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Central bank watchers have been stuck in quite the conundrum since the Bank of Japan’s (BoJ) July 31 meeting—no one can seem to tell if the bank is “easing” or “tightening.” At first, easing seemed to be winning, since the bank kept all its asset purchasing (aka quantitative easing, or QE) targets unchanged. But as time passed, more observers seemed to realize the decision to let 10-year government bond (JGB) yields rise as high as 0.2% would probably mean fewer JGB purchases, which to most sounds like tightening. But when yields hit an 18-month high at 0.145% on August 2, the bank intervened with a “special buying operation,” driving yields back to 0.115% as one policymaker said they wouldn’t hesitate to stem a rapid rise. Which … sort of seems like easing? Meanwhile, JGB yields have kept on swinging. Overall, we think the saga is emblematic of why trying to divine central bankers’ next move is fruitless—sometimes they say one thing and do another. But we would also suggest investors not read too much into one or two days’ worth of special operations and instead take a longer view. The last time the BoJ widened the JGB trading band, it amounted to a “stealth tapering” of QE. Once all the fuss dies down, this latest tweak could very well do the same. If it did, we suspect it would be an incremental positive for Japan’s markets and economy.
To see why, it is important to understand how we got here. Japan’s QE program is the world’s largest relative to GDP. The BoJ targets purchasing ¥80 trillion (roughly $720 billion) in JGBs annually—nearly 15% of 2017 GDP![i] At its peak, US QE was only 6.1% of GDP.[ii] The BoJ has been so active, it owns nearly 40% of total outstanding JGBs.[iii] But despite this Godzilla-sized “stimulus,” Japan’s economic growth has been tepid. The BoJ began the current QE program near the end of 2010, yet average annual GDP growth from 2009 through 2017 was only 0.7%.[iv] Meanwhile, average annual US GDP growth was 1.7% over that period, without its much smaller “stimulus/QE” for the last three years.[v] This doesn’t shock us. While most believe QE supported the economy and markets—and fear its end—we have long argued QE is a drag. When the BoJ bought long-term bonds, it reduced long-term rates and flattened the yield curve. Banks borrow short-term to fund long-term loans, so a flattish yield curve—with just a teensy gap between short- and long-term interest rates—crimps banks' loan profits. This discourages banks from lending to all but the most creditworthy borrowers, starving most firms of capital and the economy of fuel. It also stifles broad money supply growth, working against the BoJ’s mandate to get inflation back up to 2%. This is why we have long believed Japan would benefit from ending QE as soon as possible.
Japanese banks have long seemed frustrated with BoJ policy as well. Not only because they can scarcely make any money from lending, but because negative short-term interest rates further whacked their profits. The BoJ seemed to get the message in September 2016, when they introduced a program called Yield Curve Control (YCC), which targeted a 0% 10-year JGB yield but allowed fluctuation within a tight bandwidth, widely assumed to be +/-0.1%. At the time, long rates were negative, so targeting a 0% yield actually meant steepening the yield curve. It also meant the BoJ was buying fewer 10-year JGBs, allowing long rates to inch up. BoJ asset purchases fell to ¥50 trillion in the 12 months through May 2018, far below that ¥80 trillion full-year “target.”[vi] Tapering! But that sure isn’t what they called it, so they are tapering on the down-low.
Musers’ Note: As always, our political commentary is intentionally non-partisan. We prefer no political party or candidate and assess political developments solely for their market impact or investing lessons inherent in media coverage. Additionally, MarketMinder does not recommend individual securities. The below merely represent broader themes we wish to highlight.
In this week’s edition of our we-swear-it-isn’t-weekly column, the media learns how to scale tariffs and shatters FAANG stereotypes, the potential Tesla buyout raises some philosophical questions, Brits prepare for a “no-deal” Brexit, craft beer gets accused of being a leading economic indicator, and creative capitalists tackle a certain public safety problem.
Media Finally Realizes New Tariffs Are Tiny
As we trudge through the dog days of summer, the heat seems to be making the financial media even grumpier than usual. For all the speculation tariffs and increased protectionism would knock growth, most available data don’t show any major repercussions yet. The latest business surveys out of major economies show businesses, while wary of tariffs, are still expanding overall. Yet headlines harped on the slowdowns hitting manufacturing[i] and services sectors[ii] globally. The dour reaction to solid economic data is further evidence of the disconnect between sentiment and a better-than-appreciated reality—reason to be bullish, in our view.
