Market Volatility ETF Portfolio 2Q 2018 Review

While the U.S. stock market had a long overdue correction in February of 2018, the first quarter ended merely flat eventually. Continuing from the rebound since February low, the stock market kept rising strongly in the second quarter.

Cumberland Advisors - Quarterly Review - Market Volatility ETF
 

Out of the three major indexes, the NASDAQ is leading the race by miles ahead. The technology-heavy index has closed at all-time highs for 20 times as of June 15 this year, piling upon last year’s record of 72 times. Although the Dow Jones Industrial Average had comparably 71 closing all-time highs in 2017, the Dow has only closed at all-time highs for 11 times this year, all of which were from January 2018. Moreover, the NASDAQ has also outperformed the Dow by roughly 10% including dividends during the first half of 2018. Standing in between the NASDAQ and the Dow, the popular benchmark S&P 500 has been relatively benign in 2018. Although this large-cap index has risen over 2% in both May and June so far, investors certainly have poured more interest into the small caps in the meantime, evidenced by the second quarter performance comparison below.


Chart 1. S&P 500 vs. Russell 2000 in 2Q2018. Chart source: Yahoo! Finance.

The second quarter has seen a lower volatility level compared to the first quarter. The VIX has calmed from above 20 down to 11 handle since April. Some major factors such as the alleviated concern over trade war and the improving U.S.-North Korea relations most likely contributed he significant downward shift in volatility. However, there are still some dark clouds in the near-blue sky. For example, the crude oil is still fighting to hold the $60-$70 per barrel ground. Not surprisingly, the oil volatility OVX has gone up in the second quarter.


Chart 2. S&P 500 Volatility VIX vs. Crude Oil Volatility OVX in 2Q2018. Chart source: Yahoo! Finance.

The recovery from the February correction has shown the resilience in the stock market. It is likely that the stock market can move higher in the next quarter if the volatility remains at or below the current level. However, as some sectors such as technology have demonstrated in the second quarter, not all sectors will be able to take advantage of the calming volatility equally this year. Perhaps, 2018 will be a year that favors active investors.

Leo Chen, Ph.D.
Portfolio Manager & Quantitative Strategist
Email | Bio


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Quarterly Review: US ETF

US stocks were buffeted by crosscurrents in the first half of 2018.

Cumberland Advisors - Quarterly Review - 2018 Q1 - US ETF

There were Trump Tweetstorms, geopolitics in China and Korea, G-7 trading-partner fights with Canada, our largest and most durable trading partner. Add to that a blistering attack on the press (what happened to the First Amendment?) and a White House withdrawal from communication (as in no follow-up questions from reporters) – all this, and we even saw the president front-running the market on the recent employment report release.

Governmental chaos disturbed markets from time to time in the first half – but markets proved resilient. The flipside that enables that resilience includes higher earnings, a clearer Fed path, a slowing of the policy transition at the ECB, relaxation of US banking-system rules, front-loaded fiscal stimulus, repatriation and growth originating from the new tax code. Markets love the earnings outlook, and they love the predictable path of monetary gradualism.

We expect 2019 earnings to be about $170 for the S&P 500 Index. Think of that figure with a band of $165–$175. We expect subsequent years to have mid to high single-digit compounding growth rates. That path puts the index above 3000 by 2021. Our US ETF accounts are mostly fully invested. Some small cash reserves are in place and may be deployed at any time. Of course, all this can change at any time since we live and invest in a fluid and uncertain world.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Kim, Trump, Xi & Saving Children

We’ve collected a diverse set of quotes about Kim and Trump and Xi and the region as a whole. Of course, our vantage point for this assemblage is the United States, and our view is influenced by our financial, economic, and markets perspective.

Market Commentary - Cumberland Advisors - Kim, Trump, Xi & Saving Children

As we wrote in the four-part Thucydides series (see below), trade wars, shooting wars, and money wars are intertwined. That was so in the time of the Peloponnesian War and is just as true today.

Thucydides – series part 1: http://www.cumber.com/thucydides-part-1/.
Thucydides – series part 2: http://www.cumber.com/thucydides-part-2/.
Thucydides – series part 3: http://www.cumber.com/thucydides-part-3/.
Thucydides – series part 4: http://www.cumber.com/thucydides-part-4/

Here’s Adam Johnson in a recent Sunday morning Bullseye Brief:

“Fact is, tariffs of $50B on Chinese imports amount to one quarter of a percent of U.S. GDP. Additionally, they are dwarfed by $800B in stimulus from tax cuts, fiscal spending and offshore profit repatriation.” – Adam Johnson, June 17th  (https://bullseyebrief.com/current-issue/, subscription required)

How big is North Korea’s economy? Nobody knows for sure. Here is a June 10th Bloomberg story about estimates: https://www.bloomberg.com/graphics/2018-north-korea-economy-size/.

Steve Wasserman minces no words. This is why I asked for permission to quote the following summary. Thank you, Steve, for sharing this with our readers.

“Trump pulled off a truly history-changing summit, and of course the press are attacking without knowing what is really going on. Schumer claims Trump gave all, and got zero. How stupid. They claim having the two flags next to each other is ‘disgraceful.’ What would they do, have no N Korea flag. They say granting Kim a meeting is a win for Kim and a loser for Trump, and horrible to meet with such a terrible tyrant. Recall Roosevelt sitting with Stalin, Kerry with the Iranians. If you never meet with the really bad mass murderers, you never get anything done solving the really big issues, and you end up in a war. Hard to reach agreement if you do not talk to the other guy and only Kim and Trump can make decisions, so they had to meet. We do not know what Trump said to him. Maybe he said work with me or die, or words to that effect. We may never really know. Trump is used to talking to terrible people just like himself and the Mafia from his days as a NY real estate developer. He considers it normal to be lied to, mislead, and threatened. He was an expert at it. So when he said he prepared all his life that is what he was referring to, his NY real estate experience. We do not know, nor does the press, or the Dems, what Pompeo has been working on, nor what stage the agreements are at. Pompeo has had two teams, plus more back home, working around the clock on the details. They are not sitting around drinking tea. The Dems, the press, and conventional diplomats and academics just do not want to believe Trump really did this. Of course we need to see what happens. Of course we do not trust Kim. So he said no war games for now. No big deal. These are held in the spring. Lots of time to see if Kim sticks to the deal, and easily back on if not. War games are very helpful, but the rigorous training continues as before, so no real loss to our defense posture in Korea for now. He suspended, did not cancel. He gave a maybe, which is all. They met for five hours with Pompeo, Kelly and Bolton in the meetings, so they must have talked about a lot more than what is in that public statement. We need to see where this all goes from here, but for now there is maybe a real chance for a huge change in the prospects for peace in the region, and entire changes in how the US shapes history.”

