John McCain & Return of Prisoners

The morning email (today) from my friend Dennis Gartman really struck home with me. Dennis and I have a standing agreement to grant each other permission to quote each other. So here is what I read in Dennis’ morning missive:

170602-N-XK398-009 CAM RANH INTERNATIONAL PORT, Vietnam (Jun. 02, 2017) Senator John S. McCain III is piped aboard during a visit to the forward-deployed Arleigh Burke-class guided-missile destroyer USS John S. McCain (DDG 56). The U.S. Navy has patrolled the Indo-Asia-Pacific routinely for more than 70 years promoting regional peace and security. (U.S. Navy photo by Mass Communication Specialist 3rd Class Joshua Mortensen/Released)

“Senator John McCain has terminal brain cancer and shall soon pass from the scene. He was a hero in war; he was a hero in campaigns and he was a hero in taking the high road when then candidate Donald Trump said that he did not believe that Senator McCain was a hero or a winner because, in Trump’s very own terms, “Winners don’t get captured.” Mr. Trump was never in the position to be captured and tortured for several years as was young Lt. McCain at the time, for he avoided the draft and never served in Vietnam.

“Nonetheless, Mr. Trump referred to Senator McCain as a loser. It was at that point that we knew we were never going to be a Trump supporter, and although we voted for him we did so only because the other candidate was even more badly flawed.

“To fear the world we have organized and led for three quarters of a century, to abandon the ideals we have advanced around the globe, to refuse the obligations of international leadership for the sake of some half-baked, spurious nationalism cooked up by people who would rather find scapegoats than solve problems is unpatriotic.

“The Senator has asked that the President not attend his funeral, requesting that Vice President Pence attend in the President’s stead. We can fully understand. Were we Sen. McCain we’d not want someone who considers us to be a loser to be there supposedly to honor us in death.

“Sen. McCain was and is a great man, a great patriot and a great Senator. When he’s gone he will be sorely… very sorely… missed.”

Let me add some personal notes.

It is hard for anyone who has served in the armed forces in any branch not have the utmost respect and admiration for John McCain. I’ve had this discussion with many friends and have not found a single exception. While my military service in the Army came in the years 1966-69, my duty assignments did not include Vietnam. My personal visit to Vietnam came much later when I chaired a Global Interdependence Center Trip to Hanoi. During that trip some of us were able to break away from the meetings and visit the prison that held John McCain and see the cell he lived in. It was a moving experience.

We are now witnessing the return of three prisoners from North Korea. And no reasonable person would dispute that the release of these prisoners is a positive step. But their circumstances of imprisonment were different from John McCain’s. They weren’t shot down during a war. That said, we welcome their release as we would that of anyone held anywhere against their will and for doing nothing wrong.

History will note that the release of these prisoners from North Korea occurred on the watch of President Trump. And it has. But in our view, the reason why North Korea agreed to the release is secondary to the release itself.

These things happen when there is a détente. And right now there is an evolving détente underway between North and South Korea and directly involving the United States, China, and Japan. Reasonable people wish for that détente to succeed. Reasonable people want the risk profile of war lowered in the Asian region.

With regard to Senator McCain, Mr. Trump has a chance to demonstrate something that seems very difficult for him to do: He could apologize. He could show a side of his personality that might surprise some of his harshest critics. He could do it in the spirit of celebrating the prisoner release.

Wouldn’t it be nice of Mr. Trump to clear the air and offer an apology to John McCain while the Senator is still alive?

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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Fed, Fishing, Labor Data

We thank readers for comments on our Sunday morning piece about the Fed and the risk of policy mistakes. For those who missed it, the link is here: http://www.cumber.com/fed-employment-mistake-or-correct-munis/. For those who missed my colleague Bob Eisenbeis’s piece on Fed policy, here’s the link: http://www.cumber.com/may-fomc-decision/.

Bob raised a technical question internally, which we will share with readers.

Before we do that, however, we want to offer an opportunity to readers and others who may have an interest in joining a “Camp Kotok” gathering in Maine. For years we have received emails asking, “How do I get to go to one of these gatherings?”

So here is your chance. The weekend after Father’s Day has some open spaces (June 21–24, with early bird arrival June 20 and late departure June 25). And Labor Day weekend also has some spaces. Both are over half full. Some folks bring partners, spouses, sons and daughters, or grandkids) to either of these. They are relaxed groups of interesting people who enjoy the conversations and the pristine environment at Leen’s Lodge. These two gatherings are now open to readers on a first-come, first-reserved basis. Go directly to Scott Weeks, owner and manager of Leen’s Lodge, if you want details. You can reach him at 207-796-2929, or you can check out their website at www.leenslodge.com. You may want to use the phone first to obtain a registration passcode and discuss any details or have questions answered. Email me if you have any questions.

Now let’s return to labor-force, debt, and Fed-policy issues.

Bob Eisenbeis weighed in on the unemployment questions addressed by Philippa Dunne and Doug Henwood in our Sunday morning piece:

“I have long argued that looking at new claims without reference to the size of the labor force gives a misleading picture. Yes, the number of initial claims in relation to the size of the labor force is at a historical low. But on the flip side, if the economy created jobs at the same rate today that it did between 1960 and 1970, the jobs number should be four times what it is. Similarly, moving the reference date to 1983–2006, the number should be two times what it is now.”

My conversation with Philippa Dunne focused on the falling labor participation rate. Why is it falling? Where is it headed? I asked if we could see an unemployment rate below 3% while the participation rate trends down to 60%. Those would be remarkable numbers. Ten years ago we would have thought them impossible. Now we are getting close. So, at the suggestion of Bob, we went digging deeply into the weeds. Our effort yielded some interesting numbers.

Readers are invited to look at the changes in the labor force participation rate when examined by gender and by age. The changes are revealing. Folks above 50 have a rising participation rate while young folks have a falling rate. Here is the link to the fully detailed table at the Bureau of Labor Statistics: https://www.bls.gov/emp/ep_table_303.htm.

Bob and I considered this question: How can we measure something (like the U3 Unemployment rate) and base policy on it when we do not understand what is going on? (I’m referring to the shift in the participation rate for those above age 55.) Here’s Bob’s observation:

“Men have been slipping from the labor force since the end of WWII while Women were entering and then began to slack off – not just after the financial crisis but long before 1998. There are a lot of explanations, but there doesn’t seem to be a “natural participation rate,” hence all the demographic explanations.

I add more questions. Do those trends mean a guaranteed rising inflation rate and acceleration of higher successive price level changes? The answer may be no. If the participation rate is rising among the over-50 demographic, does that change the way we think about rising wage pressures? Are older workers more productive, more reliable, less prone to changing jobs, more inclined to company loyalty? There are a lot of questions without answers. Is the Fed asking them? Shouldn’t the questions be examined first, before setting a policy based on an unemployment rate that is low because the participation rate is falling? Bob Brusca notes how the unemployment rate would be somewhere between 8% and 9% if the participation rate were held constant.

On a separate note we ask if the federal debt burden is deflationary. Maybe it has a suppressive effect.  Barry Bannister (Stifel) has long argued that the ratio of incremental economic growth to incremental debt has been falling for years. He notes that it takes more and more units of debt to add a unit of GDP. That’s something we must think about as the federal debt explosion looms.  The debate on this item is about direction of causality.

Debt is a burden; that seems to be intuitive.  In the case of the United States, debt service payments do not reduce the principal owed. It is the interest burden in the federal budget that matters, and it is rising and accelerating. So after ten years of near-zero rates and after ten years of refinancing the nation’s mortgage, the trend is now higher and higher debt-to-GDP and rising interest rates as the debt rolls over. My friend John Silvia (Wells) raised the issue succinctly:

“Rising interest rates would only put further pressure on the federal budget in the years ahead. The question of how Treasury will finance its borrowing needs is not likely to go away anytime soon.”

