wknd notes: The Forgotten Americans

“Mate, seriously, what the hell is going on with your country?” asked my old buddy, Sunny in Sydney. Spent the week in Australia. Singapore too. And in my decades of travel, discussions, debates, never has this one question dominated all others. “America has actually become the Gong Show!” he cried, pulling up his iPhone newsfeed, replete with porn stars, trade wars, revolving doors. Bump stocks and budget deficits. Rocket men and Dennis Rodman. “It’s better than it looks, but worse than it seems,” I said, shrugging, trying to shift topic. “What kind of bollocks is that mate? Give me a real answer!” he insisted. So I tried…   

Imagine an Alien arrived just ahead of World War II. From space, it watched us spin. Americans appeared reluctant to fight. But they eventually obliterated the aggressors, who had themselves destroyed the developed world. Being the only nation left standing, America rebuilt both its allies and the vanquished from their ruin. Russia sealed itself for decades. China too. And this left America to recreate in its image all that remained. The pursuit was at once selfless and selfish. Well-intended, idealistic, magnificent, flawed, human. On balance the world welcomed the model, prospered, even though America prospered more. The nation became protector of the free world. After the Soviet model collapsed in 1989, it accepted a role as global policeman; an unsustainably expensive proposition. Year by year its debts grew as economic rivals watched their peace dividend compound. America used global trade to promote its model, and accepted trade terms that allowed every ambitious nation to catch up. America’s CEOs off-shored production, jobs, and transferred technology abroad to hit quarterly profit targets. Trade partners stole the nation’s technology too, and invested enormously in education, infrastructure, research, development – all things that America let dwindle. The Alien saw billions of humans lifted out of abject poverty. The species appeared more prosperous than it could have imagined possible amidst 1945’s smoking rubble. And it was true for everyone, except a growing group of forgotten Americans, who had been told by Washington’s elites that they were perpetually better off. They felt the opposite. They lived paycheck to paycheck, indebted. They heard the Chinese stole $1trln of their intellectual property, that Germans impose 10% tariffs on Ford imports, while America imposes 2.5% tariffs on BMWs. They felt cheated, disrespected, betrayed by allies and rivals. Having rebuilt the world, the Americans quit, and headed home. 

Week-in-Review (expressed in YoY terms): Mon: China sets 2018 GDP target of around 6.5% (2017 GDP +6.9%), China lowers budget deficit goal to 2.6% (2016-2017 goal was 3.0%), China to create 11mm urban jobs and target 3.0% CPI inflation, Germany’s SPD vote 66% to join grand coalition with CDU/CSU, Italy vote results in hung parliament (Berlusconi center-right coalition wins 37%, Five Star 33%, Democratic Party slides to 19%), Navarro “no country exemptions for Trumps tariffs,” S&P +1.1%; Tue: North/South Korea agree to direct talks, Aussie rates unch at +1.5%, Sweden’s Riksbank strikes dovish tone, US factory orders fall 1st time in 6mths, S&P +0.3%; Wed: Aussie Q4 GDP -0.4 to +2.4%, EU 2017 GDP +2.3%, Moody’s downgrades Turkey, Canada rates unch at 1.25%, Gary Cohen resigns, Fed’s Beige Book notes rising steel prices, US trade deficit 9yr high, Stormy Daniels sues Trump, S&P -0.1%; Thur: Chinese exports +44.5% (imports +6.3%), Japan Q4 GDP revised +1.1 to +1.6%, ECB rates unch (removes easing bias from statement), ECB lifts 2018 GDP +0.1 to +2.4% and CPI unch at +1.4% (2019 GDP unch at +1.9%, CPI -0.1 to +1.4%), Draghi “protectionism is a threat to growth,” Trump exempts Canada/Mexico from steel tariffs, Ryan urges Trump to step back from tariffs, S&P +0.5%; Fri: Chinese credit growth cools in Feb, China CPI +1.4 to +2.9% (food prices +3.6%), BOJ rates and policy unch, German exports fall at fastest pace in 6mths, Brazil inflation +2.84% (18yr low), Mexico’s leftist presidential candidate Amlo pledges “no nationalization, no expropriation,” Canada payrolls +15.4k (unemployment rate -0.1 to 5.8%), US payrolls +313k (unemployment rate unch at 4.1%), average hourly earnings -0.2 to +2.6%, Trump/Kim plan to meet by May to discuss denuclearization of Korea, Nasdaq record high, odds of 4 rate hikes in 2018 rise to 30%, S&P +1.7%; Sat/Sun: Intel considers bid for Broadcom, China parliament removes presidential term limit. 