I’m not sanguine about China’s intentions. In fact, I believe China has the US at a disadvantage that is not adequately appreciated. Xi doesn’t have midterm elections; he is president for life, and he has eliminated opposition. Xi has been quoted in the Western press as being opposed to lifetime rule; he has achieved just that through his internally controlled political system. As Richard Koo of the Nomura Research Institute notes, China is not only “trying to occupy the South China Sea, but it has eliminated term limits of the presidency, imprisoned human rights lawyers, restricted the freedom of the press, and is trying to place private companies under Communist Party control.”

Meanwhile, China’s military is conducting exercises: “A division of the People’s Liberation Army Air Force (PLAAF) recently organized multiple bombers, such as the H-6K, to conduct takeoff and landing training on islands and reefs in the South China Sea in order to improve our ability to reach all territory, conduct strikes at any time and strike in all directions.” Source: NightWatch, May 20th.

China did not mention which location was used. Open-source news agencies reported it was Woody Island in the Paracels. For the location of Woody Island, see this map: http://www.southchinasea.org/files/2013/03/Sovereignty-claims_in_the_south_china_sea-US-DoD-2012.png. Note that there are now three China-built runways on the island that can accommodate fighter aircraft.

The North Korea–China nexus is not well examined, in our view. It needs lots of ventilation and transparency. That’s hard to achieve when we are dealing with regimes like China and North Korea that stifle disclosure  and with regimes that continuously attack the free press (Trump’s war with “mainstream media”). In the US the division in the press is debilitating. Outlets like Bloomberg or Reuters or USA Today try to be even-handed and to practice responsible journalism. Opinions are clearly labelled as such. The range of others and their consistent biases are visible when you watch or read them side by side with the balanced ones. We frequently observe coverage of an issue both on CNN and on Fox in order to see how each of them handles it. We often compare the same reported story to the FT or WSJ or NYT versions. Internet-based sources are even more diverse and are dangerous to believe without independent verification. When it comes to the “fourth estate,” the demands on analysts are at an all-time high.

Let’s go back to China, North Korea, Trump, and US policy.

Singapore’s Straits Times reported that Kim had three planes at his disposal for the Singapore summit. Two were Boeing 747s handled by China Air, and the third was a North Korean IL-62. On his return to Pyongyang, only one of the Boeing planes flew to North Korea. The other returned to Beijing. NightWatch is one of the few sources to have followed this closely.

“It is almost inconceivable that [the Chinese Boeing 747] would have failed to carry a North Korean senior diplomat to back brief the Chinese leadership. Chinese Foreign Ministry daily press sessions implied the China was deeply involved in helping prepare Kim Jong Un for the summit.” (Straits Times)

Another important item that was not widely reported was a loan that China made to North Korea during the run-up to the Singapore summit. We have seen only one credible source (a private service) that describes it as “massive,” indicating that the loan was extended between the Communist Party of China and the Workers’ Party of North Korea. By using this technique, China can circumvent its governmental pledge to adhere to the UN-imposed sanctions.

There is also some reported restoration of the flow of goods and economic transactions between China and North Korea. China is calling that a private sector item so that it doesn’t run afoul of the UN sanctions. One reliable source indicated that the final terms of the massive loan would be implemented after the Singapore meeting. The implication is that China has a low profile but a lot of influence over the outcome of the Trump-Kim initiative.

Before we leave this region, we must comment on Japan. It is deeply involved in multi-dimensional ways in current East Asia geopolitics. For an excellent primer on Japan’s position and the political forces at work in Japan, see www.japan-insider.com. Jeff Usher’s paper entitled “Defending Japan,” dated May 13th, is a must for any serious student of the region and for any investor in the region. (What I like about Jeff is how he transfers his geopolitical analysis into actionable specific market recommendations.) In his paper Jeff includes the map of the Japanese air bases. It is important to look at this geography since Japan and the US have a multi-decade defense arrangement that allows the US to have an “unsinkable aircraft carrier” in the Pacific Ocean. With China’s expanding construction of military bases on islands and reefs, that equation is changing. Jeff notes the photo history (satellite)  of the Chinese build-out of the Fiery Cross Reef. Sources include Japan’s Ministry of Defense. See: https://www.google.com/search?q=fiery+cross+reef+before+and+after .

So where does this commentary end up? Nowhere. There is no end in view, in our opinion.

When it comes to the outlook for American politics, I have to agree with Steve Wasserman’s succinct summary:

“Trump, Pelosi, Schumer just add to the turmoil with their outlandish and stupid comments and tweets. Where is Ronald Reagan when we really need him? I fear we are in for several more years of Washington turmoil and ugly partisan battles. Nobody looks good in all this.”

When it comes to markets and interest rates and the economic outlook, the North Korea threat is now temporarily muted. But only temporarily, and only muted. We must consider that to be a success. The lack of a shooting war is in itself a success. And success must always be viewed as temporary. That is what vigilance and preparedness is really about.

The China trade war and the Trump-Xi tests of relative leadership, skill, and substance remain ahead. As we view this unfolding drama through the lenses of antiquity, today it is hard to know how to apply the metaphor of the past. We wonder if the US is Athens or Sparta; the same question is true for China.

We remain with some cash reserve. We worry about central banks’ decisions and behaviors, including our Fed’s. We worry about inflation or low-flation or no-flation, depending on how you measure it. And we worry about the US labor force and its demographic and income distributional characteristics. And lastly, we worry about our nation’s great legacy of enhancing our strength by accepting immigrants, a policy that has helped us for two centuries and is now threatened by the politics mentioned above and those internally, which I personally find abhorrent.

Now to a personal appeal to readers who may want to contact their Member of the House of Representatives.

Please note that presidents Obama and Bush had in common their personal and political intolerance for seeing a child yanked away from a mother who is seeking asylum from her home country where rape and murder are prevalent. The United States has always operated on the basic principle that our nation welcomes those who seek asylum from persecution. Whenever we have temporarily lost sight of that principle, we have paid dearly for the error.

And now, when the officer yanking the child away from its parents is wearing an American uniform, following a policy dictated by our president, Donald Trump, it makes for a very sad day in America. Such a policy is abhorrent and abusive. Shame on Donald J. Trump for every weeping child’s trauma, every parent’s despair and fear. And shame on some Senators, including McConnell and Schumer, and on Members of the House, including Ryan and Pelosi, our elected women and men, who cannot find a middle ground to solve this legislative issue.

There is an attempt to bridge the divide, and there are a number of House members from both sides of the aisle who tried to force a discharge petition and get this debate to the floor of the House. I personally applaud that effort and support them. I know one of them, Representative Carlos Curbelo, a Republican from Florida, who is putting his convictions and honor ahead of his political party. His family ancestors were persecuted by Fidel Castro, and he personally knows the value of asylum from a regime that tortures people and ignores any human rights. He has many colleagues, both Democrats and Republicans. They need to be praised.

By the way, I believe a bill passed by both Senate and House would be signed by President Trump. Democrats who do not want to give Trump a victory are just as responsible for the child being yanked away from the mother as are the Republicans who are tying up the bill because of other elements on their personal political agendas.