If we assume for a moment that the market is currently pricing in a reduced rate of Fed hiking, we start to see how all this makes sense. The Fed says one thing, but they are able to respond to incoming data when they don’t get what they expect. The market thinks the Fed’s forecast path for interest rates is too aggressive. So the market says that the Fed will eventually realize its error and alter that path. That is why the market-based expectations of future rising interest rates are lower than the Fed’s assumed narrative. It is also the reason why the forward rates suggest that the Fed will not tighten as quickly as the Fed’s narrative says. And it helps explain the flattening of the yield curve.

Maybe, just maybe, the present policy is on a three-pronged tightening course, not a single-pronged approach of raising the fed funds target rate. The three prongs are (1) rising short-term policy interest rate (fed funds target); (2) balance sheet shrinkage, which is transferring holdings by the central bank back to the markets; and (3) the intersection with policy of the increasing issuance of Treasury debt as federal deficit financing needs reach the markets.

We wonder if policy rates as defined by federal funds and IOER may be too high. We believe that the Fed’s balance sheet shrinkage pace may be too fast? Why do they have to shrink it at all? There are four elements at work now with Fed policy. Bernanke has noted the first element, the worldwide demand for US currency. He said that the Fed will eventually be enlarging its balance sheet as the demand for currency continues to rise. The second element is the US Treasury, since the Fed acts as the Treasury’s bank. Treasury’s balance at the Fed continues to rise over time as the US economy grows. Note that a rising Treasury balance held at the Fed means a shrinking balance of bank reserves.  The third element is technical: The use of RRPs continues to rise, and there is no reason to believe that trend will not continue. The fourth element is also on autopilot: Excess reserves in the banking system grow into required reserves over time as the nominal US economy gets larger.

So what’s the argument for shrinkage versus just stabilizing, rolling debt, and waiting patiently? Also, does a stronger dollar hurt or help? Is the dollar’s strength due to relative interest rate levels around the world and policy differences among major central banks? Is the Fed actually making the growth outlook worse? And lastly, does the looming deficit financing need pile onto a two-pronged Fed policy, effectively creating a three-pronged monetary tightening regime?

Now, we do not know the answers to these questions. We gather in Maine and discuss them in great detail and do so in the context of views on politics, governance, and diverse economic perspectives. And we also worry about policy mistakes. We think the Fed should be worried, too.

Let’s close with an excerpted quote from the now publicly released FOMC minutes of April 28-29, 2009.   We suggest readers think back to that financial crisis period of time.   Then read this statement in the context of today and wonder if the Fed should really read now and consider it just as applicable as it was then.   A few years from now we may see if this Fed has done that and heeded their historical warning.   Readers need only substitute the words “balance sheet shrinkage” in place of “asset purchases”.

“Under the current policy approach, the scale of asset purchases and demand for Federal Reserve liquidity and credit facilities, given their terms and conditions and the evolving financial and economic conditions, will drive the size and composition of the Federal Reserve’s assets and the quantity of liabilities. The composition of those liabilities will be determined primarily by the evolution of currency demand and other factors on the liability side of the balance sheet, with reserve balances determined largely as a residual. The balance sheet projections are “bottom up” forecasts based on assumptions about the various components of the balance sheet. We should emphasize at the outset that all of our assumptions, and therefore the resulting projections, are subject to significant error. The significant uncertainty surrounding the outlook for the economy, the uncertain response of users of Federal Reserve credit to the state of financial markets and the economy, and the fact that some elements of the balance sheet are policy choices make these projections more judgmental than typical forecasts.”

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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Fed, Employment, Mistake or Correct? Munis?

Albert Einstein was, it turns out, apparently not the person who defined insanity as “doing the same thing over and over again and expecting a different result” (see https://quoteinvestigator.com/2017/03/23/same/); but it’s a good definition just the same.

The definition certainly applies in economics and financial markets when we apply regression analysis to data on the assumption that nothing has changed. Many fail to look for new or unique information or regime changes but rather remain trapped by old ways.

In a brilliant analysis, Philippa Dunne and Doug Henwood published the following insight in their May 3 TLR (formerly The Liscio Report). For information on this first-rate newsletter, which I always read as soon as it arrives, call 518-827-7094 or email Philippa directly: philippa@panix.com. We thank Philippa & Doug for permission to share their superb work with our readers. They wrote:

“Analysts enthusiastically make claims about jobless claims in historical context, but it’s important to remember this: jobless claims are around 62% of flows into unemployment, more than 20 points below the 1990–2007 average of 85%.”

That’s a terrific snippet.

So as we thought about the monthly employment report, we wanted to frame it in this context and not reiterate the headlines that painted the news flow after 8:30 AM on Friday morning.

Let’s wade deeper into TLR for details.

“Much has been made of the low level of first-time unemployment claims. They are low, no doubt about it – 0.16% of employment, a hair above March’s record low of 0.15% and well below the previous record of 0.20% set in March 2000. (You can say similar things about continuing claims.) But, as we’ve noted in the past, the record comes with an asterisk. That asterisk is the declining share of the unemployed who are eligible for benefits. When we last visited this terrain, we noted that the insured unemployment rate was close to 70% of the official rate in the early 1970s; it’s less than half that, around 32%, today. Some readers countered that this could be explained by the rising share of the long-term unemployed in the total. True enough; now, those unemployed 27 weeks or longer account for 26% of the total, which would have been worse than a depth-of-recession neighborhood in the 1970s and 1980s. But the long-termers can’t account for this: initial claims are now around 62% of the flows into unemployment, more than 20 points below the 1990–2007 average of 85%, and had never been below 74% before 2013. Looking beneath the surface, we’d say there are some labor shortages, but the job market is not as tight as claims may suggest.”

Think about that: “not as tight as claims may suggest!”

So are the Fed’s models steering the FOMC in the wrong direction? Is monetary policy succumbing to economic insanity? Do the labor force data changes cited by Philippa and Doug help explain the flattened yield curve?

Former Fed Governor and “almost Fed Chair” Kevin Warsh thinks so.

Politico reported this on May 4, 2018:

“KEVIN WARSH THINKS THE FED IS BUSTED – Former Federal Reserve Governor Kevin Warsh, who nearly became Fed Chair, sat down with a group of reporters in Palo Alto, Calif. on Thursday night for his first on-record comments since the top central bank job went to Jay Powell…. Warsh offered a fairly stark assessment of the Fed, including its reliance on antiquated data sets (including today’s jobs report) and obsession with a 2 percent inflation target that is certainly not precise to the decimal point. Had he gotten the Fed gig, Warsh said he would have harnessed the many big brains inside the central bank to find better data. Warsh: ‘The place is thirsting to be led in new directions … I have the impression … that they are waiting on the payroll number … and they think it’s filled with important insights about the economy.’ He also dismissed the idea that slightly faster wage growth should cause the Fed to panic about inflation. ‘A catch-up in wages would not tell me that “oh my goodness, inflation is coming.” I do not have a 1978 view that unions have bargaining power and that will send us on a wage-plus-price spiral that’s going to lead to inflation.’”

Terrific analysis by TLR and a clear statement from Kevin Warsh are enough to give us pause.

We still wouldn’t buy the Treasury note or long bond. We still prefer spread product in the municipal space. When a very-high-grade tax-free instrument is paying investors a higher yield than the corresponding taxable Treasury security pays, that is a screaming bargain. We will even use the tax-free instruments in taxable fixed-income accounts in lieu of traditional corporate bonds, as the yield may be higher and the cushion against a higher future interest rate is improved by the tax-free nature of the instrument. Only a repeal of the income tax code would change that approach, and we do not believe that is a remote possibility.

The muni sector is offering bargains to those who will do the hard work to find them. Those who are running from that sector are doing so way too soon.

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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May FOMC Decision

To no one’s surprise, the FOMC left its target range for the federal funds rate constant at 1.5 to 1.75%. This decision maintains the Committee’s record of no rate hikes at meetings where no SEP forecasts were available and also spaces out its gradual normalization of policy. There is virtually no information in the statement released on Wednesday that hints at why rates were held constant. The May statement was virtually identical to the March statement, when the policy range was increased by 25 basis points.