Weekly Close: S&P 500 +3.5% and VIX -4.95 at +14.64. Nikkei +1.4%, Shanghai +1.6%, Euro Stoxx +3.1%, Bovespa +0.7%, MSCI World +1.7%, and MSCI Emerging +1.1%. USD rose +22.5% vs Bitcoin, +22.3% vs Ethereum, +1.0% vs Yen, +0.6% vs Chile, +0.3% vs Indonesia, +0.1% vs Turkey, +0.1% vs Euro, +0.1% vs Brazil, and flat vs India. USD fell -1.1% vs Mexico, -1.1% vs Australia, -0.9% vs South Africa, -0.5% vs Canada, -0.3% vs Sterling, -0.3% vs Russia, -0.2% vs China, and flat vs Sweden. Gold flat, Silver +0.4%, Oil +1.1%, Copper +0.3%, Iron Ore -4.3%, Corn +1.6%. 5y5y inflation swaps (EU -1bp at 1.71%, US -3bps at 2.38%, JP flat at 0.38%, and UK +11bps at 3.47%). 2yr Notes +2bps at 2.26% and 10yr Notes +3bps at 2.90%.

Services PMI (high-to-low): Sweden 59.0(Feb)/61.3(Jan), France 57.4(Feb)/59.2(Jan), Spain 57.3/56.9, Ireland 57.2/59.8, Russia 56.5/55.1, US 55.9/53.3, Germany 55.3/57.3, Italy 55/57.7, UK 54.5/53, China 54.2/54.7, Australia 54/54.9, Brazil 52.7/50, Japan 51.7/51.9, India 47.8/51.7.

2018 YTD Equity Indexes: Brazil +14.9% priced in US dollars (+13.0% in reais), Argentina +1.6% in dollars (+10.4% in pesos), Russia +11.2% (+9.6%), NASDAQ +9.5% (+9.5%), Finland +7.3% (+4.7%), Saudi Arabia +4.6% (+4.6%), S&P 500 +4.2% (+4.2%), Czech Republic +7.1% (+4.2%), Italy +6.6% (+4.1%), Russell +4% (+4%), HK +3.3% (+3.6%), UAE +2.9% (+2.9%), Malaysia +7% (+2.6%), Singapore +4% (+2.4%), Greece +4.9% (+2.4%), Taiwan +3.5% (+2.1%), Austria +4.4% (+1.9%), Turkey +0.6% (+1.4%), Chile +3.5% (+1.3%), Thailand +5.3% (+1.2%), Indonesia -0.1% (+1.2%), Norway +6.2% (+0.9%), Sweden +0.1% (+0.8%), Belgium +2.7% (+0.2%), Colombia +4.3% (+0.2%), Portugal +2.5% (+0.1%), China +2.7% (0%), New Zealand +2.6% (-0.1%), Korea +0.1% (-0.3%), South Africa +4.5% (-0.4%), France +1.7% (-0.7%), Netherlands +1.1% (-1.4%), Israel -1.3% (-1.6%), Mexico +4.1% (-1.6%), Australia -1.3% (-1.7%), Philippines -5.9% (-2.2%), Euro Stoxx 50 +0% (-2.4%), Hungary -0.4% (-2.5%), Denmark -0.2% (-2.6%), India -4.5% (-2.9%), Poland -1.2% (-3.2%), Spain -1.2% (-3.6%), Canada -6.3% (-3.9%), Ireland -1.8% (-4.2%), Germany -2.1% (-4.4%), Switzerland -2.4% (-4.8%), Japan -0.6% (-5.7%), UK -3.7% (-6.0%).

