The Dividend Cafe - The New Narrative: A Fed Put vs. A Trump Call

Episode Date: June 7, 2019

Topics discussed: Mr. Tariff Man moves south Are tariffs inflationary? The Fed's signal to markets. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe podcast listeners is identical this week. We're going to do kind of an overview of what's gone on in the last week, and it's a lot, and give an overview of the narrative that I want our clients thinking about this market in, the kind of context in which we're in. So I'm going to make a few comments about that. I'll reference a few things in the written Dividend Cafe commentary. And then I will say that for those who want that kind, now I'm going to be talking plenty about these threatened Mexico tariffs. But for those who want a deeper dive, particularly into the subject of the trade war and the new round represented in the Mexican threat, by threat I do mean our threat to them,

I'm doing a special advice and insights podcast dedicated just to that subject. So we won't be covering everything. We're just going to go kind of particularly into the ramifications of this present development in the trade war and really what it means, particularly the U.S. economy. And so check out the Advice and Insights podcast if you're interested in that. I believe you'll find it very informative. And there's a perspective there that might surprise some of you. Well, let's talk big picture. You know, it was last Thursday night after we had recorded. It happened to have been my birthday.

I happened to have just gotten out of the country and just sat down to sit and enjoy a sunset with my wife and probably we'd order dinner or something when all of a sudden my tweets start blowing up, my alerts, the CNBC, Bloomberg, you know, if you guys understood how many things pop up on my phone, you would be utterly appalled, as my wife is, and maybe I should be. And of course, the subject of all this was the president really out of nowhere saying, we're going to a 5% tariff on June 10th on all imports that we pull in from Mexico if they can't help us with securing our border. And then I later elaborated it would go to 10% the next month

and then 15% the month after that. It would keep going up 5% until they got to 25%. So, you know, we import, let's call it $370 billion a year from Mexico, 25%. You're not too far off from $100 billion of additional taxes that would hit the U.S. economy, paid by the U.S. producers and, of course, passed on to U.S. consumers. And unlike a lot of the stuff that we import from China, you don't have much of an ability. The administration's done a good job so far trying to kind of shelter the impact of the tariffs from consumers. You don't have much of an ability to hide the impact of higher prices in avocados and vegetables and agricultural product from consumers. Now, the vast majority of what we import from Mexico are parts that U.S. manufacturers import.

So it's a product being made in America, but uses some part in the supply chain. This is particular to an auto machinery that's made in Mexico. So this is a much more direct hit to U.S. businesses and U.S. consumers than even the so far evolution of the Chinese tariffs. Well, anyways, as far as the market goes, we tanked on Friday. And then every day this week, the markets have been higher so far, including as I'm talking here right now in the middle of the day Thursday. Monday was more of a mixed bag because technology and NASDAQ got hit pretty good Monday because of some new antitrust investigations that were announced. But the Dow was technically up Monday. But then we rallied dramatically, like over 500 points. And I don't want to take lightly what a 500-point move is a big deal.

So I talk that we're going to have both up and down volatility as long as this trade war continues around the uncertainty. And I stand by that completely. But even on the upside of the volatility forecast, 500 points is a big deal. And 200, 300 of it was perhaps a snapback from how much we had gone down previously. And we opened up 200 or 300 points. But then we got another 200 or 300 upside. As Chairman Powell of the Federal Reserve said, the Fed stands ready watching the trade war, watching some of the economic weakening we're seeing to respond monetarily. And the Fed funds futures market now pricing in like an 88 percent chance of not one but two rate cuts. Now, maybe it could be one rate cut at 50 basis points, a half a point, or two at 25 each.

But the point is, the bond market is pricing in that by September, the Fed will have taken back both their December and September hike from last year. Very aggressive monetary response. And this is kind of the foundation for the narrative that I'm speaking about here today, for those of you listening and viewing. We've been using, and I admit I didn't make up this nomenclature, but there's been talk about the Fed put, and it used to be called the Greenspan put. And one of these days, I'm going to get to this article, I literally have been telling my communications team for two years, I'm going to write, going article. I literally have been telling my communications team for two years I'm going to write.