Parsing the two statements, we find that only a few words are different. First, in describing growth the March statement said that “job gains have been strong in recent months,” whereas the May statement inserted the words “on average” following the word strong, no doubt bowing to the fact that the March job gain number was only 130K (revised up after the meeting to 134K), following February’s 326K (revised down after the meeting to 324K). Second, the May statement noted a reversal in business investment, stating that “business fixed investment continued to grow strongly,” in contrast to the March release commented that “business fixed investment moderated from fourth quarter readings.” Third, the committee observed that inflation had now moved closer to its 2% target, while the March statement said that inflation was running below target. In total, these wording adjustments were simply slight modifications recognizing marginal changes in the economy while reaffirming all the previous language about the future gradual path for policy and what evidence would prompt policy changes.

In the wake of this statement, pundits and economic commentators immediately began to speculate that the next rate hike will come in June. But there are reasons to believe that a June move might be premature, given that little new relevant information will be available on key components of the economy’s performance. The only new information about GDP will be the second estimate on Q1 2018, which will be supplemented by Beige Book information. This latter source has suggested that growth is (at best) moderate; and should that trend persist, it will be hard to justify concern that the economy may be overheating. In June there will be two numbers on job creation and several weeks of unemployment statistics. Given the variability of the CES employment data, it is unlikely that an observable trend will have appeared, unless there are more numbers like March’s. Indeed, today’s release for April showed that 164K new jobs were added, much below the 200 plus number that “informed” economists were expecting. Finally, the FOMC will have only one more observation on PCE. Given that the 2% target was hit for a couple of months in January and February of 2017 before it declined back to a low of 1.4% for several months that fall, there can be little assurance that even another month at 2% will be sufficient to cause the FOMC to act, especially with the large number of vacancies on the Board and the relative lack of experience of the majority of the current voting members of the FOMC.

But there is a longer-term issue that has gone largely unnoticed to date, concerning what is a clearly disconnect between the FOMC’s SEP short-term forecasts compared to where the Committee sees the economy in the intermediate term. To illustrate, the following table displays the median forecasts for GDP, unemployment, inflation, and federal funds rate put forward in the FOMC’s March SEP forecast.

What we see is a steady decrease in projected year-over-year GDP growth, from 2.7% in 2018 to 2.0 in 2020. At the same time, unemployment is expected to decline from 3.8% in 2018 to an even lower 3.65 for the two subsequent years. All the while, inflation is essentially constant at the FOMC’s target of 2%. However, to obtain these results, the FOMC seems to feel that further tightening of its policy rate is in order, despite the decline in GDP. But the real disconnect shows up is in the intermediate term, where growth is even slower, but unemployment now jumps to 4.5% – which is arguably NAIRU (the “non-accelerating inflation rate of unemployment,” or, more simply put, the level of unemployment that does not boost inflation) in some peoples’ minds – and inflation is still at 2%. It appears in the forecast that inflation is not connected in any way to what is happening in the real economy. Yet something has happened to cause the FOMC to reverse policy, in connection with the rise in unemployment to 4.5%. The obvious explanation is that some sort of economic contraction has occurred in the forecasts, sometime beyond 2020, which is expected to cause unemployment to jump. Questions abound here and cry out for clarification and discussion.

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 2

Many thanks to readers for comments about our “Thucydides – Part 1.” For those who missed it the link is http://www.cumber.com/thucydides-part-1/.

In this part 2 we must first offer an apology to Professor Graham Allison. An astute reader caught a typo on a third occurrence of his first name, deep in the text of part 1. Three editors and I missed that typo. Since all errors, in the end, are the sole property of the author, I personally ask Professor Allison to forgive my error.

Readers are invited to watch an exceptionally instructive recent interview with Graham Allison, recorded on April 21. Allison ranges widely on the Thucydides Trap and lessons from ancient Greek history that reach into modernity. Note his analysis of the East and South China Seas, the role of Taiwan, and the alliance of convenience between Russia and China. Also listen to how he views Europe today. We recommend devoting 15 minutes to view the full YouTube interview at https://www.youtube.com/watch?v=VAyPZ9NO70k&sns=em. The title, if you have to search for it independently, is “5 Minute Insights: Professor Graham Allison on the U.S. and China Today.”

Now to Thucydides – Part 2.

In part 1 we noted the discussion of the North Korean mountain collapse that followed last September’s nuclear test there. We speculated about this collapse’s being the motivation behind Kim’s changing posture. We wondered what the US intelligence apparatus knew and when. Or was this hugely negative North Korean development just good luck for the US? Did a leak of radioactive material into China spur China into action? Did Beijing tell Pyongyang, “Enough is enough?” Is that what eventually got the two Koreas and the US and China to work at the new détente? Could it be that the NK nuclear failure wiped out so much of their program that it forced Kim to sue for peace in a way that makes him save face by looking heroic? Does Kim face a nuclear catastrophe of Chernobyl proportions? (Here’s a story on the aftermath of Chernobyl and continuing radiation damage: http://time.com/5255663/chernobyl-disaster-book-anniversary/.) Is this a Fukushima-like disaster? (Here’s reporting on the continuing flow of radioactive water from the plant into the ocean: https://www.japantimes.co.jp/news/2018/03/29/national/seven-years-radioactive-water-fukushima-plant-still-flowing-ocean-study-finds-.Wumg48gh0kh.)

(It is worth remembering that 10 years ago the previous dictator Kim blew up the cooling tower that was the most prominent symbol of NK’s plutonium production program. He used that act as a teaser to prompt negotiations, but three years later he was back to his old ways. See https://www.nytimes.com/2008/06/27/world/asia/27iht-korea.1.14044540.html.)

Reminder: The three prongs of a Thucydides Trap are fear, national interests, and honor.

The present summation of the Korean T-Trap situation looks like this: Kim saves face (T-Trap honor); South Korea gets relief (T-Trap fear relief); China gets a Korean buffer in place without nuclear risk (T-Trap national interests); the US president gets a political victory; and the US defense establishment accepts a reprieve from war. (Donald Trump’s administration is affected by all three prongs of the T-Trap.)

With détente, everybody wins, at least, temporarily. Thucydides cites the 30 years’ peace in Greece as proof that a détente can happen. Graham Allison notes how the periods of peace are so fruitful. And he warns about how they do not always last.

Trump lovers credit the President. They support his Twitter diplomacy and “rocket man” threats. They credit him with successful belligerency. He is seen as purposefully posturing the US as the mighty and the righteous. He gets credit for supporting the Olympics in South Korea and for publicly displaying that support through the drama of Vice-President Pence’s and First Daughter Ivanka’s attendance at those games. And Trump is lauded for facilitating the détente with the cooperation and assistance of China. In his Michigan speech on Saturday, Trump took full credit for the Korean Peninsula détente, and he attributed the result to his policy and interventionism and style. To describe the extent of the role he played in achieving the Korean breakthrough, he said “everything.” The audience cheered robustly and sustainedly.

Even those who don’t like Trump must concede that this is happening on his watch and that it is a breakthrough. Or we should say, it appears to be a breakthrough.

So did the initiative really start with the NK nuclear test failure? Was Trump shrewd, or just lucky? Does it matter? Trump will be the first US president to meet with a North Korean leader. Bill Clinton reportedly came close to a meeting but didn’t succeed. Trump’s favored TV channel ran a report on the three Kims and their nuclear ambitions. The title is “North Korea’s nuclear weapons program has grown with each Kim regime.” Here is the link: http://www.foxnews.com/politics/2018/04/27/north-koreas-nuclear-weapons-program-has-grown-with-each-kim-regime.html.

