|By Matein Khalid|
Trump’s post Charlottesville remarks, the Barcelona terrorist attacks and Cisco’s results unnerved the US stock market bulls last week. Friday was a surreal moment in the history of Wall Street. It was entirely rational for traders on the New York Stock Exchange floor to cheers and the Dow Jones Index rise 150 points when news broke that Trump had fired his alt-right, white nationalist chief strategist Steven Bannon. Bannon is a populist, an economic nationalist committed to a trade war with China, an advocate of the failed border adjustment tax and the arch foe of National Economic Council head Gary Cohn, an ex-Goldman Sachs President, key to Trump’s tax reform agenda. After Charlottesville, Bannon became an instant liability for the Trump White House. His departure reinforces the authority of General John Kelly, the new chief of staff and the globalists in the White House, led by Gary Cohn. After all, rumors that Cohn would resign in response to Trump’s New York press conference was a major factor behind Thursday’s 274 point plunge in the Dow. The financial markets detest uncertainty and the Trump White House, sadly, defines political chaos.
The worst fall in the US stock market in 2017 illustrates Wall Street’s loss of confidence in President Trump, who mismanaged domestic policy (failure of Obamacare repeal), foreign policy (North Korea, Russia, China, Mexico and NATO), race relations (the catastrophic press conference), judicial policy (firing of FBI Director Comey, the ban on immigrants from Muslim nations) and even basic White House personnel selection (firing of top handpicked aides like General Flynn, Bannon, Priebus, Scaramucci). Trump has now hit new lows in approval ratings after only seven months as President in the low 30’s, a level that took President Bush seven years, a failed war in Iraq and a global financial crisis to achieve. Trump invariably pointed to new highs in the US stock market since he became President as a personal achievement. This false correlation-causation equation broke last week. Trump is not the cause of the bull market but he could well be its nemesis. Trump has lost the respect of America’s business and financial elite, as symbolized by the mass resignation of Fortune 500 CEO’s from his White House councils.
The price of gold and the Japanese yen, the ten year US Treasury note yield and the Volatility Index (VIX) are four real time metrics of financial markets angst about the Trump White House. It is still too early to conclude that Steve Bannon’s departure represents a mea culpa for the President (impossible for a narcissist, impulsive Trump!). The politics of the debt ceiling, the US budget and tax reform will be the focus of the world financial markets in September. The wild card, as always, is the Presidential mood swings. The one bullish augury that could cheer the markets would be Gary Cohn’s appointment as Dr. Yellen’s successor at the helm of a Federal Reserve and the White House’s focus on a pro-growth, pro-stimulus, pro deregulation legislative agenda. It is idiotic for a President of the United States (Divided States?) to be pontificating about the statues of despicable Confederacy slave owners like General Robert E. Lee at a time the US faces such monumental economic, trade, social and diplomatic challenges. For now, the only good news is that Steve Bannon is out and Gary Cohn is in. However, with the Volatility Index at 14, Wall Street’s pendulum of greed and fear has unquestionably tilted to fear.
The “Trump rally” that began on Election Day and continued despite the failure to repeal Obamacare or enact tax reform/fiscal stimulus amid the stench of the Russiagate scandal that could well culminate in Trump’s impeachment. Trump has managed to alienate the Republican Senate, the Fortune 500 corporate elite, the media, the intelligence agencies, NATO, Mexico, China etc. If Trump was a British Prime Minister, he would have long been ousted in a parliamentary vote of no confidence or shoved aside, as Mrs. Thatcher was, by her own Cabinet in the poll tax protests. Sentiment on Wall Street is fragile. The buy side is still nervous. Last week started with the prospect of nuclear missiles over the Sea of Japan and ended with outrage over Trump’s failure to heal the rage over Civil War generals and another horrific terrorist attack in Spain. Divergences (notably Dow transports) and breadth in the stock market are awful. For now, risk off defines the psychology of the US stock market.
Market View – Crude oil prices can fall below $40 due to the global supply glut!
