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The Looming Donnybrook Between Cyclical & Structural

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Via Global Macro Monitor,

This next quarter is going to be a major battle between the cyclical bulls and structural bears.

Cyclical Bulls

The bulls have the strength of current earnings, which may, or may not be priced (probably the later as the market is still at extreme valuations).   Furthermore, short-term indicators reflect too much bearishness – put-call ratio high at 134 percent.   Thus, we wouldn’t be surprised by a big push and full on frontal assault by the bulls in the first part of the quarter.

Seasonals also favor April.

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Effects of Tax Cuts

Much of the bullish data derives from the recent tax cuts.   We believe, though the tax cuts improve the accounting of profits, they haven’t changed the underlying economics of the stock market.

We seriously doubt the tax cut will increase aggregate demand enough to get companies lathered up enough to step on capital expenditures on a meaningful basis.  Maybe at the margins but not a game change.

Moreover, is the tax cut going to pave the way for new life changing products from Apple?   Open up new export markets for Boeing or Intel?  Significantly increase domestic demandfor good and services?   Those will happen with or without a tax cut.

Buybacks?  Yes.

The big mistake is to assume that what’s scarce is cash. The reality is that profitable investment opportunities are scarce.

What can we learn from the recent surge in stock buybacks, in which companies buy back their own shares, effectively returning their spare cash to shareholders?

Quite possibly, nothing, as far as the merit of the tax cuts goes. Standard economic theories suggest buybacks would occur whether or not the tax cuts succeed at stimulating investment. – NY Times, March 30

Increased demand and expanding markets are the mother’s milk of profitable opportunities.  Tax cuts, less so.  It was a good attempt by government to jump into the financial engineering game, however.

At some point, we expect the market to come to the same conclusion, and the epiphany will be further complicated by the realization of the perverse fiscal impact of the tax cuts and stepped up government spending.

Having said this,  we still think the corporate tax cut was the right policy but it is certainly not the economic Shangri-La that many and the markets may hail it to be.

Structural Bears

The structural bears have, what appears to be, the shifting of tectonic plates in the underlying fundamentals that have driven the global bull market in stocks.  The ground in beginning to move underlying the markets’ feet.

Major Structural Issues Coming Home To Roost 

The growing wealth and income inequality – just eight people own as much wealth as half of the world’s population — and its detrimental impact on growth;  the erosion of the liberal economic and political order, which has been the backdrop of the bull market;  the end of the bull market in bonds;  the end of quantitative easing (QE); the erosion of U.S. world leadership;  increasing trade and geopolitical frictions;   the rise of populism;  increasing concern over U.S. budget deficits and excess debt;  and the growing doubts about dollar supremacy, among others.

But those macroeconomic outcomes result from policy decisions abroad and the market-clearing movements of financial prices. Officials in important emerging-market economies chose to accumulate Treasury securities, because US yields, albeit low, were higher than in other advanced economies. A confrontational stance on trade, together with greater reliance on government debt, may well extract a higher toll to balance flows of goods and services and of capital. Moreover, the US will be paying for its current excesses with the promise of future payments, and inefficient stimulus now will not give future generations the productive resources needed to make good on it. – Carmen Reinhart, Project Syndicate, March 30

The confluence of the above negative structural factors is more than just “a wall of worry,”  in our opinion.  Furthermore,  we take the recent volatility shock and rare corresponding rise in interest rates as a signal of a regime change and the start of a bear market.

If the S&P500 trades above 2,802, and is sustained,  we will reassess our view and concede the market just doesn’t care, at least for now.

The Coming Donnybrook

We expect a major donnybrook between the cyclical bulls and secular bears in the coming quarter.  In fact, the next quarter may be one of the most important quarters in the financial markets in the past 50 years;  maybe not as significant as Q3 & Q4 2008, however.

Can the positive cyclical forces mentioned above outweigh the structural issues challenging the market’s long-term positive momentum?   We seriously doubt it but don’t entirely dismiss we may be wrong.

After all the natural trajectory are for markets is to move north and the bulls have the gravitational pull on their side, they always do.  The bears will have their work cut out for them in the next three months.   The bull won’t die without a fight.  Expect some bloody battles ahead.

The Market As The Final Political Arbiter

Finally,  the markets are going to be the final political arbiter as to whether the Trump administration is either #Making America Great Again (MAGA), or ruining the country and its standing in the world.  The president has placed his bet on the stock market as a weighing machine for his policies,  economic management, and competence of the White House.

No political statement as we leave it to the markets to vote.

The biggest overall risk, in our opinion, is that we now live in an asset driven global economy, which is prone and susceptible to perverse feedback loops.   The inflation/deflation dialectic, and subsequent asset moves will be on full display during the bear market until global markets finally realize the major central banks can not and and will not allow debt deflation to occur.

Stay tuned,  and “Let’s get ready to rumble.”

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