A Buying Opportunity in the Stock Market

A Buying Opportunity in the Stock Market

Being an investor requires not just predicting outcomes of future events but also, far more often, predicting when the market will price in events that over time do not occur.  Last week was a classic example.  The market was buffeted by the rise of four major risks to the market, none of which however are likely to occur.  If these risks subside, discounts for them will disappear, boosting stock prices back to history highs.  In other words, this is a classic buying opportunity. 

The market last week priced in four potential events that are unlikely to occur, causing market indexes to fall back into correction territory.

1)   Higher employment costs leading to higher inflation, which causes interest rates to rise, reducing the relative attractiveness of stocks.

2)   Victory of a Democrat in solid Trump territory in Pennsylvania leads to concerns that Democrats could sweep the House and Senate in the upcoming mid-term elections, imperiling the Trump agenda.

3)   Blustering over tariffs by Trump leads to a Smoot-Hawley type of trade war between China and the US, causing prices and therefore interest rates to rise, reducing the relative value of stocks.

4)   The possibility that Trump might fire special prosecutor Mueller, leading to a “Constitutional crisis” that imperils the Trump agenda.

 

1. Employment, Inflation, and Interest Rates.  Starting with the taper tantrum in mid-2013, the market has been periodically beset by fears of higher rates only to see these fears subside.  That is likely to happen again.   The link between employment and inflation has become more tenuous as has the link between inflation and interest rates. Last month’s increase in employment costs was an anomaly.  Wages continue to rise at a subdued rate, especially with the big increase in the workforce just reported.  Even if employment costs begin to rise faster, the link with inflation is tenuous at best.  Will Amazon’s pricing be affected if their labor costs rise?  The link between higher inflation and higher rates has also become tenuous.  The consumer is unlikely to arbitrage rates higher through demands for higher interest rates paid on deposits as long as the flood of cash the Fed released with its asset purchase program remains.  Why would banks pay more for deposits when $2.5 trillion of cash from the Fed is earning a risk-free 1.5% annual rate in overnight deposits at the Fed?  Chairman Powell at his first press conference stated that non-reserve liabilities will require him to maintain the balance sheet at $2.5 - $3.0 trillion for the long-term.    

2. A Democratic Sweep of the House and Senate could unlock gridlock.  The days of a monolithic far-left Democratic party may soon be behind us once mid-term elections are held.  Democrats in Trump territory are winning by adopting Trump’s agenda.  Once in office, these Democrats are likely to strike deals with Trump, the ultimate deal-maker. Remember, Reagan passed his historic 1981 tax–reform bill with far more Democratic votes than Republican. 

3. Asymmetric pricing with China is easy to spot and fix in bilateral talks.  Examples abound of cases like Elon Musk’s, where China charges a 25% tariff on car imports from America while America charges only 2.5% on car imports from China.  China could get away with this in multi-lateral WTO talks, where details like this fell through the cracks, but these cases are unlikely to remain hidden in bilateral trade talks now commencing.  American demands for reciprocity in such cases leave the Chinese little wiggle room.  A tariff war over items like this, of which there are hundreds, is unlikely.  Trump has stated that his operative word is “reciprocity.”   

4. Conviction and removal of President from office is unlikely.  Mueller has crossed a red line now that he is asking for details about the Trump enterprise, indicating to Trump that the investigation, whose mandate is to investigate Russian meddling in the election, might be straying from course.  If Trump fires Mueller, and he just may, look for the market to fall 1-2% on the news but recover as it becomes clear the Trump agenda will remain intact for years to come.  While a move to impeach would require a Democratic majority in the house (likely), conviction would require a 2/3 vote in the Senate (unlikely).  The President has the Constitutional right to fire anyone in the executive branch particularly if there is proof of bias (too many Democrats hired for the investigation) and proof that the prosecutor has veered too far from mandate.  As long as there is no “smoking gun” uncovered, the case for conviction will likely be unconvincing to Senate Republicans who despite worst-case election losses would still constitute far more than 1/3 of Senate votes, enough to prevent a conviction.  The House Intelligence Committee last week found no evidence of collusion between the Trump campaign and Russia.    

Website Design For Financial Services Professionals | Copyright 2018 AdvisorWebsites.com. All rights reserved