President Donald Trump will attend a House Republican conference meeting Tuesday night at 5:30 p.m. to talk immigration. (https://www.politico.com/story/2018/06/16/trump-capitol-immigration-talks-gop-650387) Readers have 48 hours to call a Republican congressional office and let the Member know they want this issue of immigrant children raised in the meeting.

David R. Kotok
Chairman & Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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John Mousseau, CFA® Becomes President of Cumberland Advisors as Firm Celebrates 45th Anniversary

It is with pride that Cumberland Advisors celebrates its 45th Anniversary. June 18th marks 45 years since Cumberland Advisors officially opened its Vineland, NJ, office. Eight years after moving our principal office from Vineland to Sarasota, FL, we have 45 employees, and as of April 30th, 2018, more than three billion dollars of client investment funds under management in separate accounts. Cumberland’s growth and stability are substantial, with record assets under management and a largest-ever, talented staff. The firm’s future looks bright.

John Mousseau

Just as significantly, Cumberland Advisors announces the implementation of a long-considered succession plan. David Kotok, co-founder, remains Chairman of the Board and Chief Investment Officer while transferring the day-to-day responsibilities of running the firm to John Mousseau, who has been elected President and CEO of Cumberland Advisors. With over 30 years of investment management experience, Mousseau has been a member of Cumberland Management and longtime Director of Fixed Income at Cumberland for 18 years. He has an A.B. in economics from Georgetown University, a masters in economics from Brown University, and has been awarded the Chartered Financial Analyst (CFA®) designation. “Our firm has a great tradition of separate account management and personal service,” says Mousseau. “It is an honor to be elected president by our board of directors. I’m committed to maintaining the high standards of the past and to our continued growth.”

“The best way to insure the continuous delivery of a high level of quality service to our clients is to execute a well-thought-out succession plan,” David Kotok explains. “Many firms wait too long and become reactive to unfortunate events. At Cumberland, we want to be proactive, not reactive. I’ll continue as chairman and chief investment officer for the next three years and will gradually be helping the transition of each client relationship during that time.”

David Kotok

Cumberland Advisors is a registered investment advisory (RIA) firm headquartered in Sarasota, FL. The firm has a wealth preservation bias and conservative investment orientation to manage both risks and returns. Cumberland Advisors is a dedicated fee-for-service-only asset manager. The firm offers market knowledge, analysis, and management with low fees.

The firm manages fixed-income as well as equity accounts (using exchange-traded funds only). Our clients are individuals (direct clients as well as those referred by consultants), institutions, retirement plans, nonprofits, and government entities. Various investing styles are available, examples:

Equity: Cumberland Advisors actively manages domestic and international equity portfolios using exchange-traded funds (ETFs).

Fixed Income: Cumberland Advisors actively manages fixed-income portfolios through a full interest rate cycle. Our firm utilizes a disciplined approach to select high quality, investment-grade (A or better) liquid issues. Strategies include Total-Return Tax-Free Municipal Bond and Total-Return Taxable Fixed Income.

401(k): Cumberland Advisors manages 401(k), 403(b), and 457 retirement plans.

Charitable and Foundation Special Services: Cumberland’s professionals work closely with a nonprofit organization’s management team, investment committee, and board of directors to develop a customized Investment Policy Statement (IPS) and to construct an investment portfolio in alignment with the short- and long-range financial goals of the organization.

Cumberland Advisors’ portfolio management emphasizes long-lasting relationships and continuous personalized discussion among clients, their consultants, tax advisors, and the assigned portfolio management.

The value of the firm is rooted in the professionalism, integrity, expertise, and intellect of its people. In addition to John Mousseau’s election as President, Cumberland has implemented other significant changes. Cumberland has added new non-management shareholders, and the Board of Directors has expanded to nine members. New and expanded roles at the firm include: Daisy Lopez is a member of the new executive committee and remains Executive Vice President; Dr. Robert Eisenbeis remains Vice Chairman of the Board of Directors; and Phyllis Streit is a member of the new executive committee and remains Chief Financial Officer. Matthew McAleer is a member of the new executive committee and has been named Executive Vice President and Director of Equity Strategies; Dr. Michael McNiven has been named Senior Vice President of Business Development and National Accounts; and Patricia Healy, CFA®, has been named Senior Vice President of Research and Portfolio Manager.

Cumberland Advisors has 17 Series 65 registered professionals. “We believe this number of series 65 credentialed advisors adds a great deal to the professional level of this firm,” says Mousseau. “It speaks to the emphasis we place on professional skills.”

Earlier this year, Cumberland achieved independent verification of its GIPS (Global Investment Performance Standards) certification. This propels Cumberland into an elite group of money managers that commit to fair presentation and full disclosure of investment performance results.

Cumberland Advisors - 45th Anniversary

As Cumberland celebrates its 45th anniversary, these changes are designed to ensure that the quality, personal commitment, and competence to which clients have become accustomed will continue and indeed be enhanced. With a broad range of skills and experience, Cumberland is committed to providing the best possible service and strategic advice to clients without regard to whether they are individuals in direct relationship with us or clients who are introduced to the firm through their referring consultants and supporting professionals.

Additional information is available in Cumberland’s Form ADV Part 2 disclosure. It can be found on Cumberland’s website, www.cumber.com or it can be mailed upon request. Michael McNiven, at 800-257-7013, ext. 316, can answer questions about investment styles and platforms.

For further details, please communicate with us via www.cumber.com or call Sharon Prizant at 800-257-7013, ext 335.


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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The Fed Decides

As the June FOMC meeting approached, pundits and market participants increasingly expected the Committee to raise rates.

This expectation was realized, as the FOMC raised the target range for the federal funds rate by 25 basis points. Since the FOMC had no new information on GDP, this was a decision that was clearly rooted in the context of a tight labor market and its implications for inflation down the road. Markets have interpreted this move, reinforced by the increase in the median funds rate projection for 2018 from three to four moves, as shifting from an accommodative to a more restrictive policy. There is much to glean from Chairman Powell’s press conference. For example, he announced that the Committee would begin holding a press conference after every meeting but would still prepare SEP forecasts only every other meeting. Before commenting on the press conference, however, let us look at some of the significant changes and potential inconsistencies in the press release.

After describing the continued improvement in labor markets, the statement goes on to characterize economic activity as “rising at a solid rate” and household spending as having picked up. Interestingly, in the Beige Book, only the Federal Reserve Bank of Dallas characterized district growth as solid, while four district banks said growth was modest, and seven said growth was moderate. Additionally, the Beige Book described consumer spending as “soft.” Not one of the district bank descriptions used the word solid, but rather said spending increased “slightly,” “modestly,” “moderately,” or was “mixed.” One wonders if the economy changed between the preparation of the Beige Book and the meeting or whether the descriptions were designed to bolster the policy move.

The major change in the post-meeting press release was deletion of its previous forward-guidance language that stated that the Committee’s policy rate would “remain, for some time, below levels that are expected to prevail in the longer run.” This omission was part of the reason that markets concluded that policy accommodation would be moving toward financial restraint, and this was abruptly reflected in an upward movement in interest rates along the curve.