During a private dinner I attended recently, conversation about NK morphed into talk about the reunification of Germany after decades of division. We looked at how a subsidy was transferred to the East Germans through the mechanism of maintaining the official East German Mark exchange rate when the conversion to the West German Deutschemark occurred. I personally recalled my experience of walking through Checkpoint Charlie in Berlin in an Army uniform. In those days, an American officer visiting East Berlin in civilian clothes risked arrest and imprisonment for spying. We went only in uniform. I remember vividly the machine gun slowly turning as I transited the border maze. A few others at the dinner offered metaphors of breakthroughs and how they occurred. Nixon-China and Reagan-Russia were cited as cases of success that avoided war and overcame the heightened risks of a T-Trap, with its asymmetric information. Historic T-Trap failures in history were also cited. Perhaps Chamberlain’s pacifist initiative with Hitler was the most dramatic.

Trump lovers and Trump haters aside, Kim’s about-face is happening on Trump’s watch. If peace breaks out on the Korean peninsula, Trump will be the sitting president of the United States who will be credited with success in that chapter of history. Now I have just invited an onslaught of rebuttal.

Passions about Trump run to the extreme. We saw that in Michigan from the Trump lovers.

Thucydides’ repeated warnings about emotions are confirmed in Americans’ behaviors today. Passions run high on both sides.

Here is a quote from an avowed Trump hater:

“He’s now jumping to take credit for whatever good happens in Korea. (He’ll blame others for anything that goes wrong, of course.) China reveals that Kim Jong Un blew up his nuke testing site and faces an existential cost threat to clean up his self-inflicted mess (the threat compares to making N Korea clean up the Hanford Washington breeder reactors). Then S Korea impeaches a leader for corruptly taking instructions from a chaebol (think, Trump taking orders from Putin). They then elect Moon on a platform to unify with the North; China rightly decides they have a better chance to succeed trading with Korea than conquering it (not to mention the chance Korea will either pick up the nuclear cleanup costs or get the US to help, saving China billions). AND TRUMP SAYS PEACE HAPPENED BECAUSE HE DID A GREAT NEGOTIATION JOB. The problem, of course, is that claiming credit is simple, but understanding reality is complex, so Trump may well succeed. In the end, it matters little in comparison to the world’s real problems, but that makes it no less maddening. THIS IS A GOON FOR WHOM ONLY 8% OF THOSE WHO KNEW HIM BEST (Manhattan residents) VOTED.”

Readers may wish to learn about Hanford, the site of a US nuclear site tunnel collapse in 2017, for reference. Its nuclear history starts in 1943 and continues until today. Here’s a background piece: https://www.energy.gov/em/hanford-site. And here’s a story on the collapse of the radioactive materials storage tunnel in May 2017: https://www.washingtonpost.com/news/post-nation/wp/2017/05/09/tunnel-collapses-at-hanford-nuclear-waste-site-in-washington-state-reports-say/?utm_term=.4bae7e6bd069.

We hope for a successful détente. Our view is that any action that reduces the risk of a T-Trap war is an action worth taking. We don’t think this is about Trump-hating or Trump-loving. We look beyond the warnings of Thucydides about emotions. It is the outcome we seek. If NK shuts down its nuclear program, the world is a better place. If the Korean peninsula thaws in its version of an East Germany–West Germany détente, the world is a better place. Will America be willing to fund some of the costs? That question is probably coming. Will the Congress have the vision to look beyond hating each other across the Republican-Democrat divide? Sadly, Thucydides’ history suggests only maybe and only temporarily.

Thucydides didn’t have nuclear weapons to write about. His Peloponnesian War experiences involved ships powered by wind or rowed by slaves, battering rams, the phalanx, the cavalry, archers, mercenaries, and hoplites (spear, shield and helmet-armed infantry). Battle was by sea or land. No satellite imagery. Information was sourced with spies and lookouts. Remember, this was 2500 years ago.

We did find Thucydides’ account of a plague that struck Ancient Greece, which may offer instructive parallels to the effects of a potential nuclear disaster in the Korean Peninsula. It happened in 431–430 B.C.E.

Until the time of Thucydides, plagues were attributed to the deities. We see that in the biblical narrative of the Ten Plagues in Egypt and we see it likewise in Homer (The Iliad) and Herodotus. That changed with Thucydides. Readers may recall that in part 1, we discussed how Thucydides focused on human behavior. He ignored the gods. He was looking at the methods and decisions of man.

We will end this part 2 with a portion of Thucydides’ description of the plague that hit Athens. That plague had spread around the Mediterranean from Egypt and Libya to Greece. It may have weakened Athens to the point where it lost the war with Sparta. We can speculate about that. Thucydides writes that “The plague had indeed begun immediately after the Peloponnesians (Spartans) had invaded, and it never reached the Peloponnese to any significant extent, but spread particularly in Athens….”

We ask that readers think of modern history as they read the following. Contemplate the outcome of a nuclear disaster, whether the massive deaths at Hiroshima or the suffering from Chernobyl. For an American image, research the effects of the 1918 flu epidemic in the United States 100 years ago. (See https://www.smithsonianmag.com/history/journal-plague-year-180965222/.) Use your imagination to move from ancient to modern.

Here is Thucydides:

“Other victims were in good health until, for no apparent cause, they were suddenly afflicted. The first symptoms were a high fever in the head and reddening and inflammation of the eyes; then internally foul smell. There followed sneezing and hoarseness of voice, and shortly the affliction moved down to the chest accompanied by a violent cough. When it settled in the stomach the turmoil caused there led to the voiding of bile in every form for which the doctors have a name, all this with great pain. Most then suffered from an empty retching which brought violent spasms… the surface of the body was not particularly hot to the touch or pallid, but reddish and livid, breaking out in small pustules and ulcers… the sensation of burning heat inside the body was so strong that sufferers could not bear the pressure of even the lightest clothing or sheets, or anything other than going naked, and their greatest wish was to plunge into cold water… many did throw themselves into cisterns, overcome by an insatiable thirst: but as a rule the quantity of water drunk made no difference…constant infliction was desperate restlessness and inability to sleep… the majority died from internal fever after six to eight days… others died from subsequent weakness when the disease spread down to the bowels causing heavy ulceration and the onset of completely liquid diarrhea… symptoms appeared when the disease took hold in their extremities. It attacked genitals, fingers, and toes, and many lived on with those parts lost; some too lost their sight. There were those who on recovery suffered immediate and total loss of memory, not knowing who they were and unable to recognize their friends… the pathology defied explanation… although many bodies lay unburied, the birds and animals which prey on human flesh kept away from them, or, if they did eat, died of it.”

Thucydides continues, “Such was the affliction which had come on the Athenians…. For all the time the Peloponnesians were in Athenian territory, the plague continued to take lives both among the expeditionary force and in the city of Athens, so much so that… the Peloponnesians cut short their presence in the country for fear of the disease….”

(For an extensive discussion of plagues in ancient times read “Plague in the Ancient World: A Study from Thucydides to Justinian,” by Christine Smith, available here: http://people.loyno.edu/~history/journal/1996-7/Smith.html.)

Has Kim created his own plague in North Korea? What are the true informational asymmetries at work among the key players – North Korea, South Korea, China, and the United States? Has the Thucydides Trap narrative changed in modern times? Are the dangers not greater now than they were in Thucydides’ time?

We will wrap up this part 2 with a special note. A very thoughtful reader sent the following:

“An interesting aside: ‘In his book titled The Oracle, science historian William Broad and his scientist team prove the existence of the crossed fault lines and the presence of an intoxicating gas called ethylene in the rocks below the ancient temple…. The presence of hydrocarbon gases can induce a narcotic state similar to that recorded from the trance state of Pythia.”
https://www.ancientpages.com/2016/11/03/mystery-delphi-oracle-prophecies-pythia-drugs-guiding-ancient-greek-civilization-thousands-years/

“If I’m not mistaken, you’re suggesting world peace could be obtained through sharing a ‘peace pipe,’ thus all the focus on medicinal cannabis.”

Part 3 is ahead.
 
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 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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Thucydides–Part 1

“Let China sleep; when she wakes, she will shake the world.”
– Napoleon, 1817 (citation source: Graham Allison)

“We really don’t think it was tariffs – those have been in the public domain for days. Rather, we believe the market has a very unhealthy dynamic at the moment. Washington policy is critical to the market direction, but information asymmetries there are profound. No one wants to buy the dip if a real seller with better DC sources caused it.”
– Datatrek, March 22 (Kotok note: On this date an interim stock market bottom may have occurred.)

