Whistling Past The Graveyard

You’d be forgiven for asking whether markets have become wholly detached from the reality of the trade situation.

Monday marked the fifth consecutive day of gains on Wall Street, and the rally was led by chips and auto shares, which pretty clearly points to trade optimism.

The SOX has now risen in five of the last six sessions. Additionally, it’s worth noting that high yield spreads tightened by the second-most since the gargantuan January rally last week.

While it makes some measure of sense to assume that Trump’s decision to “back down” from the Mexico tariffs suggests he likely won’t risk moving forward with levies on the remaining $300 billion in Chinese goods at the beginning of next month, don’t let it be lost on you that Monday was yet another day when Trump made an explicit threat and everyone ignored it.

During his interview with CNBC (which also produced more criticism of the Powell Fed and allusions to fines for big tech companies who “discriminate” against conservatives), Trump told Becky Quick that if Xi doesn’t meet with him at the G20, the tariffs are a go. He was unequivocal. Here’s the clip:

Later, during an interview with Fox News, Mike Pence doubled down on some of his trademark China tough talk. “It’s not just a matter that China is half of our international trade deficit, it’s well beyond that. It’s the way China has conducted themselves”, Pence said, referring to China like an unruly toddler, as he’s wont to do. “The threat of intellectual property, what we call the structural issues, protecting private property, and basically the international rules that have governed international trade for generations. And the United States is going to continue to stand firm on that”, Pence added.

It’s important to note that China is far from out of ammo when it comes to responding to further US aggression. In addition to Beijing’s new corporate blacklist, China could cancel aircraft orders, institute a rare earth embargo, depreciate the yuan and, of course, liquidate US Treasurys, the so-called nuclear option. The onshore yuan sank on Monday to its weakest since November, catching up to Yi Gang’s comments after the holiday. Over the weekend, reports from The New York Times and Reuters detailed a sit-down Beijing called last week with global tech heavyweights.

“Many would expect the US to ‘win’ the trade war, but we don’t think China’s ammunition chest has run empty either”, BofA cautioned on Monday. “Neither side has seen enough reason to move back to the negotiation table [and] as a result, we will likely remain stuck in limbo with more dramatic threats and strong rhetoric used on each other for at least another 2-3 months”, the bank’s Helen Qiao said.

Meanwhile, equity funds have seen some US $35 billion in outflows since May, an amount Goldman notes is “comparable to Q4 last year.” The bank also observes that thanks to the latest outflows, “cumulative flows into equity funds domiciled in the US have been flat since the end of 2017”.

(Goldman)

On the other side, fixed income funds have seen some of the largest inflows in nearly two decades.

2019’s rally has been notoriously “flow-less” and with the data rolling over, that lack of enthusiasm is likely to persist, despite last week being a good week for inflows into SPY. “Historically equity fund flows have closely tracked growth and with the Global manufacturing PMI dropping below 50 in May, investors have been reluctant to take more exposure in equity”, Goldman writes.

Ultimately, one wonders whether we’ll all be sitting around a month from now shaking our heads at this five-day rally. It seems like just a matter of time before Trump pops up on Twitter with another tariff broadside.

During his exchange with Becky Quick, Trump also said that, contrary to popular opinion, the worst-case scenario (25% tariffs on all remaining Chinese imports) is actually the best possible outcome. “Look, from my standpoint, the best deal we can have is 25% [tariffs] on $600 billion in goods”, the president mused.

And while market participants may be whistling past the graveyard when it comes to underestimating the odds of the trade war spiraling further out of control, Americans in general might be demonstrating an even more precarious penchant for obliviousness when it comes to the state of democracy.

On Monday afternoon, while speaking to reporters at the White House, Trump explained what makes him different from Richard Nixon. “He left”, Trump flatly stated. “I don’t leave. Big difference.”