Going back to October of 1998. Now, the Fed had probably had a philosophy of coddling risk assets and viewing themselves as providing a put to the markets. Well, before then, by October of 98, I was a very young investor at the time, but very heavily involved in a lot of the technology things going on and formulating my own investment worldview. I remember it honestly like it was yesterday. The market had gone down about 20 percent. Long-term capital management hedge fund had imploded. The Russian ruble crisis. You had a lot of emerging markets weakness around the globe. Issues with Thailand, issues with Mexico.

But the U.S. economy was on fire. Unemployment was very low. GDP growth was like over 5 percent. And Greenspan came in and cut the federal funds rate in October 50 basis points, half a point. And a lot of people believe that's really the octane that put the next inning into the dot-com bubble. And of course, in 1999, you just had this tremendous migration blow off top into a lot of those hot technology names. And it was March of 2000 where finally that bubble kind of exploded.

But my point being that ever since then, that's a pretty extreme example where there's not really any thoughtful rationalization for what they did other than their belief. Most of the time, Chairman Greenspan was pretty explicit about it, pretty transparent, that they believed in this concept of the wealth effect and that they needed to protect risk assets for the sake of the overall macroeconomic impact, the trickle-down effect it represented. For right or for wrong, that's their belief. But they have done very little to peel that back for the last 21 years.

And I think on into his successor, Richard Bernanke, who, of course, really governed in a very difficult time through the financial crisis, and then Chairwoman Yellen and so forth. Now, Chairman Powell looked to some degree like maybe he, late last year, might be the first chairman to say, I'm not here to protect real estate assets. I'm not here to protect stock assets. I'm not here to protect stock assets? Am I here to protect riskier credit assets? We want to normalize the economy and create a more natural rate in the short-term Fed funds rate. And that's now completely gone back to Fed reversion to the mean whereby they view themselves as a protector of risk assets. And so they've called it the Greenspan put over the years, the Fed put. But now the nomenclature I'm adding, and forgive me for the long explanation,

but it's an important setup, is what I'm calling the Trump call. So for those who understand option derivatives, you have put options and call options, and the Fed providing that kind of put of protection to the downside. But then President Trump, at this point, I believe the narrative that it's just posturing. We're just going to negotiate to get a better deal. If that is indeed what's happening, which is entirely possible it is, it's beyond ineffective when everybody knows that that's what's happening, right? So to the extent people come to me and say, why do you get so upset about the trade war? President Trump is doing an art of the deal thing

and so forth. And I say, maybe where it will be, but if you know it and I know it, don't you think China knows it? Don't you think Mexico knows it? So I kind of believe that there is still a sort of self-protective element politically, self-interested element politically, by which a deal will have to get done. And I don't know what the break point is. with Central American immigration issue. And so these tariffs aren't going to go on. Well, it's possible. Don't think it would do a lot for his own credibility. I certainly hope that's what he does. I think it's the right thing economically because we face a big impact

from what is going to happen here with these tariffs. And that's the subject of this Advice and Insights podcast I referenced earlier. But again, with China, I don't have any feeling or any indication that this is going to be resolved anytime soon. And so we're seeing it very clearly. I don't want to mince any words. We're seeing it very clearly in the data. The capital goods orders are declining.

I believe that if these Mexico tariffs go into effect, it will have a pretty immediate and certainly direct impact to U.S. jobs, particularly in California and Texas. And I quote a study about that in Divinity Cafe this week. The job, you know, let's say it goes all the way to the 25 percent level. Ninety billion dollars of new taxes would be the largest tax increase in over 30 years. So you would have, I think, an economic impact, regardless of what anyone thinks about politically. I don't imagine any viewers or listeners right now have to guess what I think about it politically, but that's not really my point. I'm only saying this to you from an objective investment and economic outlook standpoint, that this would be highly contractionary and almost guarantee an accelerated recession in six months, a year, year and a half. There's a lag effect that's somewhat hard to forecast. I don't really believe it'll get to that point,