Is the US stock market worried about a “Thucydides Trap” and its implications for US policy? We think the answer is yes (hat tip to Jason Trennert for raising the question) and that it may explain why a trillion dollars in market cap can get wiped out quickly and why (as Strategas’s Don Rissmiller has noted) all of the “discounted benefit of the tax cuts ($800 billion fiscal stimulus) got erased by $37 billion in tariffs.”

Market Commentary - Cumberland Advisors - Thucydides Trap

Let’s tackle information asymmetries, Trump, and Thucydides.

We begin this multi-part commentary with a recommendation of Graham Allison’s book. We suggest that it go immediately to the top of your reading pile. The title is Destined For War: Can America and China Escape Thucydides’s Trap? (See https://www.amazon.com/Destined-War-America-Escape-Thucydidess-ebook/dp/B01IAS9FZY.) For the government and academic credentials of Graham Allison see: https://www.hks.harvard.edu/faculty/graham-allison. For an overview of the Belfer Center at the Harvard Kennedy School, see: https://www.belfercenter.org.

Graham Allison coined the term Thucydides Trap (T-Trap) to describe the reactions between world powers and how one of them may engage in an action in response to how it perceives the other (information asymmetry at work). Over and over in the history of the world, a rising power challenges a a dominant power, creating fault lines of stress and competition between the two. Allison provides a detailed historical log of 16 such major events in the last 500 years. He documents how 12 of the 16 ended in war.

As investment professionals, we must immediately note that in the first four of Allison’s 16 events (Spain versus Portugal, 15th century; three rounds of the Hapsburg Empire’s demise) there was no stock market. In the other 12 examples there were bourses. Amsterdam’s was the first one, trading shares of the Dutch East India Company in 1602. Over the following four centuries, other stock markets came into existence. In each occurrence of a T-Trap scenario, there was a serious market reaction. There are no exceptions. War or a perceived risk of war moves stock market prices.

We believe that the Datatrek warning about information asymmetries is correct and that Allison’s concept of the T-Trap is applicable in many forms today, although Allison focuses primarily on the geopolitical realm. Here is Allison as he argues that the US-China relationship is developing as the 17th T-Trap case study. (Remember, he has 500 years of history on his side of the argument.)

“In the seventeenth case, an irresistible rising China is on course to collide with an immovable America. Both Xi Jinping and Donald Trump promise to make their countries ‘great again’. But unless China is willing to moderate its ambitions, or Washington can agree to share primacy in the Pacific, a trade conflict, cyberattack, or accident at sea could be the spark that ignites a major war.”

Note that the moving agendas in relations between North and South Korea, as well as between Japan and the US, are also parts of the huge global realignment underway. All these countries but North Korea have major stock markets.

When we say moving agendas, we need to always be thinking about asymmetric information. Here is an example of what we didn’t know and the North Koreans did know: it may explain Kim’s motivation.

Source: NightWatch. “On 25 April, the South China Morning Post reported that North Korea’s mountain nuclear test site has collapsed. Two separate groups of Chinese geophysical scientists studying the mountain have reached the same conclusion. A research team from the University of Science and Technology of China (USTC) in Hefei concluded that the collapse occurred because of the detonation last September of North Korea’s thermal nuclear warhead in a tunnel about 700 meters (2,296 feet) below the mountain’s peak. According to an analysis posted to the team’s website, the 100-kiloton explosion on 3 September vaporized surrounding rocks and opened a chasm that was up to 200 meters (656 feet) in diameter. A large section of the mountain’s ridge slipped into the pocket created by the blast. The explosion turned the mountain into fragile fragments, the researchers wrote. The USTC team plans to publish its findings in the Geophysical Research Letters of the American Geophysical Union, according to the Post article. Another research team at the Jilin Earthquake Agency of the China Earthquake Administration in Changchun reached similar conclusions to the USTC team. It concluded that the fracture created a “chimney” that could allow radioactive fallout from the blast zone to rise into the air. This team published its findings in the 16 March edition of Geophysical Research Letters of the American Geophysical Union.”

A specific domestic stock market asymmetry is found in the Amazon-Trump squabble. Remember that Jeff Bezos owns the Washington Post and that Trump doesn’t like anyone who is critical of him. Also note that more people use Amazon and vote for it with their pocketbooks every day than voted for Trump (or for Clinton, if that matters). Amazon outpolls Trump with real money bets by its customers.

Here is information asymmetry applied to the stock market. If you knew that President Trump would soon be picking a Twitter fight with Bezos and Amazon, would you front-run the news (or tweet) and sell Amazon? That’s what went down once their fight started. We’ve seen many other examples, too, where Washington politics made news and dramatically changed market prices.

Here’s another info-asymmetry example: If you had had early warning signs that the new tax law bill would have a component that was detrimental to MLPs, would you have bought, held, or sold MLPs? Clearly, the tax bill hurt certain MLPs.

In an era of tariffs, barriers, protectionism, and trade wars, doesn’t this T-Trap scenario (with its component of asymmetrical information) apply to every item in the commercial arena? Isn’t that one of the outcomes of protectionism? Would you buy, sell, or hold if you knew, before a tariff announcement, that your item was going to be mentioned? Remember the trade negotiation with China is underway, right now!

The T-Trap has nothing to do directly with stock markets; it is about lessons from history. It is about imperfect information leading to mistakes and mismanagement of geopolitics. And it is about the assumptions used and decisions taken by nation states and their leaders. What Graham Allison says about the T-Trap and why it is important is best summed up in a remark often (but perhaps incorrectly – see https://quoteinvestigator.com/2014/01/12/history-rhymes) attributed to Mark Twain: “History never repeats itself, but it rhymes.”

Stumbling into a Thucydides’ Trap results in painful time of reckoning — a “day of wrath, that day which will reduce the world to ashes,” if you will permit me an old Latin phrase that comes to mind (Dies irae, dies illa Solvet saeclum in favilla).

There is no evidence that corporate shares existed and traded in the ancient Greece of the Athenian historian Thucydides. There is some evidence that deals occurred with partnerships and similar organizations. The Greek stock market is modern, not ancient.

There is, however, evidence of using money to settle disputes without war and of encouraging commerce over war. There is also evidence that during 30 years of peace following a treaty agreement among the Greek city states, dispute resolution was handled according to agreed-upon procedures. Thucydides includes such references in his chronicle, The Peloponnesian War.

The Delphic Oracle was an early version of an international court. We might think of it as a dispute-resolution system among the Greek city states, playing a role not unlike that of the World Trade Organization today. Early Greece offers a lesson for our trade and tariff disputants. There are benefits of peace over war, as Thucydides carefully chronicles. But, as in ancient times, the benefits of peace are now being placed at risk. (We encourage readers to examine the history of Pythia, the high priestess of the Temple of Apollo.)

Thucydides was not the first historian to chronicle ancient times. But he was the first who did so in human terms. Throughout The Peloponnesian War (I’m using the Martin Hammond translation) Thucydides avoids references to “the gods.” Thucydides wrote about man’s behavior instead. He left the Greek gods out of the story in order to show how people were, how they behaved and made decisions. He quoted them carefully.

In our multipart series we will talk about T-Traps and trade (although we have hit that one hard already). And we will discuss money (gold). We will try to focus on victory versus defeat. And we will offer investment positioning that may have T-Trap conceptual support for its rationale.

Let me segue to some excerpts from Thucydides. Also, please think about our T-Trap theme in the context of today’s world and in the particular context of US-China relations. Try to imagine today’s bilateral discussions reported by Thucydides with non-Greek names like Trump or Xi or Abe or Navarro or Bolton or Kudlow or Mnuchin as replacements for the leaders of Corinth, Sparta, and Athens. Thucydides dealt with Greek city states, but the context today is nation states.

My takeaway is that 2500 years later very little has changed, and history has been proven to rhyme.

