Time to Step on the Gas
The Year of the Clawback. That’s what we at Maverick Trading are calling 2019. Looking back on the whole year, 2019 looks wonderful, with the S&P 500 enjoying a 30% gain. However, this completely neglects the market devastation in Q4 2018, where the S&P plummeted a full 20% and didn’t bottom until Christmas Eve.
While the markets did, initially, regain the highs of 2018 in April 2019, May through September was a choppy market filled with both bullish and bearish headfakes and many traders were juked out of their shoes on more than one occasion. In fact, from a technical standpoint, while the S&P did flash a minor bullish confirmation at the beginning of October, overhead resistance was not truly cleared out until the last week of October.
On a January to December basis, 2019 looks outstanding. On a two year basis, the S&P has gained 20%, averaging 10% per year, which is good – above historical norms – but not as eye-catching as the 2019 headline numbers. In fact, compared to 2018’s highs, the 2019 market is only around 9.5% above those highs and it took a full year to repair Q4 2018’s damage. Good but not “Wow.”
In the FX realm, trading throughout the first three quarters of 2019 was lackluster, with volatility largely below expectations. However, late in Q4, volatility decided to come back and sit down at the FX table. As we will discuss shortly, several fundamental theses are showing signs of triggering in FX and, if history holds to type, we may trade these themes for a good portion of 2020.
Since 2019 required a Herculean effort to repair the damage of Q4 2018, what does 2020 have in store for traders?
First, in equities, surgically excise the thoughts that the market has come so far that it must take a break or that the Bull Market has to be over. From both technical and fundamental standpoints, we find no reasons to not be bullish.
Technically, we saw what was essentially a five to six month base from the end of April until a confirmatory breakout in late October. On a weekly chart, the S&P 500 bounced off the 20 period Simple Moving Average the second week of October giving the first conclusive confirmation signal and, by the fourth week of October, had cleared out all the overhead resistance established by the July and September swing highs. Every other swing low on a weekly chart for the past two years had closed well below the 20 period SMA, many times very significantly.
All that said, our conclusion is that from a technical basis alone, we anticipate being net long in our portfolios well into Q2 of 2020.
Several fundamental situations support the technical case for bullish exposure in equities.
Politics aside, barring President Trump having a Jack Nicholson-like “You’re g**damn right I ordered the Code Red!” moment on Twitter (not a completely implausible event), it is nearly a foregone conclusion that the President will be acquitted in his eventual impeachment trial in the Senate, should the House ever deign to transmit their Articles of Impeachment to the Senate. The markets have clearly done the math on this and have priced impeachment in as a non-event.
However, let’s say that all 45 Democrat Senators and the two Independent Senators who caucus with the Democrats (Angus King and Bernie Sanders) vote to convict the President – a near statistical certainty – but also at least 20 Republican Senators decide to commit seppuku and ritually disembowel themselves (politically) on the floor of the Senate and vote to convict as well.
Result – President Trump becomes former-President Trump, and Vice President Pence becomes President Pence. We’d essentially have the same policies with a lot fewer tweets.
Net effect, we’d incur some short-term volatility as people digest what happened and bounce right back into the uptrend. We feel the market has priced this in as well.
US-China Trade War
If we had to lay the blame for the volatility and choppiness we saw during the five basing months we identified in 2019, we would attribute it to the US-China Trade War. This was the largest headline risk throughout 2019 and there was so much news and reaction to the news throughout the year that we started to experience what we called “headline exhaustion.” News and statements around this issue began having less of an effect on the markets as people became accustomed to tariffs and rhetoric as the new normal.
The agreement to Phase I of a trade deal and the rollback of tariffs was welcomed with a sigh in the markets, but the result was not the markets accelerating in their gains, but pausing slightly. It was a classic case of buy the rumor and sell the news. Back and fill progress in Phases II, III, etc of the US-China trade deal will inject occasional volatility in the markets, but the overall feeling is that while the process will be ugly at times, progress will be made and it will be a net positive for the economy.
Our assessment of the situation is that China needs the US more than the US needs China. We will see and hear about far more of the economic dislocations within the US simply because of the disparity between a free press and state-run media, but simple math dictates that China’s dependence on the US as its largest trading partner puts it on the short side of the equation. The US will get concessions, but not everything it wants, and the pace of negotiations will be slower than most people realize.
After raising rates in 2018, the Fed reversed course in 2019 and delivered two quarter point rate cuts. A good portion of the rationale for the rate cuts was, of course, the aforementioned US-China trade war. GDP growth slowed, but did not go negative in 2019. As of November 2019, the US inflation rate stands at 2.1%, right on the Fed’s inflation target. The unemployment rate is historically low, at 3.6%, but wage growth is only starting to materialize.