These growthy economic data are purchasing managers’ indexes (PMI)—monthly surveys measuring business activity. Responding firms confirm whether activity rose or fell that month. PMI readings above 50 mean a majority of those surveyed reported higher activity; under 50 means more saw activity fall. Though PMIs register only growth’s breadth, not magnitude, they are useful snapshots of how businesses are doing. July PMIs of major economies all exceeded 50—a sign firms across manufacturing and services industries are growing overall, which is consistent with other data pointing to a broad global expansion. Yet many media took the glass-half-empty approach.
In the US, the Institute for Supply Management’s (ISM) July manufacturing PMI hit 58.1 while its nonmanufacturing PMI was 55.7. Headlines fretted US manufacturers were encountering “roadblocks”[iii] and services industries were losing momentum.[iv] This theme persisted overseas, too. IHS Markit’s eurozone July services PMI recorded 54.2 while its manufacturing PMI registered 55.1. Experts responded with comments about eurozone growth “ebbing”[v] and trade uncertainty hampering manufacturers.[vi] The UK’s IHS Markit/CIPS July services and manufacturing PMIs were 53.5 and 54.0, respectively. Folks worried services—about 80% of UK GDP—were now moving into the “slow lane”[vii] and weakening domestic demand was hurting manufacturing businesses.[viii] Even in China, where the Caixin PMIs for services and manufacturing remained above 50 with July readings of 52.8 and 50.8, respectively, analysts argued the twin issues of the US trade spat and softening domestic demand were hurting growth.[ix]
If you happen to know any telephone wire thieves, you may have noticed them looking a little sad lately. One possible reason (aside from the fact living life on the lam can be stressful): Copper prices have plunged -16.5% from June 8 – August 2.[i] Aside from larcenists, this drop spooked many who view the metal as a barometer of global economic health. Copper (the logic goes) is a key ingredient in manufacturing and construction projects—and since it trades globally, falling prices could signal heavy industry is flagging around the world, potentially threatening growth and markets. Thanks to copper’s alleged forecasting powers, financial wags long ago conferred upon it an honorary economics doctorate.[ii] But there are two problems with this thinking, in our view: First, as a mere metal,[iii] its price movements don’t have special significance. Second, we think copper’s recent travails appear sentiment-driven—linked to ill-founded trade war fears—and unlikely to last.
Among the explanations media toss out for falling copper prices, most pertain to perceived problems in China, which consumes about 40% of the world’s copper output. The most commonly cited: An escalating US/China trade war choking off global commodity demand and economic growth. As evidence, pundits point to recent “disappointing” Chinese data—like GDP’s slight downshift (to 6.7% y/y in Q2 from 6.8% in Q1)[iv] or recently decelerating Fixed Asset Investment (which grew 6.0% in 2018’s first half, the slowest on record).[v] Business activity surveys also ticked down in July from June.[vi] To many, this is evidence of China withering under US tariffs’ onslaught—and thus using far less copper. Lastly, some fret a recently weaker yuan relative to the dollar makes copper more expensive for Chinese importers, crimping profits and investment. But in our view, all these explanations fall short, as they ignore sentiment’s role in setting short-term commodity prices. Like stocks, commodities are subject to near-term volatility but move cyclically on supply and demand in the longer term. Trade war chatter can ding sentiment—as can growth jitters. Chinese stocks—which entered a bear market earlier this year based on similar worries—are another exhibit in the case for sentiment’s short-term influence.
But in the longer term, fundamentals win out—and in our view, copper market fundamentals favor higher prices. First, as Exhibit 1 shows, copper supply growth is slowing today and should continue easing over the next few years.
In the latest chapter of the US and China’s ongoing trade conflict, the US threatened to ratchet up the tariff rate on $200 billion in Chinese imports last Wednesday. China responded two days later with new tariff proposals of its own—and Washington promised to “stand tough.” Though media portray this as another step to a damaging trade war, the latest escalations still lack the size to derail the US, Chinese or global economies at large, in my view.
The US government’s latest tariff salvo isn’t exactly brand new. Rather, the US is upping the ante from its originally threatened 10% tariff rate on $200 billion in Chinese imports—aimed at a number of consumer goods ranging from fish to baseball gloves—to 25%. In response, China is aiming new tariffs at $60 billion in US imports. Overall, the rates on China’s list vary between 5% and 25%. The lower rates are focused on more advanced, less replaceable goods such as small planes and computers, while higher rates zero in on more replaceable, commoditized products. China had already threatened tariffs on basically all US imports, so this is largely a change in rates from 10% to 25%—similar to the US threat. China stated its implementation date will depend on US actions.
