need to fear. We are not there yet, but this is why gold, canned food and clean water need to be in every portfolio. For today, the headline machine is in charge. One thing I think all readers need to grasp: Trade tactically. That's technical. Invest strategically. That's fundamental. Both skill sets are required for the do-it-yourself crowd. Then again, even for those who due to time constraints are reliant upon advice, why not know more than the advisor? You'll be shocked at what you hear from some of them when they realize that they are not the subject matter expert present.
Wednesday A.M. Trading Thoughts
-- Marvell Technology (MRVL) reported in-line earnings on better-than-expected sales due to reduced margin. The firm guides similarly. There are two thoughts here. This is a trade war name that would benefit heavily from loosened restrictions on making sales to Chinese telecom giant HuaweiTechnologies. Marvell is also a 5G technology implementation play. I am long this name. Do I add here on Wednesday morning? Too sensitive. Only at a discount approaching the 200-day SMA ($23.84). With the shares higher, I likely sit on my hands.
-- Zscaler (ZS) is lower overnight after guiding toward reduced (adjusted) profitability for the current quarter. You may recall that I have been long this one for quite some time, and it took me nearly all of that time to get this position into the black. Down almost 5% overnight, but still trading above the $50 level, I have a net basis of $49.61 to protect. It took way too much effort and manipulation to turn this name positive on my book, and I will not be sorry to see it go.
-- Got long some Apple (AAPL) on Tuesday as I said I would. Didn't get the low by any stretch. Paid $258 like I said I would. Still working on a new target price, but I'll sell it at $265 today if the market pays me that price later. (Apple and Marvell are holdings of Jim Cramer's Action Alerts PLUS charitable trust.)
-- Nearly covered the Target (TGT) short on Tuesday for a profit, but decided to keep the position for now as a partial hedge against long-side exposure. Did remove derivative exposure at a (very) small loss as those products presented the opportunity to do so.
Economics (All Times Eastern)
08:15 - ADP Employment Report (Nov): Expecting 139K, Last 125K.
09:45 - Markit Services PMI (Nov-rev): Flashed 51.6.
10:00 - ISM Non-Manufacturing Index (Nov): Expecting 54.5, Last 54.7.
10:30 - Oil Inventories (Weekly): Last +1.572M.
10:30 - Gasoline Stocks (Weekly): Last +5.132M.
The Fed (All Times Eastern)
10:00 - Speaker: Reserve Board Gov. Randal Quarles.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (CPB) (.71)