Summer of our Discontent In Markets - Part 1
Major equity and commodity markets are transitioning to risk-off. Many market observers rush to paint any downturn as the precursor to a 2008-style crisis. That does not appear to be in the cards. However, the odds of double-digit percentage downturns has risen. I am taking this view based on the convergence of three sets of analyses:
Macro event risk is driven by gut-wrenching cycle shifts related to the public sector (governments) such as:
- Lurching government actions in reaction to a decreased confidence in those very institutions
- Wholesale restructuring of post-WW2 institutions and alliances in the name of freedom versus autocracy
- Growing (and rare) bipartisan consensus in DC to regulate Big Tech
This is the subject of the rest of this post.
Early Warning Signals have materialized for a Critical Transition in the S&P 500 and other major markets. In particular, many markets are exhibiting Critical Slowing Down on various timeframes. While research on the application of these theories to financial markets has shown mixed results, it remains a valuable tool to be used in conjunction with other types of analyses. I will address this in Part 2 of the post series.
Price and momentum in major markets, especially crude oil and equities, suggests that the path of least resistance is lower. I will address this in Part 3 of the post series.
There is a strong case for current uncertainty to be resolved and for markets to stabilize in the medium-term. I discuss this in Part 4 of the post series.
Private Sector Confidence
For those who place blame for recent market turmoil on President Trump, recall that I have argued we are in a phase of private sector confidence, as discussed here and here. To recap, people (and not just Western) have wholeheartedly embraced the technological revolution driven by private enterprise. Nearly everyone above the age of 15 has a smartphone, allowing connection to anyone else in relentless pursuit of private gain.
CEO’s are now celebrities, and celebrities want to be CEOS. Even professional athletes are jumping in, with many becoming venture capitalists.
During this era, society as a whole has less confidence in public institutions, namely the government. One by one, government services and sponsored-monopolies are being replaced by solutions delivered to the supercomputers in your hands. The epitome of this cycle may have been the election of a complete outsider, the real estate and entertainment businessman, Donald Trump, to the most powerful office in the world. His election has propelled many other private sector moguls to contemplate politics, such as Howard Schultz, Mark Cuban, and Oprah Winfrey.
Unsurprisingly, the entrenched public sector is not taking well to this shift in confidence, and the greatest risk to society is from miscalculated public sector actions. Picture a trapped animal, lurching out in incoherent directions as it fights for survival. The list of possibilities includes:
- Mishandled trade negotiations (e.g., overplay or underplay your hand)
- Nuclear power confrontation in South Asia, Korea or the Taiwan Strait
- War in the Middle East
- Unchecked nationalism again taking root in Europe
- Increased instability due to degradation of multilateral institutions
- Excessive regulation of Big Tech
- Abuse of technological innovations for control (e.g., facial recognition)
It’s Not a Trade Battle, it’s an Ideology War
Trade dialogue is the event risk of the day. Let’s unpack it a bit.
Many have expressed shock at the lack of a trade deal with China, the May 30th announcement to place tariffs on Mexican goods, and the May 31st decision to terminate India’s designation as a beneficiary developing country. While there are many logical arguments here, there should be no SURPRISE as to the actions of the White House.
Markets are only now understanding that the current US administration is engaged in a war of ideology, not trade. Autocratic philosophies have gained favor across the globe, as countries have watched the Chinese economic miracle with awe. The philosophies are all slightly different, ranging from Us v. Them nationalism (numerous countries in Europe), religious division (India), and naked autocracy (Turkey).
The sad irony of this statement is that many see the seeds of naked autocracy taking hold in the United States. On one hand, as I have argued before, Congress has evolved to a state of impotence, apparently abdicating its checks and balances authority, certainly in terms of legislation. The current 116th Congress (Jan 3, 2019 – Jan 3, 2021) has passed 18 laws through 21% of its tenure, on pace for an astonishingly low 86 laws in two years (versus an average of 537 per Congress since 1973)!
Analysis of Executive Order data surprisingly paints the counterpoint. While current perception is that President Trump has usurped legislation into the West Wing, history suggests that the current generation of Presidents are rather meek in their exertion of Presidential authority. The heyday of Executive Orders frequency was from Teddy Roosevelt through Harry Truman, with FDR averaging over 300 executive orders a year in the depths of the Great Depression and WW2!
Freedom, By Any Other Word
Ultimately, the voters are much more important than the politicians. Especially those who elected President Trump.
As I wrote in late May, the average middle-class American who voted for President Trump has come to connect freedom with economic opportunity. This is a completely reasonable conclusion given the generally upward progression of the American Dream in the 20th Century, during which time the U.S. fought back autocracy in two hot World Wars and a global Cold War.
Responding to lost economic opportunity in the heartland, they voted for so-called America-first politicians and policies. Since then, any metaphor of autocracy, be it trade with China, support of Middle Eastern powers, detente with North Korea, government regulation, or open borders, is met with disdain from this voting bloc. So has proposed regulation of Big Tech in the name of free speech, something I will touch on in the next post.
President Trump is acutely aware of this reality, and although he has exhibited traits of autocracy and supported policies that at times may hurt his voting bloc, he knows they remain supportive of him.
As I discussed here, it’s time to take the President at his word. Expect him to double down on anything that is a metaphor for freedom v. autocracy.
President Trump, as well as Brexit proponents, has successfully painted the post-WW2 liberal world order as an anachronism no longer associated with freedom and economic opportunity. Right or wrong, the various multilateral institutions underpinning this order have come under attack, from NATO to the United Nations as have traditional political structures, especially in Europe, where nationalism is on the rise.
Event risk is high, and it is all government-driven. Markets are finally taking notice.
In the next post in this series, I will discuss Early Warning Signals for a likely Critical Transition that I have identified in the S&P 500 and other major markets.
Any opinions or forecasts contained herein reflect the personal and subjective judgments and assumptions of the author only. There can be no assurance that developments will transpire as forecasted and actual results will be different. The accuracy of data is not guaranteed but represents the author’s best judgment and can be derived from a variety of sources. The information is subject to change at any time without notice.