The latest OPEC meeting in Abu Dhabi did not reassure the global oil trading markets and energy stocks in Wall Street remain the S&P500 index’s worst performing sector of 2017. In retrospect, the Saudi-Russian deal last November has failed to stabilize the market as Brent/West Texas crude prices are 20% below 2017 peaks. OPEC made a strategic mistake exempting Libya and Nigeria from its output cuts as both countries have flooded the wet barrel (physical) crude market by more than 1 million barrels a day. Iraqi compliance to the Vienna deal has been a joke at only 30%. Kazakhstan actually raised output since last November. US rig count has almost doubled since summer 2016 and the frackers of West Texas have produced 900,000 extra barrels a day since OPEC inked its historic deal in Vienna in November 2016. Saudi Arabia can no longer play the role of swing producer, the central bank of black gold it played in the Sheikh Yamani era, in the Age of Shale.
Even a 1.8 million barrel a day output cut by OPEC, plus Russia, and other global oil producers has been insufficient to rebalance the world crude oil market. The North Korean geopolitical crisis has cast a shadow on Asian oil demand growth while prices have now fallen to below post Vienna deal levels. In 2009, Saudi Arabia had engineered a “shock and awe” 4 million barrels a day OPEC output cut, the biggest since Sheikh Abdullah Tariki and Juan Pablo Pérez Alfonzo founded the organization in 1960. This was sufficient to lead to major rise in crude oil prices from a post Lehman low of $38 in the global recession of 2009 to as high as $115 in June 2014, the month this millennium’s most traumatic oil price crash began. The world needs a credible Saudi brokered 3 million barrels a day oil cut and compliance by major producers like Iraq, Iran, Nigeria, Angola and Algeria.
Global financial and political realities make such a “shock and awe” OPEC deal impossible to negotiate and impossible to enforce. The result? The global supply glut worsens. Speculators continue to sell crude oil futures in the financial pits of London, New York, Chicago and Singapore – and Brent crude once again falls to $40 a barrel. The velocity of US shale oil production is simply beyond the control of OPEC, which barely supplies one third of global crude. Compliance to last Vienna’s output deal has been poor by some of OPEC’s biggest producers, notably Iraq. The Qatar crisis is yet another bearish data point for oil prices.
It is only a matter of time before Saudi Arabia and Russia conclude that there is no point in bearing the disproportionate political and financial burden of the Vienna deal. That will be the point when crude oil prices collapse, possibly to February 2016 lows of $28 a barrel. Meanwhile, the rise in US land drilling rig counts and supply elasticity of production promises another surge in US shale output.
The Energy Information Administration in Washington predicts the US will produce 9.9 million barrels a day in 2018, the highest Uncle Sam ever produced. This surge in American output in 2018 mean the odds of another oil price crash become almost certain and the strategy of relying on Saudi output cuts to stabilize the world oil market will no longer work. In any case, US producers are programmed to hedge their output any times prices approach $50 in West Texas spot crude. Like gold in the 1990’s, Pavlovian futures hedging by thousands of small producers almost guarantees a protracted bear market in crude oil. This is the reason why even the fall in US crude inventories has not been sufficient to boost prices in August. The surge in US gasoline storage is also an ominous sign as the US summer driving season is set to end after Labour Day in September. The collective net long position in West Texas crude oil futures could well unwind with a vengeance by October.
Non-OPEC output growth is another bearish data point for crude oil prices. The IEA’s growth estimates for non-OPEC output is 1.073 million barrels a day in2017. The US, Canada and Brazil are all ramping up output after fire related outages were resolved. Russia and Kazakhstan, desperate for petrocurrency revenues, have both rejected deeper cuts. This increases the odds of another oil price crash.
Macro Ideas – What next for South Korean, Hong Kong and Indian shares?