Let’s go back 2500 years to an assembly in Sparta. Greek city state allies of the Spartans have gathered for a meeting. Thucydides quotes a speech by a leader from Corinth:

“Spartans, the trust you place in your own constitution and society makes you less trusting of others when we have something to say to you…. Many times we have warned you of the harm we anticipated from the Athenians…. The time is past for debating whether or not there is aggression against us: The question is how to resist it.”

There are Athenians in the assembly who happen to be in Sparta on business. They speak up:

“Our delegation was not sent here to engage in dispute with your allies, but on a separate mission from Athens. Nevertheless we are aware of considerable outcry against us, and we come before you now… to ensure that you are not too readily influenced by your allies into making a wrong decision on matters of great importance.”

After extensive debate involving many in the assembly, the Spartans clear everyone else away and meet among themselves. Many want war at once. Their king, Archidamus, displays patience and experience. He argues that Sparta is not ready for war:

“Spartans, I am old enough myself to be experienced in many wars, and I see some of you here the same age: None of them will share the longing for war felt by most who have never known the reality. Our navy? We are inferior. Our finances? Here we are more deficient. My advice is that we should not yet take up arms. We should look to acquire further allies… we can supplement our naval resources… let us first see to our finances…. We are not schooled in the useless over-intelligence which can make a brilliant verbal attack on the enemies’ plan but fail to match it in consequent action…. It is our principle to make practical plans on the assumption of an intelligent enemy, and not let our hopes reside in the likelihood of his own mistakes, but in the security of our own precautions.”

One of the five magistrates of Sparta (who collectively have more power than the king) takes the other side and calls on the Spartans to vote for immediate war. The resolution to go to war against Athens is deemed the majority view. Thucydides summarizes:

“This resolution of the Spartan Assembly, the treaty [with Athens and other city states], which had been broken [by Athens] was made in the fourteenth year of the duration of the Thirty Years Treaty.”

Thucydides’ analysis is critically important:

“In voting for war on the grounds of breach of the treaty the Spartans were not so much influenced by their allies as by their fear of increasing Athenian power.”

One element of T-Trap behavior is fear. Thucydides demonstrates this reality repeatedly.

The other two key elements are state interests (what is in the interests of the states and of their leaders?) and honor. “National interests are plain enough,” says Graham Allison. “The survival of the state and its sovereignty in making decisions in its domain free from coercion from others are standard fare in discussion of national security.” Allison warns about maintaining “objectivity” and about the flaws of emotional behavior and acting on misperceptions.

The last pillar is honor. Allison notes: “To many modern ears the word sounds pretentious. But Thucydides’ concept encompasses what we now think of as a state’s sense of itself, its convictions about the recognition and respect it is due, and its pride.” Wow – the danger of appealing to pride as a political motivator.

Fear, interests, honor. Those are the operative three prongs of T-Traps.

Allison concludes that, “Ultimately, the leaders of Athens and Sparta were overwhelmed by their own domestic politics. Pericles and Archidamus understood the insight about the inherent weakness of the leader.” (Can this insight be applied to a US president? Is it is true for all US presidents?) That weakness, too, is part of the foundation of the T-Trap. We add that not having full information (the risk of asymmetry) exacerbates that weakness.

So are stock markets dealing with the risks of T-Traps? We believe the answer is yes. Is the US-China trade skirmish the beginning of a new cold war? That is the suggestion from BCA Research. Does the skirmish have global implications? Yes, says George Friedman. His book “Flashpoints, The Emerging Crisis in Europe” needs to be read in conjunction with Graham Allison’s.

In the next parts of this commentary we will discuss money and investments when T-Trap risks are rising.

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 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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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Global Economy Strengthening with Upside and Downside Risks Broadly Balanced

Last week the Spring Meetings of the International Monetary Fund (IMF) and the World Bank brought together in Washington the world’s finance ministers, central bankers, financial experts and economists, other government officials, and invited representatives from the private sector, academia, and civil society organizations. A central issue for discussion at these meetings is the outlook for the global economy, based on the projections and analyses of the IMF. The economic projections and the views reportedly expressed by participants were largely encouraging for investors; but risks in the outlook, particularly for the medium-term years following 2019, rightly received a lot of attention.

The IMF is projecting world economic growth for both this year and 2019 at 3.9%, somewhat higher than the already robust 2017 pace of 3.8%. Growth was particularly strong in the closing half of 2017, with upside surprises for advanced, emerging-market, and developing economies alike. In the advanced economies the acceleration was due largely to stronger investment spending, whereas for emerging-market and developing economies the main boost came from private consumption. Also, a rebound in trade was particularly helpful for Asian economies. A recovery in commodity prices was due primarily to rising prices for oil and natural gas and was thus a strong positive for exporters of those commodities.

The global economy appears to have lost some momentum in the first quarter of this year. The J.P.Morgan Global Manufacturing and Services Purchasing Managers Index (PMI), published by IHS Markit Ltd., indicates that global growth slowed to a 16-month low in March. The average reading for the quarter was the best since 2014, due to the strong beginning of the quarter. The global pullback in March was notable in the Eurozone Composite PMI (manufacturing plus services), where the numbers were the weakest since the start of 2017. Unusually cold weather was a factor, but fears were expressed that Europe and even the global economy may be headed for a slowdown. A decline in new export orders in Japan as the stronger yen began to affect exports, along with sluggish household spending in the US, contributed to those fears. Economic growth in both the euro area and the US appears to have slowed to less than 2% in the first quarter, compared to fourth-quarter 2017 rates of 2.9% and 2.4%, respectively. Japan’s economic growth was very low and risks being negative for the first quarter.

While there are risks, our base forecast anticipates that the first quarter’s weakness will prove to be short-lived. The IMF does not provide quarterly projections, but their strong annual forecast implies this. Most early indicators are consistent with some acceleration of economic activity. The Markit Flash US PMI for April indicates faster growth for both manufacturing and service sector firms. New order growth is the strongest since March 2015. The Nikkei Flash Japan Manufacturing PMI for April revealed stronger growth in output, new orders, and employment, along with improved business confidence. The Markit Flash Eurozone PMI for April was less positive, unchanged from the March pace, showing solid growth but continuing to be weaker than it had been earlier in the year. Demand has weakened, and supply chain constraints remain widespread. The rate of employment growth has risen, however. Another positive signal is the solid private sector growth in Germany after it eased in March to an eight-month low.

The strong expansion projected for the global economy in 2018 and 2019 includes growth by the advanced economies of 2.5% this year, easing back to the 2017 rate of 2.2% in 2019. Central to these projections is the expectation that the world’s largest economy, that of the US, will advance by 2.9% this year and 2.7% in 2019. The expected macroeconomic impact of the December 2017 tax reform, particularly the lower corporate tax rate and the temporary full expensing of investment, together with increased government spending, will begin to be felt in the second quarter and emerges as a powerful fiscal stimulus in the remainder of the year and in 2019. The temporary nature of some provisions will have a negative effect further ahead, beginning in 2022.

Economic growth for the Eurozone is also projected to be above trend, 2.4% this year and 2.0% in 2019, supported by continued monetary stimulus, improving labor markets, and healthy external demand. Domestic demand also is expected to remain robust. The problem of capacity constraints together with high corporate profitability should encourage business investment and job creation.

The Japanese economy is projected by the IMF to moderate from its strong above-trend growth of 1.7% last year to a still above-trend 1.2% this year and then further, to 0.9%, in 2019. Our projections are somewhat stronger, 1.5% for this year and 1.1% for 2019, but the trend is the same. The continued strength of the Japanese yen is hurting exports and export profitability. Political uncertainty in Japan is high, with the future of Prime Minister Abe and his economic policies currently at risk. Japan, like many other countries, also faces the risk of a growing protectionist trend that would impact global trade.