As for the Summary of Economic Projections (SEPs), median GDP growth was moved up one tenth of a percent in 2018 and was unchanged in 2019 through the Longer Run. The unemployment forecast edged down even further to 3.5% in 2019 and 2020 but remained at 4.5% for the longer run. Finally, inflation, edged up slightly for 2019 and 2020, with the median funds rate now moving up steadily from 2.4% in 2018 to 3.4% in 2020. The anomaly in these SEP forecasts, as we have noted in previous commentaries, is the increase in the Longer Run in the unemployment rate to 4.5% with a drop in the median funds rate by half a percentage point to 2.9%. What might the committee expect to happen to generate this result? Is this an admission that the described policy path for the funds rate risks an overshoot and may cause a recession? When asked about this at the press conference, Chairman Powell simply stated that the figure was just an estimate and could change, but he offered no clues as to precisely what the Committee anticipates or why.

Turning to the press conference itself, there were several takeaways and uses of key words that warrant comment:

Persistent – This word was used in describing the FOMC’s 2% inflation target and the fact that the FOMC endeavors to avoid persistent deviations from that target. What was not explained, however, was how long and how large a deviation would have to be in order to be considered a persistent deviation that requires policy action. Uncertainty – Chairman Powell used the word uncertainty in several contexts, but most revealing was his use of that term when discussing the Committee’s Longer Run unemployment forecast. He clearly viewed that projection as an estimate of the so-called natural rate of unemployment consistent with stable prices. When pushed as to why the 4.5% Longer Rate isn’t closer to the 3.5% value for 2020, he said that it very well might be and that there is a range of uncertainty around that estimate, on the order of plus or minus .75 to 1 percentage points.

Unobservables – Closely related to his discussion of the natural rate of unemployment was his caution that one had to be careful in becoming too attached to estimates of economic variables, like the natural rate, that cannot be observed. The range of “uncertainty” around such values calls for caution when making policy.

Cushion – Powell was asked if one of the motivations for increasing rates was the desire to create an additional cushion so that the FOMC would be able to lower rates should that be necessary. He emphatically said that he did not consider that factor in his decision-making framework. He went on to argue that pursuing a cushion strategy held the risk of overshooting and even causing a downturn. He preferred a strategy of proceeding slowly to avoid overreaction.

So, in summary, Chairman Powell continued on his quest, quite successfully, to communicate with the public in plain English. He conveyed a view that was less “hawkish” than a cursory reading of the statement might suggest. Furthermore, he tried to downplay the significance of the adjustments that were made to the SEP forecasts. Finally, when pushed, he said the Committee was not yet ready to declare victory when it came to its inflation objective.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Thucydides–Part 4

In the modern geopolitical world, money and payments are integrated in war (and trade wars) and politics. We see that intrigue in the daily news flow. Some 2400 years after the Peloponnesian War, we can still glean from antiquity lessons to guide us. The Thucydides Trap includes money as a tool of war or as a tool to avert war. History demonstrates that it takes a sound economic program and a well-managed finance model to fight a war or to deter the other side from launching a war against you. Again, we draw upon Graham Allision’s excellent work, Destined For War: Can America and China Escape Thucydides’s Trap?

Thucydides Trap

Today, monetary tools for economic warfare include foreign exchange rates, deployed in currency wars. Fiat money – whether dollars, yen, euros, rubles, or yuan – is the prime payment mechanism that is manipulated. Economic and payment sanctions are also tools of war. Blocking banking system access and freezing individuals’ and countries’ finances are weapons as well.

Nowadays, cryptocurrencies provide the alternative vehicle used to transfer payments between sanctioned parties. Iran needs a missile part. It cannot pay North Korea through any banking-system transfer, and North Korea has no way to safely receive the payment. Crypto solves this payments problem. It also solves the problem of those who wish to hoard wealth outside scrutiny. Of course, they must not lose their “key.”

In the time of Thucydides, money was rather simple, usually coins – gold, silver or copper or an alloy of metals. Money was necessary for war. Greek city states raised money through either taxes or trade tariffs. They also appropriated what they could during wars. To the victor went the spoils, as the saying goes. The losers got death or slavery, and poverty.

Then, as now, war cost money and a lot of it. Thucydides chronicles payments to mercenaries. He even notes how mercenaries hired by one side went to work for the other side if their first employer lost the battle and along with it the ability to pay. The mercenaries were in it for the money. Thucydides notes that certain soldier-mercenaries received a drachma a day. Those payments were probably in Athenian silver coins (owls), since Athens’ currency was widely accepted in the Mediterranean region.

Thucydides describes how the costs of war had negative effects. (Think of this as a defense-budget debate 2400 years ago.) Fiscal decisions could determine the outcome of battles. An example from Thucydides’ chronicle occurred in connection with Athens’ conflict with Sparta in Sicily when, in the summer of 413 BC, a contingent of 1300 Thracian mercenaries arrived in Athens. They were late due to weather delays. We must recall that ship travel in those days was perilous and often unpredictable.

Demosthenes had already sailed for Sicily with his forces. He might well need the Thracians; but since the Athenian leaders couldn’t communicate with Demosthenes and lacked information symmetry about battle conditions in Sicily, they had to make a fateful decision. Thucydides reports that they elected to send the mercenaries back to Thrace because “they thought it too expensive to retain them.” According to Thucydides, this decision turned out to be a mistake, as the battle over Sicily turned the war in Sparta’s favor and cost the Athenians dearly.

The chronicle describes what happened after the decision on the mercenaries was made. He details how murderous the Thracians became. He lists the cities they sacked. Thucydides writes, “These Thracians, when they have nothing to fear, are as bloodthirsty as any other barbarian race, even the worst, when pupils had just come in for their lessons: they butchered the entire school.” Thucydides details the Thracian carnage in gory detail. He also chronicles the outcome in Sicily and lists the final losses of the Athenians in citizens, slaves, and money (which meant fewer hired mercenaries in future).

Borrowing for war was not an option in Thucydides’ day. You either had the cash or you didn’t. Athens was wealthy and had an open form of government thus we can get information from Thucydides’ chronicle and from records.

Historians estimate that Athens’ defense reserve was between 6000 and 9700 talents. This was a huge sum. Consider the ratios. A drachma in weight was about 1/8 oz. The famous ten drachma coin (tetradrachm) is based on this weight. 100 drachmae equaled 1 mina or approximately a 1 pound weight. 60 minas equaled 1 talent in weight which is about 61 pounds. Thus we can estimate the Athenian coin reserve at about 18 to 28 tons. Most of this reserve was silver. Note that the ratio of gold to silver in those times was about 14 units of silver for each unit of gold. A worker with skills might earn about a drachma a day and an unskilled worker about a half drachma. Soldiers and sailors were paid about a half drachma a day during regular (peaceful) times. That pay doubled to about a drachma a day during battles and other military campaigns.

