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Market Lab Report - Premarket Pulse 9/24/18

Futures are lower at the time of this writing as fears mount that trade issues between the U.S. and China will continue. Hong Kong's Hang Seng is trading lower by more than -1% while Japan, China, and South Korea are closed for a Monday holiday. 

Investors remain focused on the Sino-U.S. trade war as China added $60 billion of U.S. products to its import tariff list. This was in retaliation against U.S. duties on $200 billion of Chinese goods that came into effect at 04:01 am GMT Monday. 

Nevertheless, despite the trade frictions of the U.S. vs. the world, U.S. markets continue to approach or achieve new highs yet again in this QE-driven bull. Many analysts and market pundits have chimed in on the overvalued and bubble-prone nature of the current environment. They cite various metrics such as overvaluations in stocks brought on by stock buybacks which artificially inflate earnings, helping stocks beat earnings projections. Corporate debt now stands at 45% of GDP, an all-time high with share buybacks expecting to top $1 trillion in 2018. 

Of course, such have called for major tops in the market for many years running. But the uniqueness of this QE-driven bull keeps people on the wrong side as they attempt to guess the top. Anotable economist John Maynard Keynes once said, “The market can remain irrational longer than you can remain solvent.” Such measured guessing is liable to be wrong as Goldman Sachs recently asserted because one is hard pressed to compare today's market environment with past markets. 

Nevertheless, as I've mentioned, Ray Dalio of Bridgewater has put forth a powerful case about today's markets being similar to the 1930s markets. Dalio's concern is we may repeat 1937 when the Dow Industrials fell -50.1% due to extreme imbalances between the top 1% and bottom 90%. In addition, repeating conditions leading up to the crash of 1937, both today and then had a period of easy money fueling GDP growth and low unemployment. Dalio has also suggested a major currency devaluation coming potentially in the next couple of years given the extreme levels of past, present, and future debt. 

Indeed, a number of variables leading up to the 1937 crash seem comparable to where things sit today. Monetarists such as Milton Friedman blamed the -50.1% drop in the Dow on the Fed's tightening of the money supply in 1936 and 1937. But since the Fed has tightened 7 times since 2015 as reflected in the discount rate being pushed from 1.0% to 2.5% without any serious correction, it suggests global QE continues to play a huge role in preventing meaningful market corrections. But as global QE winds down, the odds of a far more serious correction increase. 

In some measured alignment with the monetarist school of thought, Austrian school economist Johnathan Catalan blamed 1937 on the relatively large expansion of the money supply from 1933 to 1937. But again, as Nobel Laureate economist Robert Shiller recently said, the stock market is “highly priced,” but “it could get much more highly priced.” There is an emotional, irrational element to the S&P’s strength, according to the economics professor. He went on to say, “It has something to do with our president, who is an exceptionally business-oriented president and who wants to deregulate and who favors lower taxes." Reagan's pro-business policies certainly had much to do with dictating the bull market that started in the early 1980s.

As rates continue to rise, it is no surprise that XLF (Financial ETF) issued a pocket pivot along with a number of financial stocks. The yield on the 10-year Treasury note jumped 3.7 basis points to a four-month high of 3.085% after better-than-expected housing starts data. Higher Treasury yields can give a boost to bank earnings, because that can increase the spread between what the banks make on longer-term assets and what they pay for shorter-term liabilities. So we have stocks mimicking the XLF pocket pivot such as C, BAC, SCHW, etc. With rates continuing to rise, banks could further benefit. 

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