Percent: “What if I told you that Trump was our destiny?” I asked Sunny in Sydney, still trying to explain America. He laughed. “I’m serious.” First, one simple stat. Roughly 50% of Americans with high-school or less education participate in the labor force. The other 50% don’t. The opportunities for them to retrain are severely limited. The impact on their communities and families is devastating. That kind of social decay quickly becomes entrenched. The chances that the children from these communities will live the American Dream is nearly zero percent. 

Percent II: “Do you think a single establishment Democrat or Republican would have done anything to improve these forgotten communities or address the conditions that contribute to their problems?” I asked Sunny. He shrugged. “Zero percent chance,” I said. Not a single President or party has earnestly attempted to help these people in decades - which is why we’re here. Bernie Sanders would have tried, but establishment Democrats denied him a fair shot. Obama did not improve their lot. And the chances that Clinton would’ve helped are zero percent.  

Percent III: “You know what frightens American voters?” I asked Sunny. “NRA?” he asked. They’re scared of becoming the forgotten people Trump talks about. They see technological disruption, driverless taxis, trucks, robo advisors, global supply chains. They’ve seen others displaced, outsourced, struggling to reinvent themselves as disruption creeps inexorably up the economic ladder. And they see the globalist political/business/central banking elites conspiring to stay on course. Enriching one another. Widening inequality. One hundred percent.   

Desperation: “Know how you can tell Americans were desperate for change?” I asked Sunny. He shook his head. Trump jumped off that bus and grabbed 53% of the white women vote. Just imagine the landslide if an anti-establishment candidate had come along who had not ranked as the most ‘unfavorable’ in history? Now Evangelical Christians are splicing scripture to justify Stormy Daniels. America was crying out for a Trump. But the only choice we got was The Donald. And had we not gotten him in 2016, just image who we would’ve gotten in 2020?  

Creative Destruction: “Want the good news?” I asked Sunny. He nodded. We’re not going to have a full-blown trade war. Did that once, 1930s. We’re broke, we can’t afford a war. We’re just shaking things up hard. Pulling back on global supply chains. Rebuilding some barriers. Charging people for stuff. Want military protection? Pay us for it. No more free riding. And we’re going to get our workers paid more. We’re going to rebalance the way we divide the economic pie. It’ll be messy. Ugly. And you better hope we succeed. If we fail, we’ll implode. 

Creative Destruction II: “Want more good news?” I asked. We’re addicted to entertainment. And we have the most entertaining President in history. Which means we’re more politically aware/energized than ever. Trump inspired a sexual assault/harassment movement. 325 women are now running for US House, 72 seek reelection. 75 are running for governorships, 4 seek reelection. He’s inspired an impassioned debate about racism. Immigration. Division. Media. Guns. Trade. Inequality. Kids are engaged. It’s remarkable. Where will it lead? A better place. 

Anecdote: Some investors bought stocks. Others purchased bonds. The two in combination held certain appeal. 60% of the former and 40% of the latter seemed like good round numbers. So it went for decades. In fact, it still does. But we improve in all pursuits. And as we sought to enhance investment returns, we discovered the power of diversification. Our business schools taught every eager attendee that it represents their only free lunch. As graduates, they all sought as many portfolio line items as possible. And when they ran out of unique stocks and bonds, they turned to private equity, venture capital, real estate, mortgages, structured credit, commodities, farm land, timber, patents, litigation finance, toll roads. When they’d exhausted the list, they turned to Wall Street, which delivered an endless supply of derivatives to help them buy all the things that they already owned, but in ways that made the risk appear fresh, unique - thus worthy of a new portfolio line item. Naturally, it didn’t stop there. An advantage of diversification is that it lowers the risk in a portfolio. And this meant that investors could apply leverage to their diversified portfolios, borrowing money to buy more investments to produce higher returns per unit of risk. And the greatest boon to this construction was the fact that for a few decades, both bond prices and stock prices rose in unison. What drove this curious phenomenon was a combination of cheap starting valuations and a disinflationary world order, led by America, champion of free trade. This allowed investors to generate spectacular returns, but even still, with all the diversification, the leverage, they were unable to meet their 7.5% annualized target returns. So they pushed harder, seeking every advantage. In time, they all adopted virtually the same portfolios. And then America changed course. Just a little.  

Good luck out there,

Eric Peters

Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, drink with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.