Sparta was a more closed form of government. Records are less clear and estimates of wealth are much less accurate. We do not know much about acceptance of Sparta’s money. Clearly Athens had a huge advantage with its monetary integrity. In the end and after the disastrous campaign in Sicily, the money alone was not enough to prevent a Sparta victory.

Most loans in ancient Greece were personal. There were a few loans to city states, but they came into being in the century after the Peloponnesian War period. Were they the first “municipal bonds”? Often such city-state loans required the guarantee of a prominent citizen. But debt financing came into being after the period chronicled by Thucydides.

Because there was little use of debt- or deficit-financed military appropriations, city states paid cash to fight wars. That meant they needed to keep the cash secure. So this history revolves around where the wealth hoard was kept, who knew about it and who guarded it, how much they had and how much the other side thought they had. They paid spies to find these things out, and they resorted to bribery when they could. All of these money issues went into assessing whether or not to do battle. Some estimates suggest that the cost of a siege or full battle could be 2000 talents. It is not clear how much was in gold or silver. Many scholars believe the references are to silver because it was the basic wealth metal in Athens.

For guidance on coinage we turn to references by Neil Macgregor, written in his capacity as the director of the British Museum. He attributes the first standardized gold coinage to the Lydians. MacGregor cites others’ work on how the Lydians purified gold and how King Croesus became the ancient symbol of wealth. “As rich as Croesus” was the phrase for centuries. For history see: https://en.wikipedia.org/wiki/Croesus.

Lydia lost its wars with the Persians and was conquered by Cyrus the Great, who captured King Croesus. According to MacGregor, “Cyrus shrewdly appointed Croesus as an adviser – I like to think, as his financial adviser – and the victorious Persians quickly adopted the Lydian model, spreading Croesus’s coins along the routes of the Mediterranean.”

So what does this history have to do with the Thucydides Trap and the Peloponnesians War? A lot.

The Persians were eventually defeated by Athens. Athens then added huge amounts of wealth to its hoard, supplemented by production from the Athenian silver mines. Thus Athens became very rich as well as powerful. Sparta did not issue its own coinage to nearly the extent that Athens did – Athenian money was known and accepted throughout the Mediterranean region. The drachma was truly the regional reserve currency of its time. For a detailed discussion of ancient Greek coinage, see https://en.wikipedia.org/wiki/Ancient_Greek_coinage.

So we see Athens triumphing over the Persians and being defeated by Sparta in Sicily; and in both cases economic factors were key.

In this series about the Thucydides Trap we have cited the lessons offered by Graham Allison and others. In this part 4 we wanted to reach into the monetary realm. The words of caution are centuries old. They apply today.

Now to a real treat. At the end of this commentary we want to quote from the famous treatise A History of Interest Rates, 2000 BC to the Present by the late Sidney Homer. IMHO, anyone in the bond business who hasn’t read this book and doesn’t refer to it from time to time is missing a key component in the education required to manage debt instruments.

The marvelous work of Sidney Homer on interest rates includes tables and details on interest rates charged on loans in Ancient Greece. (My copy is the second edition, his own revision before his death.) See pages 40–43. Sydney Homer describes the period that preceded Athenian democracy, and there are lessons in it for the present day Washingtonians who think they know everything. Here are two paragraphs. We suggest reading them in the context of today’s debate over loan forgiveness and deficit financing.

“In 508 B.C. democracy was established in Athens. From this time on Athens so rapidly outdistanced other Greek cities in trade and finance that the history of Greek credit and interest rates is largely, but not entirely, a history of Athenian credit and Athenian interest rates.”

Homer sagely continues:

“Before the beginning of the fifth century B.C., the minting of money in Greece was hampered by a scarcity of metals. After 483 B.C. a series of marvelous finds occurred, and precious metals spread throughout Greece. Each city struck its own coinage. Every foreign transaction thus required a money-changing transaction. Many cities engaged in unscrupulous alloying, but such frauds could only work internally. A few cities by their integrity gained universal acceptance for their coinage. Athens had the advantage of the silver mines of Laureion. The Athenians took every precaution to maintain the integrity of their famous ‘owls’. Even in times of tragic national disaster, when the treasury was empty and Attica occupied by an enemy, Athens refused to debase this silver coinage. As a consequence, the Athenian ‘owl’ became current in all markets and an article for export. It remained a most acceptable currency throughout the Mediterranean for 600 years, long after the disastrous defeat of Athens in the Peloponnesian War, 431-404 B.C. This tragic event, immortalized by Thucydides and mourned to this day by lovers of human excellence, was not a turning point in the financial history of Greece.”

So Sydney Homer establishes that the Athenian drachma was world’s first true reserve currency, which dominated for 600 years. He makes clear, too, that Athens’ loss of the war was not the loss of the credibility of its coinage. He describes the how the cities accumulated treasure before the Peloponnesian War. And he recites how the temples (especially Delphi) acted as banks and as lenders. Homer details these loans and articulates the mechanism used for personal loans, real estate loans and, after the Peloponnesian War, for a few loans to governments.

Here is a quote regarding the latter.

“Loans to states were thus exceptional until the third and second centuries B. C. There were occasional early loans to states, but these were compulsory or of a political character. The famous loans of the Temple of Athena to the city of Athens during the fifth century B.C. were a religious fiction: the money was the war reserve of the people of Athens. Interest on these loans was nominal and was rarely paid, but an effort was made to return the principal to the Temple, that is to say, restore the war reserve.”

A century after Thucydides’ chronicle, the Greek system endured a series of muni defaults. We can think of this as an ancient version of Stockton, California, or Detroit or Puerto Rico. Here’s a final word from Sydney Homer:

“In 377–373 B.C. thirteen states borrowed from the Temple at Delos, and only two proved completely faithful; in all, four-fifths of the money was never repaid. Thereafter the temple preferred loans to individuals, secured by land.”

And there it is, an ancient lesson that we go on learning today.
 
Thucydides – series part 1: http://www.cumber.com/thucydides-part-1/.
Thucydides – series part 2: http://www.cumber.com/thucydides-part-2/.
Thucydides – series part 3: http://www.cumber.com/thucydides-part-3/.
Thucydides – series part 4: http://www.cumber.com/thucydides-part-4/
 
David R. Kotok
Chairman & Chief Investment Officer
Email | Bio


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Man Bites Dog by Bob Brusca

With all the Trumpian hullabaloo over trade, I want to share with readers a balanced, well-reasoned analysis of US trade issues penned by my good friend Bob Brusca, Chief Economist of FAO Economics. Bob makes it clear that while there are pros and cons to the US’s longtime propensity to run trade deficits, there is one overriding danger in doing so, and there are consequences that are affecting our economy today and will affect it even more seriously in the future.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Man Bites Dog; Dog Gets Tetanus Shot
by Bob Brusca
(Or how our fellow G-7 members learned to whine about trade)

All six of our fellow G-7 members are now complaining about the US and the ‘National Security’ tariffs being imposed by the Trump Administration. I will admit that I do not like this specific strategy. But on the issue of trade confrontation the US’s becoming more aggressive is long overdue. These countries among others have long taken advantage of the US and are provided in general much better access to the US market than US firms are provided access to their markets. In the case of Canada, trade is governed by the NAFTA agreement, for better or worse.