For reference, Exhibit 1 shows US tariff rates during the 1930s trade war compared to those recently implemented and threatened. While media continue fretting the world’s two largest economies hitting each other with tariffs that will devolve into a trade conflict akin to the 1930s global trade war, we are still nowhere close to that. The Smoot-Hawley tariffs resulted in a much higher effective tariff rate (19.8%) compared to the total threatened tariffs today (7.5%).
Fed head HQ—the Eccles building, named after an independent-minded fellow—is both physically and institutionally set away from Treasury. (Photo by traveler1116/iStock by Getty Images.)
Obligatory political disclaimer: We endeavor to be politically agnostic and favor no party or politician as bias blinds when investing.
In this week’s edition, our random selection of small financial and economic stories includes FANG ETFs that exclude the “F”, innovators making clothes from cow manure, a strongly worded yet sparse Fed statement and more. As always, MarketMinder doesn’t recommend individual securities—we just mention some now and then, when they illustrate a broader theme we want to highlight and maybe crack a joke or two about.
Did This FANG ETF Lose a Tooth?
If you have watched CNBC, opened a finance news website or accidentally stumbled upon finance Twitter[i] within the last two years, you have likely seen the acronym, FANG. You have likely also learned that FANG stands for Facebook, Amazon, Netflix and Google. You may also have seen its cousin, FAANG, which adds Apple. So if you happened across an ETF with the ticker, FNG, that aims to give investors exposure to “the FANG investment theme,” you might expect it to contain, well, Facebook, Amazon, Netflix and Google. As Bloomberg reports, however, you would be wrong. The fund started dumping the social network months ago.
The flattening US yield curve has been all over headlines lately, which may make it seem like new news. But like other ghosts that have popped up during this bull market, flat yield curve worries have made appearances before, similarly warning economic trouble was brewing. Yet the US economic expansion has chugged along. In my view, these headlines share a timeless investing lesson: Past movement doesn’t determine the future.
Here is a chart of the 10-year US Treasury yield minus the effective fed-funds rate since this bull market began in 2009. The line falling closer to zero means the spread is narrowing—said differently, the yield curve is flattening.
Exhibit 1: The Yield Spread Since 2009
Editors’ Note: MarketMinder does not recommend individual securities. The below merely represent a broader theme we wish to highlight.
We don’t usually wish to be bugs, but if we could be a fly on a wall (or decorative plant) anywhere in the world, it would be in Chinese President Xi Jinping’s office. For absent this—or, we guess, technological bugs—we can only speculate on how he and fellow Chinese officials are reacting to the Western world’s tightening the economic screws on the Middle Kingdom and targeting their latest grand economic central plan. President Trump stole most of Wednesday’s headlines with a proposal to ratchet a potential new tariff on $200 billion worth of goods from 10% to 25%, but we think more interesting developments are flying under the radar. First US lawmakers tacked some language onto the Defense bill that will expand the government’s ability to block takeovers on national security grounds once President Trump signs the legislation, which the Senate passed Wednesday. Then the UK crafted a similar bill and sent it around for public comment just before Parliament’s summer break. Symbolically, today Germany’s government officially blocked a Chinese takeover of a machine tool manufacturer, the first merger rejection under a law passed last year.[i] In short, it seems America and Europe are banding together to block China from potentially stealing trade secrets as it races to meet its “Made in China 2025” plan, which sets an ambitious goal to be a leading global technology producer by, well, 2025. But setting political aims aside, these measures might also seem to limit the flow of global capital, not to mention escalate a potential trade war, both of which markets might dislike. After looking over the details and considering recent history, however, it seems to us these developments don’t represent a radical sea change toward more protectionism.
If blocking Chinese takeovers were some new, sudden development, there might be some negative surprise power here. But in our view, the US, UK and German laws merely formalize the status quo. All three have blocked Chinese takeovers of companies in “sensitive” industries in recent years, either officially or by jawboning enough that the companies voluntarily dropped merger plans. Among the more high-profile examples, Chinese oil company Cnooc almost bought Unocal in 2005, before Congress lobbied hard for the Committee on Foreign Investment in the US (CFIUS) to review the deal, leading Cnooc to drop its bid. President Obama blocked a Chinese firm from building a wind power farm near a Naval facility in Oregon and barred a state-owned investment fund from buying a German chipmaker with American assets. The Trump administration has already blocked two potential Chinese acquisitions of US chipmakers. Across the pond, former UK Prime Minister David Cameron largely welcomed Chinese investment, but his successor, Theresa May, cooled the government’s stance before writing the new bill. Her cabinet blocked a Chinese firm from buying an aerospace company that manufactured parts for the Royal Air Force earlier this year. As for Germany, Chancellor Angela Merkel’s cabinet teamed with the Obama administration on that squashed semiconductor deal.