Emerging-market and developing economies as a group are projected to experience buoyant growth at rates of 4.9% this year and 5.1% in 2019, up slightly from 4.8% growth last year. The largest Asian economies are central to these estimates, with China’s growth moderating from 6.9% last year to 6.6% this year and 6.4% in 2019, and India’s growth accelerating from 6.7% last year to 7.4% this year and 7.8% in 2019. China will continue to rebalance its economy from investment and industry toward private consumption and services. In India the transitory effects of the currency exchange and the imposition of the national goods and service tax will diminish while private consumption is expected to be robust. Economic activity accelerated in March, signaling stabilization after weaker performance earlier in the year. Both China and India also face great uncertainty about future trade relations.

Latin American and Caribbean emerging and developing economies are projected to continue a gradual economic growth recovery from the effects of the fall in commodity prices during 2014–16. Following last year’s 1.3% advance, growth in 2018 is projected at 2.0% and in 2019 at 2.8%. Brazil’s recovery from a deep recession and its significant structural reforms program are central to the region’s projected improved performance.

The IMF cites a number of risks to their optimistic outlook for the next two years, risks that are more concerning for the medium term (2020 and beyond), including geopolitical strains, a sudden and severe tightening of monetary policies, waning popular support for global economic integration, and a move toward protectionist trade policies that would impact global trade. The latter issue was debated at the annual Spring Meetings, with many participants stating that the growing number of trade disputes, if not resolved, could deteriorate into tit-for-tat imposition of trade barriers that would derail the global economy. US Treasury Secretary Mnuchin complained about persistent trade surpluses and stated that “We urge the IMF to speak out more forcefully on the issue of external imbalances, including by providing clear policy recommendations for countries with large surpluses, in support of more balanced global growth.”

We have stated our concerns about the current administration’s rejection of multilateral approaches to trade issues. Trump’s rejection of a possible return to the Trans Pacific Partnership (TPP) on the eve of Japan’s Prime Minister Abe’e recent visit was a lost opportunity to strengthen US trade relations in the Asia Pacific region and to open markets for US firms and farmers. The jury is out on whether Trump’s unilateral threats of tariffs will result in successful trade negotiations. There have been some promising signals, which have reduced investor concerns. Clearly, failure would have serious implications for the global economy and financial markets.

Our International and Global Portfolios are fully invested.

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


Sources: International Monetary Fund, Barclay’s Economic Research, Financial Times, IHS Markit Ltd, Bloomberg.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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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Marcus Island

An isolated Pacific island barely big enough to accommodate an airstrip has gained global importance (see photo: https://en.wikipedia.org/wiki/File:Marcus_Island_DF-ST-87-08298.JPEG). Some 787 miles east of South Iwo Jima, Marcus Island, or as the Japanese call it, Minami-Tori-shima, meaning “Southern Bird Island,” is the southernmost island under Japanese governance and within the Japanese economic security zone. In its history (detailed on Wikipedia at https://en.wikipedia.org/wiki/Minami-Tori-shima) Marcus Island has been under American sovereignty and governance and Japanese sovereignty and governance.

So why is this fleck of land in the vast Pacific now so important?


Marcus Island
 

The answer is compelling: Japanese researchers have discovered huge deposits of rare earths in the seafloor surrounding Marcus Island. One recently released scientific estimate suggests that the 1000 square miles of mud in the area contains “such a high concentration of certain rare-earth elements (REE) that it could meet the world’s REE demand for almost a millennium.” This is a monster upward revision to the initial estimates.

Initial indications were that about half a century’s worth of global demand of REE could be met from this mud. That was big news to start with. (A lot depends on which chemistry techniques researchers use to determine the estimate.) The original studies we saw were confirmed by research teams from Waseda University, (https://www.waseda.jp/top/en), a school not particularly well-known in the West but a top Japanese university.

The island is now recognized to have strategic importance far beyond historical expectations. Note that there are very few proven deposits of rare earths in the world: China is currently a major global supplier; another is the Republic of Congo, which is an unstable source.

The key issue here for Japan is to be able to develop the mining operation within the Japanese economic zone. You had better believe that REE was a discussion topic at Mar-a-Lago and that the security of the region was on the table. Shinzo and Donald may have enjoyed their golfing rounds, but the REE deposits that make Japan the Saudi Arabia of REE had to be a big part of the conversation.

Note how quickly Donald said that, to get the trade balance right, the Japanese could buy more American weapons. They are doing so. And also note how the relationship has been positively intensified – as it should be, in our view.

The Japanese have had to live with a pacifist constitutional defense limit that was imposed by Douglas MacArthur after World War II. In fact, the draft of the Japanese constitution was written first in English and then translated into Japanese. The Japanese had surrendered, and General MacArthur imposed the conditions. His scriveners did the rest.

So Japan now finds itself limited on expenditures for defense needs that are being continually stretched, while Japanese politics run their course and may eventually lead to a constitutional change. The change would likely have already happened had the prime minister not become embroiled in a scandal over a land deal for a school with which his wife was involved. Meanwhile, his government has experienced resignations stemming from sex scandals. His political opposition senses his weakness and may deny him a third term.

All that said, the underlying trend of expanding Japanese self-defense activities continues and is encouraged by the United States. Now we see a new, overt act as added confirmation. Japan has launched a 2100-person “Amphibious Rapid Deployment Brigade.” It is the first such force publicly unleashed since World War II, according to a report by Geopolitical Futures (April 11, 2018). See https://geopoliticalfutures.com.

That force is stationed at Sasebo, which also happens to be the base for the USS Wasp amphibious assault ship. The combination of the two Sasebo-based forces is designed to defend and protect the southernmost Japanese islands. Sasebo is a major base in the defense of Minami Torishima. (Japan comprises an array of 6852 islands, only four of which are large.)

Meanwhile trade-war rhetoric continues between the US and China, while the East China Sea and South China Sea grow more and more significant in the geopolitical realm. Japan remains a close and reliable ally of the US, and its importance is growing once again.

Detente with North Korea may ease pressure on Japan. The North Korea–South Korea dance is fascinating, as the US orchestrates via stormy (tongue-in-cheek allusion intended) tweeted diplomacy. My how the language of the tweets has recently changed!

Markets do not expect peace to break out. The recent political changes are not priced in; notwithstanding that they are very positive. The chances of a successful Trump peace initiative are remote and have been mostly overwhelmed by Trumpian bellicosity.

But maybe, just maybe, the Trump haters will have to deal with a peace initiative. What will they do? Maybe, just maybe, the Trump lovers will no longer be able to indulge in belligerence directed at North Korea. What will then energize them?

Maybe just maybe, the midterm elections will produce a surprise outcome. If so, what will markets do?

For markets, uncertainty premia are high. But will tax reform, fiscal front-loaded stimulus, and repatriation overcome the obstacle of the Fed’s gradual tightening and Trump’s trade-war rhetoric? We shall see.

We remain nearly fully invested. We like the Energy sector and continue our overweight position. And we still like the banks as a group, notwithstanding the substantial fines being paid by those that have misbehaved. We also favor the smaller and middle caps, as we have done for months.

We don’t yet know how to play a rare earths mining revolution in Japan by means of an ETF. There, our exposure is limited. Jeff Usher has contributed some single stock suggestions in his newsletter, Japan Insider (https://www.japan-insider.com). Jeff offers excellent coverage of Japan, its politics, and its markets.

We do know that the rare earths story is a strategic market positive for Japan and for the United States.

Stay tuned.

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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Global Dialogue & Exchange of Divergent Perspectives: The Rocky Mountain Economic Summit

Leo Chen, Ph.D., Portfolio Manager & Quantitative Strategist for Cumberland Advisors, will join me to speak on July 12th for an annual gathering of economists, bankers, academics, and finance industry representatives known as the Rocky Mountain Economic Summit. If you missed Dr. Chen’s recent commentary on the VIX and volatility in the market, you can still read it online here or around the web; it’s been getting a bit of press this week: The VIX and the S&P 500-An Equity Market Duet

If you’d like to know more about Leo, there is a link to his bio at the bottom of the commentary.

