Trump Still Negotiating With China

There is certainly communications inconsistency from the White House on the China trade talks. Mnuchin stated there had been meaningful progress with the negotiations and the plans just needed to be implemented. In an impromptu media Q&A with the President who was at a meeting with the President of South Korea, President Trump stated the negotiations were only a start and that he wasn’t satisfied. Furthermore, he said he wasn’t pleased with the surprise second meeting between Chinese President Xi and the North Korean leader Kim. He stated the tone changed surrounding the upcoming summit with North Korea on June 12th. Trump is wrapping all the issues together, namely the denuclearization of North Korea, the trade deficit, and his personal relationship with the leaders.

It seems like his dissatisfaction with the meeting between North Korea and China caused him to change his language on trade. Everything is on the table until the North Korean summit, so prepare for volatility in the markets as the high stakes negotiations begin. The first step is for the summit to happen in the first place. A lot of geopolitical negotiations are done beforehand as the meetings are scripted for the media. If the meeting takes place, I expect a good outcome. It’s tense for the markets as the global economy and the ability to maintain and expand peace are up in the air. Clearly, the market ignores the economic data when these geopolitical announcements take place.

Surprisingly Excessive Optimism

Yesterday, the S&P 500 was up slightly before the Trump Q&A and it closed down 0.31%. Technically, this wasn’t a big move. It eliminated some of the greed that was entering the market. As you can see from the chart below, the NDR Daily Trading Sentiment Composite as of Monday was at 72.22 which signals excessive optimism. This category of above 62.5 has been hit 28.27% of the time since 1995 and is consistent with an annualized return of -8.64%. The category has been maintained 29.62% of the time and had a return of -6.78% from 2006. It’s definitely weird to see such high optimism with the S&P 500 off its all time high, but a few down days will wipe that away quickly. Interestingly, the CNN Fear and Greed Index was up from 56 to 59 even though the stock market was down. There needs to be a bigger downturn to wipe the greed off that one, but 59 still isn’t close to the extreme greed category, so it’s not a huge problem.

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Flattening Curve As Cycle Reaches The Late Stages

The yield curve had been steepening for a few days as American economic growth had been outperforming the other markets. The trend had gotten so extreme that the 10 year US treasury had the highest yield as compared to the 10 year government bond yields from the other major economies for the first time since June 2000. It’s easy to see why those values are justified, but it’s difficult to see what the future holds. It’s very difficult to maintain streaks such as that. The streak looks like it could be ending as the curve has flattened in the past few days and the 10 year yield is down slightly over 6 basis points since the high of 3.11% on May 17th.

The latest difference between the 10 year yield and the 2 year yield has fallen to 47 basis points. The 2 year yield is going to keep increasing until it looks like the Fed will be done hiking rates. Even though we don’t want the yield curve to invert, we also don’t want the Fed to stop hiking rates because that signals a recession is coming. It’s certainly possible that the Fed somehow stops hiking without causing a recession, but the Fed would only stop if inflation or growth lowered which would be a problem in itself. The way I see monetary policy, the Fed will be done hiking rates in 2019. I think the 2 year yield will probably get above 3% before the cycle ends.

Trump Dollar

The U.S. dollar was down very slightly on Tuesday and looks to be up slightly as of early Wednesday trading. Even though some headlines and analysis I’ve read have pronounced the rally is over, there hasn’t been much action to support that. I think the dollar will begin to have a serious effect on S&P 500 earnings if it gets above $95 and stays there (it’s at $93.70 now). I didn’t believe in the relationship between Trump’s approval rating and the strength of the dollar when the relationship started being tracked in 2017.

As you can see from the chart below, there has been a slight uncorrelation, but the relationship is still decently strong. Trump’s approval rating has increased as the dollar has risen. This is a weird correlation in one sense because Trump seems to want a weak dollar. On the other hand, the economy has been doing well recently which is pushing up the dollar and possibly his approval rating.

Dollar Oil

In a previous article, I mentioned that it was amazing to see oil rallying while the dollar strengthened. The chart below pours some cold water on my point because the dollar and oil haven’t had a consistent correlation. Sometimes they are negatively correlated, other times they have no relationship, and other times they are correlated. The chart below shows a negative correlation in 2018, but in the past month both have been up. That must not be enough to register on this chart.

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Conclusion

The geopolitical worries are a reason for stocks to selloff, but they don’t make me bearish. I cannot predict such high stakes historic negotiations between political leaders. This doesn’t mean I won’t make bets on the market. I’m bullish because of the fundamentals. Generally, these issues don’t affect markets for the long term. The only reason why the markets have been affected for a few months is because uncertainty still reigns. I’m obviously hoping there isn’t a trade war and peace is agreed upon.