Was it Mike Tyson who said everyone has a plan till they get punched in the nose?
Unless your plan is to not get punched in the nose!
Here’s your plan …
A special counsel has been tapped to investigate the conversations between Russian officials and the Trump administration. Namely, the involvement Russians did or didn’t have in the U.S. presidential campaign.
I frankly couldn’t care less what comes of it.
But you might care … if you’re invested in the reflation trade. You know what I’m talking about — that oomph behind the bull market since Donald Trump was elected.
Much remains uncertain as this investigation begins. But perhaps that’s just what the market can’t afford — certain uncertainty.
If there is no reassurance of a tax plan.
If there is no reassurance of an infrastructure plan.
If there is no reassurance that Ivanka and Jared can make this country happily ever aft … errrr …
Basically, if Trump’s economic initiatives cannot instigate economic activity, what then justifies current market valuation? Ha.
I laugh because it’s a seriously ridiculous question to even ponder.
Yet I’m serious.
It’s nearly impossible to justify current valuations. But, for your entertainment, let me try real quick …
• Fueling the bull market is hope that policy initiatives will generate growth
• Holding up valuations is the confidence that policymakers will backstop the financial system
Recent events have not jeopardized point No. 2. But confidence isn’t actually controlled by policymakers. It’s merely managed as best as possible. So far so good, I guess.
But the only thing we have to fear is fear itself, or so said someone sometime.
If growth expectations implode, the likelihood increases that confidence could implode. Then we are staring into the bigger-than-usual 1% decline in U.S. equities last week. And we’re asking: Should we be scared?
But you better have a plan.
If I had to bet on whether the special investigation into Russia will uncover earth-shattering revelations that warrant impeachment, I — with no Washington, D.C., wisdom (oxymoron?) — would bet the odds are slim to none.
If that proves likely sooner rather than later, this will blow over and the market will have shed nary a tear. It will be back to hoping for details of Trump’s economic policy promises. U.S. equities will levitate, the U.S. dollar will recover and interest rates will go back to drifting higher.
BUT … if this doesn’t blow over quickly, there is a storm a-comin’.
Everything acceptable and pleasing this year will have been for naught. Growth expectations will shift to idle. Federal Reserve rate-hike expectations will shift to dovish because growth won’t be strong enough to support debt servicing.
The Federal Reserve Bank of New York just issued its Quarterly Report on Household Debt and Credit. Household debt just eclipsed the high it set in the third quarter of 2008: $12.73 trillion today vs. $12.68 trillion then. Note that the makeup of total debt shows troublesome signs in auto loans, credit cards and student loans, rather than in housing.
Not sure what that means, except to say that consumers might have trouble contributing to GDP gains. And businesses aren’t in any better shape with respect to debt, as I mentioned last week: Lady at the Tea Shop, "Have we not learned anything?"
To be sure, debt doesn’t become a problem unless we start worrying about it and we lose the collective capacity to service it. The preferred way to "service" debt has become to take on more debt to generate growth to pay off debts.
If can can’t expect enough growth to sustain debt-servicing costs, then what choice do we have?
But I don’t really want to get into that today. Rather, let me finish by giving you one picture and some concluding comments about what it means in the grand scheme of things …
Here is the iShares MSCI Emerging Markets ETF (EEM).
This is the chart I’m working from on forecasting emerging markets. I can make the case for a decline of between 8% and 18% in the next two to four months.
But the bottom line: The price of EEM is overextended and it’s due for a corrective decline.
Emerging-market equities have risen sharply because 1) the valuations are more attractive relative to U.S. equities and 2) a depreciating U.S. dollar has helped keep capital flows favorable and stabilize cross-border debt-servicing costs.
If last week’s tremors in U.S. and global equities become something more frightening, then emerging markets are extremely vulnerable. Their economies depend on having enough liquidity available, and we could see it dry up.
I lied about showing you one picture. Here’s a second and third, each from Variant Perception’s blog …
The above chart shows that, as excess liquidity recedes, emerging markets suffer.
The below chart is for your reference — showing where ETF capital flows have been moving in the past one and three months.
Fear destroys liquidity, and emerging-market investors should well know that by now.
Certainly, as uncertainty remains certain, emerging markets will struggle.
If you want to protect yourself, use stop-loss orders or just get out of that exposure entirely. If you prefer to be proactive, consider bets on an inverse emerging-markets ETF, including the ProShares Short MSCI Emerging Markets (EUM) or the ProShares UltraShort MSCI Emerging Markets (EEV) for added oomph. Those ETFs let you bet against emerging markets without having to "sell short" an ETF or stock.
Also, for even greater leverage, there is the Direxion Daily Emerging Markets Bear 3X Shares (EDZ). It’s designed to move in the opposite direction, three times as fast as emerging market equities.
The thing I kind of like about this trade, too, is that it’s not presently entirely contingent upon a fear event materializing.
If things go back to normal and if Trump is expected to be cleared of drinking too much vodka with Vladimir Putin, then the U.S. dollar would seem due for a strong rally.
A strengthening U.S. dollar is quite likely to put the brakes on emerging markets. At least for the time being.
There’s your plan to keep from getting punched in the nose: Sell emerging markets!