While too early to tell, the Fed may actually have pulled off the miracle of moderating interest rates to avoid a recession. In most historic cases, the Fed increased interest rates too far, too fast, causing a recession.
We view Fed Chairman Jerome Powell as figuratively standing in the middle of a minefield, uttering in a hushed voice: “Nobody move!”
With 5% unemployment traditionally considered “full employment,” the current rate of 3.6% should have provided and currently be providing more pressure on wage growth, but we are only now seeing the beginning signs of that. The Fed can point to the numbers to say that they’ve fulfilled their dual mandate of price stability and full employment, but without commensurate wage growth, purchasing power, especially at the lower end of the economic spectrum, will decrease.
This position of precarious perfection and the Fed’s desire to not mess with the machinery can be seen in their statements: nearly all Fed governors have re-adopted the mantra that the Fed is “data dependent,” to the point they have reportedly printed t-shirts and coffee cups with the slogan so they don’t forget. Essentially, the Fed is in wait and see mode.
Our outlook on the economy versus the markets is that the economy does better than the market in 2020. Our view is that the economy begins to pick up speed and inflation begins to creep upward, putting pressure on corporate bottom lines. If this scenario comes to fruition, we actually see the possibility of a single rate hike in late 2020, most likely after US elections.
A caution regarding the Fed and the US economy: knowing that the US-China trade war was adversely impacting the US economy (although to a lesser extent than the Chinese economy) the market shrugged off weak GDP data for Q2 and Q3. The market is likely to dismiss any GDP weakness reported for Q4 2019 as it views the trade war as something in the rearview mirror, but that is likely to be the last free pass the markets give economic data. Any weakness reported from Q1 2020 is likely to pause any bullish move until additional clarity can be had on the state of the economy.
The three and a half year drama that has been Brexit appears to be entering its final stages, with the resounding election of Boris Johnson’s Tories. Johnson’s stance is that there will be a Brexit, Hard or Soft, come 31 January, 2020. While UK and EU diplomats are frantically trying to iron out the UK’s exit to minimize disruptions, Johnson has instructed UK government agencies to plan for a Hard Brexit while continuing negotiations with the EU.
Our position is that the election of the Tory government and the absolute decimation of the Labor party puts the UK in the superior negotiating position. It’s been made clear to EU negotiators that any sympathy for Remain among UK politicians and diplomats has been burned out at the roots by the British people. The UK negotiators have new marching orders and are preparing to weather a storm of a hard Brexit.
While there was hope in the EU for essentially a Brexit-light option or even an outright new referendum on Brexit, there was little to motivate EU negotiators to grant concessions to the UK. Now, with the UK girding itself for battle, the situation is brought into a stark light: the EU needs the UK more than the UK needs the EU.
The evidence for this has been gathered over the past three and a half years. The day after the initial Brexit vote in 2016, with the surprise outcome, while the FTSE was down nearly 4%, the remaining European bourses were down even further, some up to 6%.
Additionally, in the aftermath of the Brexit vote, the pound lost a good deal of value. However, in the aftermath of the December’s election which installed the Tories in uncontested power for the next five years, the Pound gained over 700 pips versus the Yen. From its high on 9 August, 2019 to its low on 13 December, 2019, the Euro lost over 1,100 pips versus the Pound. Investors and bankers now (privately) view Brexit as an opportunity for the UK to accelerate its economy, leaving the rest of the Eurozone behind.
In the realm of rank speculation, we privately suspect that a rather extensive US-UK trade deal has already been quietly negotiated through back channels and will be publicly rolled out immediately after the official Brexit date. This will help to minimize any economic dislocations in the UK caused by Brexit and will pressure the EU to ease regulations and business protections that the US finds onerous in hopes of the EU getting an equally favorable trade agreement with the US.
What this means for the currency markets is that since the Pound approached historically low valuation in 2019, that trend has reversed and a major trading thesis in 2020 will be long GBP, almost to the point where the GBP becomes a Risk-On currency during 2020.
On a macro basis, we view 2020 as a Risk-On environment. In addition to being long GBP, we will also be watching AUD and NZD for long entries, as part of a feedback loop resulting from the easing of US-China trade tensions discussed above. We will look to pair strength in these currencies against what we foresee to be weakness in JPY and possibly CHF. We would look to add USD as a counter-currency if we begin to see sustained rises in commodity prices.
We’ve been increasing our bullish exposure in equities since October 2019, but we’ve cautioned our traders to “work their way up through the gears” and take their cues from the market action. From an allocation standpoint, we’re currently in third gear, about to go into fourth, and looking forward to hitting fifth gear and cruising down the highway. It is time to step on the gas. Welcome to 2020.