The Global Interdependence Center and The Bronze Buffalo Foundation are the hosts for this year’s Rocky Mountain Economic Summit. We’ll be meeting in Victor, Idaho, just outside of Jackson Hole, Wyoming, at the Teton Springs Lodge & Spa. This is the tenth annual Rocky Mountain summit which will bring together economists and entrepreneurs from around the country to discuss issues and opportunities relating to the global economy. We just held an equally impressive gathering in Florida for our Financial Literacy Day that included president and CEO of the Federal Reserve Bank of Atlanta, Raphael Bostic. Join us in Wyoming for another top caliber event that continues the Global Interdependence Center’s work in promoting global dialogue and the exchange of divergent perspectives. Seating is limited, so please check GIC’s website for availability.

Patrick Harker, President and CEO of the Federal Reserve Bank of Philadelphia, will deliver a keynote address this time and attendees can ask specific questions of Harker or other speakers. We have just posted Raphael Bostic’s talk during Financial Literacy Day at USFSM on the Cumberland Advisors website, so you can read a transcript of my talk with him or watch the video version here: www.cumber.com/financial-literacy-day
David Kotok & Raphael Bostic

If you missed it, I suggest you read our recent missive, Lunch In Punta Gorda. Nine people in total met in a private room for lunch in Punta Gorda, Florida with Martin Barnes as the organizer. We discussed The Fed, politics, the bull market, trade and trade wars, gold, banking, and more. Danny Blanchflower seeded the idea, and we were joined Tim Dalton, Ned Davis, Bob Eisenbeis, Jeff Saut, and a certain ancient one (who must remain anonymous) but who calls himself “economist 63,” and another one who calls himself the “Swiss Gnome.” We published our takeaways, being candid and careful about attributions.

A full list of speakers and the agenda for the Rocky Mountain Economic Summit can be found at GIC’s website and GIC Members are invited to stay for the private Roundtable Discussion on Friday morning, July 13th. This meeting will be held under the Chatham House Rule, so expect candid opinions and economic, social and political issues discussed in depth.

Please join us.

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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Some Thoughts About The Stock Market

We thought we would list a few things for readers to think about when contemplating the US stock market.

1. The first is a brilliant research observation from Morgan Stanley’s Andrew Sheets, who writes from London:

“The result can materially boost the income a USD investor receives if they buy overseas assets and remove the currency exposure: the hedged carry on a 10-year German Bund for a US investor is ~3.5%, not that 0.5% yield one sees on the screen. The hedged carry on Swiss equities is 7.0%. Who says there’s no yield?”

2. Adam Johnson of Bullseye Brief ( www.Bullseyebrief.com ) phrased the investor’s dilemma well:

“Let markets plummet 3–4% overnight as CNN pundits react to NYT text alerts… Wait for strategists to downgrade S&P targets… Sit tight as oil approaches $70… Then buy five favorite names, the ones which have no business being down 8%, and/or write out of the money puts struck another 15% lower to capture vol blow outs. Three days later, markets have rebounded and our accounts are a little fatter. Got it?”

3. Lindsey, a brilliant Cumberland reader, sent this note:

“It seems that the scale for measuring periods of market calmness is at best one day now. In thermodynamics terms we are in a state of high entropy requiring a release of energy (i.e., volatility), and thus spontaneous reaction occurs to maintain equilibrium. Things start to unwind when enthalpy goes to a negative condition in which no level of chaos (entropy) can maintain equilibrium. How far things drop depends on the amount of energy needed to be extracted to arrive at a level in which equilibrium can be maintained. Have we arrived at the max free energy? If I could answer that I wouldn’t be sitting here babbling away.”

4. Michael Cembalest enlisted a marvelous metaphor in his Annual Energy Paper from JP Morgan Asset Management:

“That’s why ‘Pascal’s Wager’ comes to mind. According to the French philosopher, if you believe in God and he does not exist, you experience a ‘finite loss’. But if you do not believe in God and he does exist, you experience ‘infinite loss’. Consider the following theories. Greenhouse gas emissions impact temperatures, which in turn impact sea level rise. And/or efforts to substantially decarbonize via wind and solar power will fall short of climate-related goals….”

Cembalest concludes:

“Maybe that’s right, and maybe it isn’t. However, the infinite loss case (you don’t believe the theories are true) is much worse than the finite loss case (theories are wrong but you prepare anyway). As a result, after looking at electric vehicles and other renewable energy topics this year, we also examine flood mitigation projects in coastal cities, which may be needed just in case. We conclude with thoughts on the intersection between food, energy, urbanization and proposed changes in the US Electoral College: maybe drafters of the US Constitution had more foresight than they’re being given credit for.”

(Kotok personal note: The 35-page Cembalest paper is a magnificent assemblage of thinking about energy-related investment issues.)

5. Ian Bremmer (@ianbremmer) offered a list to contemplate (hat tip to Dennis Gartman):

“[The] market return for the first 444 days in office: FDR: 70.4%, Reagan: 41.4%, Teddy Roosevelt: 37.4%, Obama: 32.5%,Clinton: 32.2%, George Bush Sr: 21.4%, Trump 20.7%. Sources Bloomberg/Axios.

Dennis notes:

“We shall not scoff at 20+% returns, for that would be illogical, but this is winning by beating only the negative returns that accrued to those investing in equities in Mr. Carter’s or Mr. Ford’s first years in office. If ‘winning’ is coming in 6th… well we’ve said enough, haven’t we?”

6. Credit Suisse offered that the US equity market is “53% of the global stock market” as of the end of 2016. They noted how the number of listed companies has been shrinking (7322 in 1996, down to 3671 at the end of 2016). Note that the number was 4796 in 1976. That’s right. And further, says Credit Suisse, “The Wilshire 5000 Total Market Index, established in the mid-1970s to capture 5000 or so stocks with readily available price data, now has only 3816 stocks.” The Credit Suisse research paper (The Incredible Shrinking Universe of Stocks, March 22) is packed with citations of serious research and data. Congratulations to Michael Mauboussin, Dan Callahan, and Darius Majd for this superb analysis.

Some closing takeaways.

If the number of stocks is a shrinking universe & if the nominal GDP of the US is rising (from $12 trillion in 1996 to $19 trillion in 2016 in constant 2016 dollar terms) & if the taxation of those companies has improved their outlook (via last year’s tax reform act) & if the number of passive holders of those stocks is rising (there were two ETFs in 1996 compared to 658 in 2016, and there was under $2 trillion in mutual funds in 1996 compared to almost $9 trillion in 2016) & if corporate profits as a % of GDP are now much higher & if, if, if… then we have an explanation for a strong upward trend in stock prices. It is a strategic trend.

Credit Suisse estimates that the “listing gap” between the US stock market and the rest of the world is about 5800 companies. They cite research that suggests the US “should have MORE THAN 9500 LISTINGS.” The paper also describes reasons why companies delist and why there is a shrinking “propensity to list.”

Cumberland’s position:

We remain nearly fully invested in our US ETF portfolios. We are sticking with our estimate that the S&P 500 index will cross 3000 around the decade’s end (in 2–3 years.) We like the Energy sector and we like the Financials (banks). We think that “machine learning” AKA “artificial intelligence” is a powerful force that will raise US productivity and accelerate America’s GDP growth without inflationary pressures, provided the inflation rate is properly measured and hedonically adjusted.

We must remind our readers (our clients already know these details) that all of this could change on very short notice, or it could persist for years. The present chaos of political governance makes for unpredictable outcomes. And the world is a dangerous place. That complexity and risk makes our daily work demanding and never boring.

In a speech in Cape Town in June 1966, Robert Kennedy said: “There is a Chinese curse which says ‘May he live in interesting times.’ Like it or not we live in interesting times. They are times of danger and uncertainty; but they are also more open to the creative energy of men than any other time in history.”

Quote Investigator offers some history regarding this quote about interesting times. See: https://quoteinvestigator.com/2015/12/18/live/. It may not have originally had a Chinese attribution. However, given the world today and US-China relations, we like the sourcing and the reference to Chinese philosophy, proper or not. In our view, Robert Kennedy was prescient.

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.

Sign up for our FREE Cumberland Market Commentaries

Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.