Los Seis Caballeros: The US is an unfair trader?

First let’s look at the complainants: In this corner stands the group consisting of Canada, Germany, France, Italy, the UK and Japan. The US stands alone.

Man Bites Dog Dog Gets Tetanus Shot 01

These countries (summed) have tended to run $200 billion worth of surpluses (US deficits) annually over the past decade on their bilateral accounts with the US (ten-year average is $196.5b, made smaller by the US import contraction in the Great Recession).

Why does this matter?

International economists (full disclosure: I am one) will tell you that having a bilateral deficit does not matter. They will go on to say that whether a country has a surplus or a deficit does not matter. This latter point is ‘evolutional.’ Old economics texts refer to running a current account deficit as ‘living beyond your means.’ That is hardly a statement of ‘neutrality.’ But the real point is this: WHY are so many countries running a surplus vs. the US and why are US deficits so intractable? In the case of the US, where GDP is 70% made of consumption, it is to take advantage of cheap consumer goods made abroad, NOT to invest. As a result the US more easily can finance its fiscal deficits and keep interest rates low. It can carry a higher debt load, and citizens benefit from cheaper goods today as future generations are saddled with the debt whose accumulation permits this state of affairs. Milton Friedman is reported to have said, if someone is willing to sell to you below cost you should buy as much of it as you can. Well, we have been doing that; and living for the short run has consequences. There is still a question of damage and distortion. The damage and distortion include the fact that in this instance there is intergenerational unfairness. We do the excessive consuming while future generations do the excessive paying.

The real point is that our deficits do matter and are bad because they represent consumption not investment. If the US were investing for its future these capital inflows that finance the deficit would finance themselves. But when we only use them to pay off and sustain high fiscal debt or corporate debt and to fuel consumption, then the deficits are bad.

Deficits being good or bad should not be a function of the currency regime. Under the gold standard countries WOULD NOT run deficits because they would have to pay for them in gold. Now that we only pay with fiat money IOUs, economists are no longer so concerned about whether it’s a deficit or a surplus on current account – but that is wrong. The gold standard was too restrictive, but that does not make the anything-goes floating currency regime right regardless of the outcome. Countries still need to mind their balance of payments and to run deficits for the right reason… and duration.

It should be lost on no one that the most fiscally sound countries do not run strings of current account deficits. They run surpluses.

Under a fluctuating exchange rate system, exchange rates are supposed to move to put current accounts back in equilibrium – has this happened?

The Kvetching Six

Man Bites Dog Dog Gets Tetanus Shot 02

We do not even have to look at exchange rates to answer this question. Only the UK metrics are close to a balanced position with surpluses sometimes and deficits other times. Everyone else runs only surpluses (US deficits) all the time on their bilateral accounts.

My position on this [issue] is that this is proof that WTO has got it wrong and these countries are foreign exchange manipulators that do not allow their currencies to RISE (undercutting their competitiveness and increasing their purchasing power). As a result they stay too competitive. The US remains uncompetitive. And US demand serves to stimulate growth in these countries. And, yes, the US gets more and cheaper goods as a result. It also gets higher unemployment (or less labor force participation), lower wages, lower inflation, lower interest rates, and is encouraged to carry more debt financed by foreign capital inflows (the counterpart of current account surpluses).

Of course, I do not even have on this chart some of the Asian countries that maintain an economic agenda of export-led growth.

Under FREE TRADE each country is supposed to produce according to its comparative advantage. But the US is producing less; Asia is producing more; and the US is consuming more as the structural US current account gap leaches US income off and stimulates growth overseas while taking away from growth in the US. US spending stimulates growth abroad as US citizens buy imports (foreigners’ exports) and their exporters thrive on these payments. This is NOT FREE TRADE.

It is also true that the US has fewer commercial policy (tariffs quotas and other restrictions) impediments for foreign goods, making the US an easy export target compared to other countries where US goods DO NOT face the same level playing field.

Trump’s ‘National Security’ tariffs do not remedy any of this, but they do put the rest of the world on notice that the US is finally going to stick up for its firms and that US commercial policy may be used even when the problem is not a specific foreign commercial policy.

You see, it is impossible to force a nation to appreciate its currency. But if it keeps its currency too low and keeps an unfair advantage from that, what recourse is there? Foreigners blame the US. We consume too much and save too little. But it’s the natural thing to do when faced with the choices they give us. Foreigners buy a lot of US-based financial investments, which keeps their own currencies weak. Capital flows into the dollar strengthen the dollar and weaken the currency they come from. In this way foreign holdings of US Treasury securities in particular (allegedly made to beef up needed foreign exchange reserves) are instruments of long-term currency manipulation.

Man Bites Dog Dog Gets Tetanus Shot 03

Looking at the G7 (putting the US back into this group), the chart above shows current account positions as a percentage of GDP by country. From early 1996 through 2008 the US ran the largest deficits relative to GDP. Since then Canada and the UK have surpassed the US. France has run deficits from 2008 (no data before then). Italy is back to running surpluses; so is Japan in the wake of its natural disasters, when it unexpectedly needed to import oil when it had to shut down its nuclear reactors. Germany has a surplus at 8% of GDP and may still be growing it larger.

So how is the US a trade pariah with this record?

The specifics of the Trump action are poorly chosen. The national security ruse is thin gruel, but it is legal and accessible. The US has much stronger grounds to pressure even our closest allies to shape up and be fair.

To be really fair we can step up and shoulder our share of the blame. US economists for years were in denial about the damage that global unfair trade was doing to the economy. They called it ‘fair trade’ or said it was close enough to it. Well, it is not close enough to it. The US balance of payments currently is being repaired by oil and fracking. We should not let the illusion of a smaller trade and current account deficit, because of our selling our natural resources, mask the fact that US firms are not as competitive as they need to be AT THESE EXCHANGE RATES.

There is no foolproof way to get other countries to revalue their currencies. Forcing current-account-surplus countries to make changes is nearly impossible. But Trump’s actual use of commercial policy to go after imbalances caused by other issues may have merit. Trade needs to be fair. Americans have enough ‘stuff.’ We don’t need more cheap stuff; we need jobs. And while there are gobs and gobs of jobs, there are not enough good ones. A weaker dollar would help that. But of course one aspect of Trump’s policy is that the dollar has actually been rising. And this is in part because the Federal Reserve has a program of steadily raising rates.