but we don't know. And this is a little different than the China tariffs in the sense that a lot of his policy advisors supported. Some did not. Some kind of support a hybrid effect. Let's get a deal done. But we understand using tariffs for negotiating leverage. Others flat out disagree with it and others just love it and say, let's put on tariffs and never take them back. But this issue with the Mexican tariffs, there's not support within his council. His chairman of the Council of Economic Advisers resigned on Monday. His U.S. trade representative, Bob Lighthizer, who's really well-known as a pretty pro-tariff protectionist guy, is really against this policy move. So what that's done is, for right or for wrong, it's added uncertainty. It's added to the idea that there's a certain erratic issue at play that may not allow market forecasters to be able to know what to do.

So I would consider that a headwind in the markets that represents, oh, things could be getting a lot better. There's good things happening, but there's that Trump call factor. But then you go, oh, I want to get pessimistic. I'm worried about tariffs. I'm worried about recession. I'm worried about the bond, the yield curve, you know, pointing to low growth, the deflationary pressures.

And yet then there's the Fed put that makes it very hard. People can literally, this expression we use a lot in the trading world, but you can get your face ripped off trying to be pessimistic on this market if the Fed comes in and surprises you with monetary stimulus. It may not last. It may delay the inevitable, a further pain down the line. But I don't think a lot of people want to wait three, four, five years to be right in a bearish thesis.

And I think that that risk is out there. So the Fed put in the Trump call, that's kind of where we're at. And I will say it's very interesting that I talked at great length six months ago, eight months ago, over that period of time from Q3 into Q4 of 2018 about the two-headed monster. What was facing markets was concern about how tight the Fed was going to get and then concern about the trade war. And that both of those two heads sort of alleviated coming into 2019. The Fed signaled no more rate hikes for the foreseeable future. They signaled kind of surrender around their quantitative tightening. And then the trade war was really looking as if some deal with China was imminently

forthcoming. And then now both of those things are back at play, except for in the Fed's case, it's the opposite. The Fed now is not the two-headed monster. They appear to be the friend of markets. That's what you've seen a lot this week. So what do I do about it? Do I want to go place a large position on the side of the Fed put or a large position on the side of the Trump call? I do not, because I believe both will probably be at play for some time. The language Chairman Powell used this week, specific to we want to protect and extend this phase of economic recovery,

that they see themselves as there to try to extend another one, two, three innings. I hope the policy front in which they're having to maneuver the so-called Trump call aspect with trade and tariff policy does not represent an insurmountable problem. to stay in a balanced asset allocation, to stay in the middle of the road of whatever their kind of natural, strategic risk-reward spot ought to be. And that's what we're doing on behalf of clients. We've raised a decent amount of cash. We're slowly trying to deploy some.

We have been very patient, and now we have dry powder we want to be able to deploy. Not substantial, but enough that we can add value if we end up getting some of these positions right and whatnot. But the fact of the matter is that anyone who gets a 500-point update in the market and thinks, okay, good, we're out of the woods, is probably going to be very frustrated because I think that a 500-point down day can happen at any

point, and you could have three of them in the next nine days, and then you could have four 300-point up days and so forth. Volatility is what I expect with uncertainty around these two different competing factors. So the Fed put versus the Trump call is the narrative we're in now. It could be updated. There could be resolutions sooner than expected on all these trade aspects, but that's what I wanted to lay out as our narrative right now here at the Dividend Cafe. In DividendCafe.com this week, because I'm going to wrap it up now, there's a lot more specifics around data of the Chinese,

excuse me, the Mexican tariffs. And then I do go into some of the other subjects as well that I haven't here on the podcast and video. Really want to continue exploring this issue of what excessive debt levels. And I talk more about this Japanification term. There's some great charts there. So, yeah, I really want you to go to a cafe because not only are there the charts as always, but there's some content that I think is important for you to check out. A lot went into this week's commentary. A lot goes into it every week. That's all I got for this week's Dividend Cafe podcast and video.

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