Sentiment May Be Bullish, But Weakening Fundamentals Mark The Turn

The divergence between the stock market and the underlying economy has gotten ridiculous. While most of the productive economic indicators are falling, the stock market keeps rallying after each correction. The market does not pay attention to fundamentals anymore and is largely driven by popular opinion, aka sentiment.

The schizophrenic stock market is primarily driven by two major supporting factors: resumption of Fed monetary easing and the completion of a trade deal between China and the US.

The problem now is that neither is likely to happen in the short run. I do think the Fed will eventually be forced to resume QE-type policies in an attempt to stave off a deflationary recession. But I don’t think China is going to agree to what the US considers a fair trade deal anytime in the near future.

Trade Wars Have Casualties Too

The latest on the trade front has China reneging on verbal agreements on trade by changing key provisions during review of the written documents. The result of this action by China caused Trump to implement billions more of tariffs on Chinese goods.

China has responded by increasing tariffs on US goods into China. The reality is that China has historically had higher tariff rates on US goods, but the additional trade pressure will slow down the ability of US companies to do business in China.

The trade war has only escalated after recent talks. There is a business and a cultural reason for China’s actions. China does not respond well to the blustery dialogue Trump is famous for using in his US real estate dealings. They are a culture that requires mutual respect, and not excessive use of threats when completing negotiations. Trump’s approach has backfired in these negotiations. However, the current administration is not fully to blame for China’s about-face in negotiations, which is much too simplistic of an explanation.

China needs US dollars from trade to finance their industrial sector. China is at the same time trying to advance their economy beyond industrial production and into services and technology to compete in the global markets. The plan is to build their middle class and increase the average wages of their people. At the same time, China is in the process of aligning with Russia, the Middle East, and Europe in their Belt & Road trade initiative.

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