I hope this discussion puts the trade issues in perspective. One big problem is that no one really can observe and identify an equilibrium exchange rate. Also that an exchange rate is necessarily a bilateral thing – it takes two to tango. And it is often hard to get agreement on what it should be. But over long periods of time we can look back and see what misaligned currency rates have done. The trail of US current account deficits is such a thing. Viewing it as a problem unfortunately gets us caught up in a crossfire in which some push for a strong dollar for political or geopolitical reasons or just for what they think are patriotic issues. And if you are the greatest, best, most productive economy on earth, you will have the strongest currency, and it would not kill you. But if you are no longer that dominant economically and if you still push for such a strong dollar, bad results will follow… as we have seen. So the US situation has been the result of US misunderstandings about the facts regarding its international competitiveness and foreign opportunism. But US deficits are leaching wealth from the US. We are living off of our ‘former greatness.’ Our labor market lacks skills. The dollar can’t be the strongest currency in the world unless our capital is the newest and the best, operated by the brightest. And now the only way we get there is with H1B visas. That is not the answer.

We have many needs as a country. And you can’t start by boasting. You can trash talk before the game, but if you don’t bring it during the game, in the end you will be embarrassed. That is what is happening to the US in the wake of all this strong-dollar talk. We should aspire to a strong dollar someday. But not today. You can’t impose that on an economy that is not ready for it without some very adverse results.


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Causality

On day 1 our econometrics professor warned us to be careful with correlation: A strong correlation doesn’t necessarily mean causality. This is the case with the VIX. It’s closely related to the S&P 500 with a negative correlation, but the relationship may not be causal. I will never forget the example our professor gave us: The number of people who have drowned by falling into a swimming pool, it turns out, is highly correlated with the number of movies Nicolas Cage has filmed. Unlike school vending machines that can be causally linked to childhood obesity, Nicolas Cage didn’t need a scientific study to prove his innocence.

However, investors sometimes mistakenly assume causality between seemingly related events. If a rise in VIX is accompanied by some down days in the stock market, did the VIX cause stocks to fall? To answer this question, we need to know how the VIX is calculated. The VIX uses factors from the options market, one of which is the observed forward index price calculated by out-of-money options in the short term. But this correlation calls for caution about endogeneity: The VIX is derived from traders’ perceptions about the future, but actual futures prices also affect traders’ perceptions. How can we be sure that the VIX causes stock price to change? If anything, VIX is more likely the effect than the cause in this relationship. Analogously, the more firemen are sent to a fire (effect), the bigger the fire is (cause). From the perspective of future perceptions, VIX appears more likely to correspond to the firemen who respond to the fire in numbers according to its size than to the fire itself.

What is causation as opposed to correlation, then?  Here’s an example of causation: Consuming alcohol can cause a hangover the next morning. Unfortunately, causality is not as easy to identify in finance as it is in the case of having too much to drink. Oftentimes, what appears to be causation turns out to be just correlation. But why is causation so important for investors? The reason is simple: If a variable can cause stock prices to change, then it is a predictor. Who wouldn’t like to know tomorrow’s stock prices? If we have causation, we have a way to anticipate what’s coming. Why is it so difficult to identify a causal relationship? It is not because there is a limited supply of crystal balls; instead, the stock market is too complex. The stock market is sensitive to all information pertaining to the future. Therefore, it’s not just one variable but many that affect the stock market. Those variables can be as simple as some new product or quarterly earnings, or more intricate ones such as a tax bill or an interest rate change.

At this point we seem to be mired in a paradox: If there are so many factors that can cause stock prices to change, why is it so difficult to identify one? The answer once again falls upon the complexity of the market. Investors and financial engineers have studied the stock market extensively. Although there have been many models, such as the Fama-French three-factor model, created to attempt to explain stock prices, unfortunately, no model yet invented captures the complex interactions of the stock market. This limitation makes it extremely difficult to test any variable against the so-called benchmark. Currently, one of the most-used ways to mitigate this problem is to test one variable at a time against a bundle of existing factors. Nevertheless, our modern research methodologies still only allow us to conclude with a probability rather than certainty. To complicate matters further, the stock market is dynamic. This challenges any model used to predict the stock market. In other words, a factor may have a causal relationship with the stock market at a certain time but not at all times. The explanation is straightforward. If a factor were known to cause stock prices to change, then investors would use that factor repeatedly. By Goodhart’s Law, that factor would not be rendered ineffective over time.

Finally, the key difference between causation and correlation is simple. Causation means A happens before B, while correlation suggests A and B both happen at the same time. Let’s use the figure below, for instance. By rule of thumb, household income is likely to lead personal expenditures, which may explain why there is a slowdown in income preceding each decrease in expenditures.

Personal Consumption Expenditures and Median Household Income in the United States. Source: St. Louis Fed. 
Leo Chen, Ph.D.
Portfolio Manager & Quantitative Strategist
Email | Bio

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France Notebook

We are back in Southern France, in the town of Bonnieux, perched on a hilltop in the Luberon region of Provence, far from the hustle of Paris. The country has recently endured a record number of thunderstorms, which have caused some serious flooding, and continues to experience a series of rail and airline strikes. However, France’s economic performance continues to be robust despite some recent moderation, and French equities have been outperforming most other advanced-economy equity markets except that of the US. The iShares MSCI France ETF, EMQ, is up 3.9% year to date as of June 6 and 10.15% over the past 12 months. In comparison, the iShares MSCI EAFE (all advanced counties ex North America), EFA, is up just 0.6% year to date and 6.11% over the past 12 months.

France has the advantage of a strong and stable government, in marked contrast to the political turmoil to the south in Italy and Spain, the Brexit-related uncertainties across the Channel in the UK, and the disturbing antidemocratic developments to the east in Hungary and Poland. Fortunately, France’s neighbors in the northern tier, most importantly Germany, are also stable politically, with healthy economies.

French President Emmanuel Macron is no longer in the “honeymoon” period that followed his election. He continues to press ahead, nevertheless, with his reform agenda, believing he has a strong mandate to do so. The reforms, for the most part, are directed at improving the performance of the economy and are welcomed by business and financial markets. The opposition on the Left continues to resist the reforms but to little apparent effect.

Macron continues to push his ambitious proposals for reform of the Eurozone’s institutions. He and Germany’s Merkel are now in effect the two leaders of the Eurozone, and they are expected to set the reform agenda. Merkel appears to go along at least part of the way with Macron’s wide-ranging proposals. Both support the creation of a European Monetary Fund (EMF); but while Merkel sees the institution’s main role as strengthening budgetary discipline, Macron sees the EMF as a tool for fighting future financial crises. A clearer idea on this and other issues should come out of this month’s EU summit.

The issue of refugees and migrants continues to be very challenging for all of Europe. The emergence of a populist government in Italy was driven in large part by this issue, as are the political developments in Hungary and Poland noted above.  In France the whole country was moved by the courageous act of a 22-year-old migrant from Mali, M. Gassama, who had no papers. He came across a scene where bystanders were looking up at a young child dangling from a fourth-story balcony. Without hesitation he climbed up the four stories, leaping from one balcony to the next, and rescued the child. The country was thrilled, President Macron met the young man and offered him French citizenship, and the Paris Fire Brigade offered him a job. The event brought attention to the uncertain futures of the many migrants without papers who also have made long and dangerous journeys to France. The new populist government in Italy is likely to make it even more difficult for the European Union to reach agreement in this area.

