After breaking out to fresh new highs last week, the Aussie market is set to fall sharply today. The reason? US President Trump said he would impose tariffs on all steel and aluminium shipped into the US from Brazil and Argentina.
In Trump’s own words, via Twitter:
‘Brazil and Argentina have been presiding over a massive devaluation of their currencies, which is not good for our farmers. Therefore effective immediately, I will restore the Tariffs on all Steel and Aluminium that is shipped into the US from those countries.
‘The Federal Reserve should likewise act so that countries, of which there are many, no longer take advantage of our strong dollar by further devaluing their currencies. This makes it very hard for our manufacturers and farmers to fairly export their goods. Lower Rates and Loosen — Fed!’
This pretty much encapsulates Trump’s economic policy. He’s trying to bring back trade related jobs to the US. To do so, he needs a competitive currency.
But with the US competing against economic basket cases and socialists (Europe) and communists (China), capital is going to flow into the greenback, isn’t it?
To see what I mean, take a look at the US dollar index. It shows the performance of the US dollar against its major trading partners. As you can see, the dollar bottomed in early 2018 and has been in a bull market ever since.
That’s a reflection of global capital flowing into the US. It’s the strongest economy in the world.
The problem for Trump is that a strong dollar is not helping him boost exports. It’s making a range of industries uncompetitive with the rest of the world. Hence his constant pressure on the Fed to loosen interest rates. He wants a weakened dollar, and damn the consequences.
That’s why Trump uses tariffs as an economic weapon. Tariffs are a way of evening out the playing field when you can’t manipulate your currency.
Trump’s economic policy has some major big picture implications.
The whole structure of the post-war global economy developed from the US being a consumer of last resort. The US consumed Europe and Japan’s exports, making those economies highly productive.
Now it consumes China’s exports.
To pay for these exports, the US issues debt. This debt finds its way into foreign central banks. Because the US dollar is the world’s reserve currency, this debt becomes a reserve asset in foreign banking systems. It allows for the creation of more credit.
US trade deficits then, are a mechanism to create liquidity for the global economy.
That’s not going to end anytime soon, mind you. The US trade deficit is structural. It’s running at around $200 billion per annum.
But Trump wants to reduce it by increasing the US’ export competitiveness. That’s a longer-term project. But his determination to use tariffs to even the playing field tells you he is serious about achieving it.
Don’t be too bearish on the Stock Market just yet…
Shorter term though, let’s take a look at the markets…
They have been on a tear this year. But they’re again stretched. We could be in for a decent correction here.
Let’s take a look at the S&P 500 first…
It broke out to new highs in late October. It’s been a bullish move. But it wouldn’t surprise me to see a correction take the index back to around the breakout point. That would be a retrace of approximately 4.5%.
That’s hardly a major correction. If support came in at that level, the upward trend would remain intact and the market would still be in a bullish position.
What about the Aussie market?
Here is a chart of the All Ordinaries…
It broke out to a new all-time high last Wednesday. The move lagged the US by over a month. Now, it looks like its falling sharply, and therefore potentially rejecting that move.
That could set us up for another sharp correction like we saw in early August. While it felt nasty at the time, it’s important to note that it didn’t result in a change of trend for the overall market.
I use 50- and 100-day moving averages to give me a sense of the medium-term trend. When they cross to the downside, it indicates that the trend could be in the process of changing.
That hasn’t happened since October last year.
So it’s important to keep in mind, if the stock market corrects in the days and weeks ahead, that the overall trend is more important than the daily price moves.
With the US Federal Reserve back pumping money into financial markets (but it’s not QE) and the RBA threatening QE, stocks are likely to remain supported on any decent pullback.
So don’t become too bearish until you see more definitive signs that the trend of the market is changing.
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