Nathan Mayer Rothschild’s pre-Waterloo advice to buy “when there is blood on the street” now unquestionably applies to South Korea equities. After a spectacular bull run in the first seven months of 2017, the KOSPI fell victim to the escalation in geopolitical tensions between Washington and Pyongyang. It is so ironic that the Nuclear Age began in another August 72 years ago after the US dropped two atomic bombs code named Fat Man (Hiroshima) and Little Boy (Nagasaki)! History was then tragedy and history now is farce as Fat Man and Little Boy exchanged nuclear threats. The KOSPI now trades at 9.8 times earnings, a significant discount to MSCI Asia at 14 times earnings.
Since the nuclear Armageddon scenario on the 38th parallel is absurd, I believe South Korean equities are now the most compelling value trade in Asia. True, foreign investors have been panic selling in the Hermit Kingdom/Republic of Samsung (this mega-chaebol is 20% of national GDP!). Yet the new center-left Moon government will boost domestic spending, wage growth, health insurance coverage and deliver a pro-growth supplementary budget. The key electronics/IT sectors can well grow earnings by 40% in the next twelve months. This makes it attractive to accumulate South Korea’s tech blue chips, led by Samsung Electronics even though I doubt if chaebol corruption, low payouts, high accounting risk and the grotesque Kim regime in North Korea will allow a significant valuation rerating of the KOSPI index. Yet South Korea’s battered tech/electronics sector and major banks now offer an irresistible risk/reward calculus to me. South Korea is a proxy for a warrant on global economic growth and electronics/tech cycle. With the first synchronized global expansion since 2010 and Silicon Valley tech ecosystem in boom mode, South Korea exporters will remain no brainer buys in this correction.
The decline in Asia equities in an opportunity to accumulate bellwether shares in China and Hong Kong. President Xi Jinping will ensure economic growth remains stable and no credit shocks roil the financial markets in the run up to the Communist Party’s National People Congress. This means Beijing will attain in Politburo’s 6.5% GDP growth target and the “One Belt, One Road” initiative could well mean $1 trillion in new infrastructure projects that could transform entire sectors of the Chinese economy, notably in the vast western province of Sinkiang. While I normally detest investing in state owned companies and Orwellian Marxist-Leninist dictatorships, it is impossible to ignore the myriad macro data points in both Mainland China and Hong Kong.
Inflation adjusted interest rates in China are now zero. State reserves have now once again risen above $3 trillion. The People Bank of China and the Politburo have cracked down on rampant speculation in property, wealth management products and flight capital outside the Middle Kingdom.
This means Chinese shares traded in Hong Kong will once again attract a tsunami of Mainland domestic liquidity, the reason I believe the H share index could well rise to 12000. Both Mainland pension funds/insurance companies and global investors will accumulate Chinese H shares this autumn. Unlike 2015, there is no margin trading Frankenstein in Hong Kong, the Federal Reserve will not aggressively hike US dollar interest rates, Asia ex Japan funds are still underweight Chinese H shares and Shanghai A shares are now included in the Morgan Stanley emerging market indices.
Chinese H shares in Hong Kong trade at 6.9 times forward earnings, well below their 10-year average multiple of 8.9. Yummy, Comrade Chopsticks!
Indian shares trade at 19 times earnings, far above MSCI China and their own 10-year average multiple of 15.4 times earnings. India has been the crowded, consensus trade in the emerging markets, thanks to $30 billion in offshore debt and equity inflows into Dalal Street attracted by the BJP’s reformist agenda, the prospect of RBI rate cuts and lower inflation, the GST and the highest GDP and corporate earnings growth in Asia. The path to Nifty 10,000 included more than a dollop of “irrational exuberance”, notably in the IPO and small cap sectors.
India no longer makes sense for a “beta trade” as earnings growth rates decelerates in 2018, possibly to 12%. This means the current India bulls could be gored as the stock market trades one standard deviation above its valuation band. The real money in India will be made via stock selection (my picks are ICICI Bank, HDFC Bank, Cipla) and long duration G-Sec debt, thanks to the highest real interest rates in Asia on the prospect of at least two more RBI rate cuts.