French newspapers these days are full of the international tennis tournament underway at Roland-Garros and the upcoming World Cup soccer matches, with France’s first match on June 16th versus Australia. But even more attention is being given to the anticipated confrontation between President Trump and the heads of state of the other six countries that make up the G7, who are gathering for a summit in Quebec June 8th and 9th. Both Macron and German Chancellor Merkel have indicated in advance their reluctance to agree to issue the traditional joint G7 statement at the end of the meeting without the leaders finding common ground on tariffs, Iran (the Europeans demand to be exempt from any new US sanctions), and the Paris climate accord. That outcome seems pretty unlikely.

All of the other G7 members, America’s closest economic and military partners, are infuriated by Trump’s decision to pursue protectionist measures against them. At last week’s G7 finance ministers meeting, Canada’s finance minister, Bill Moreau, said, “Unfortunately, the actions of the United States this week risk undermining the very values that traditionally have bound us together.” Canadian Prime Minister Justin Trudeau summed up the views of United States allies, stating, “The idea that we are somehow a national security threat to the United States is quite frankly insulting and unacceptable.” “Deeply deplorable” was Japan’s Finance Minister Taro Aso’s assessment of America’s actions.

The French clearly share this strongly negative reaction. The French finance minister, Bruno Le Marie, referring to “the G6 plus 1,” said, “We cannot understand the American decision on steel and aluminum.” He explained that European steel companies face the same problem as American steel companies do, excess steel production capacity in China, and therefore the American action is clearly misdirected. President Macron’s formerly positive relationship with Trump has deteriorated sharply. It appears that the trade action was the last straw, and Macron will state his views strongly at the summit. In this he will have support from across the political spectrum in France and from Germany’s Merkel, although she will likely make her points in a more measured way. Trump may well seek to cut separate deals with individual European members, dealing with them on his preferred one-on-one basis. But that approach will not work with the European Union, which negotiates trade matters on an EU basis.

Until this morning (June 8th), global markets have been discounting the likelihood of a serious trade war breaking out, but the risks of this happening appear to be increasing. As this note goes to press, an outspoken Twitter war has broken out between Trump, Macron and Trudeau, with Trump now complaining about agricultural tariffs and “non-monetary barriers” and indicating he will leave the G7 Summit before the discussion on the climate and environment. This does not bode well for this heads-of-state gathering.

Bill Witherell, Ph.D.
Chief Global Economist & Portfolio Manager
Email | Bio

—————————
Sources: Financial Times, Le Figaro, Le Monde, New York Times, Bloomberg, CNBC.com


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Predictions: a follow up

In our recent commentary “Predictions,” we quoted Daniel Kahneman and the story of the cost overruns and prolonged construction period associated with the Scottish Parliament Building. The project’s troubles didn’t end when the ribbon was cut. Brian Barnier, who is a voracious reader, sent me the article linked below, detailing the urgent repairs necessitated by the Parliament Building’s faulty construction and design:
https://www.dailyrecord.co.uk/news/scottish-news/terrified-workers-down-tools-after-1083836. I’m a little older than Brian, but I’m fully simpatico with his appetite for confirmed information.

I share the article with readers as a follow-up to my piece on predictions (http://www.cumber.com/predictions/). It’s a three-minute read. Here is an excerpt:

“PARLIAMENT chiefs could be hit with their biggest ever repair bill after potentially lethal faults were found on the roof of the £414million building. Emergency site visits were arranged on Friday after contractors refused to carry out maintenance work on the roof, claiming it is dangerous for them and the public. Meanwhile, our astonishing pictures show a loosened 100lb granite block on the side of the Holyrood building being held in place by makeshift wooden wedges just yards above the Royal Mile.”

We have here another chapter in government incompetence and the mess it can create.

Some readers chastised me for slamming Democrats, since all the sponsors and other proponents of the legislative proposal in the US Senate for “work at taxpayers’ expense for anyone who wants it” are Democrats, like Senator Booker, or independents, like Senator Sanders, who caucus with Democrats. Other readers asked why I didn’t focus on artificial intelligence (AI) as a risk that would eliminate many jobs with machine learning.

Supporters offered that there were lots of “buggy whip jobs” that disappeared when automobiles took over the roads and that agricultural jobs were winnowed by tractors and other farm machinery.   History says AI will increase productivity and plant the seeds for an entire generation of jobs that are presently unknown. History also says education and training are the keys to that success.

My point is that government intervention in a market-based clearing system has a bad history. Kahneman has demonstrated that in his book. And most economists and financial folks would agree that government intervention often causes more problems than it fixes. I used energy subsidies as an example.  But there are many examples of subsidy like sugar which is killing people alongside corn syrup.

My friend Chris Whalen points to the causes and effects of banking system failures. His recent piece referenced Ed Kane’s seminal work on “zombie banks” in Europe. Google Ed Kane if you don’t know him and his efforts as a professor of banking and finance.

The key point is that a political economy needs constant surveillance and scrutiny. Government has an inherent bias, and that bias must be tempered by those who are willing step forward to offer well-researched views. In the social media world of today there is a lot of confusion about what constitutes a researched view vs. an unsubstantiated assertion or opinion. To paraphrase a known media social-ist: beware of fake research.

Lest I be misunderstood, the critics who assumed that I am opposed to immigration are dead wrong. We have 6.5 million unfilled job openings in America right now. Many would come to the US and fill those jobs, bringing with them skills we need and do not have. They are discouraged from doing so by the Trump Administration. That policy of discouragement is awful for our country.

Last night I had dinner with a young person who wants to be an American. He drives a car legally, with a license. He works. He saves. He reads. His English is perfect. He is a taxpayer. He is living on the edge since he falls under the DACA program. He does not want to go back to his country of origin. He has a good reason. There is great personal danger there.

My fishing guide in Miami originates from Cuba. He obtained asylum after a multi-year ordeal to get a foot on American soil. He is now a citizen. He has a family. He works. He votes. He served in the American armed forces. Obama failed by eliminating Cuba asylum. Trump fails by not restoring and expanding it. Venezuela?  I’m biased. One of my ancestors walked 1000 miles to escape a czar and take a steerage passage to Ellis Island.

There are millions of such stories. America can thrive and grow with immigrants and more of them.  America can shrink and age without them.

Meanwhile our universities are shutting down courses because of a fall-off in foreign students. Higher education is a great American export. The US is squandering a competitive advantage. And the buyer comes here to make the purchase and pays cash. We don’t have to ship a higher education anywhere. But when we make it more difficult for prospective international students to get here, they go elsewhere to study. Consequently, US universities don’t have the money for this course or that one, so the course gets cancelled. This is now a national phenomenon. Don’t take my word for it; go ask the dean or admissions officer at the college you know well.

Many readers said my earlier piece on jobs wasn’t a rant at all, but a thoughtful discussion. Thank you for the encouragement. Here is a non-rant to add to your day.