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US Trade Deficit

source: tradingeconomics.com Largest deficit since October of 2008 as exports declined for the third month and imports recovered

Weak US manufacturing PMI

source: tradingeconomics.com

Lowest expansion in factory activity since August 2017

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Meanwhile the global economy is deflating, and the S&P 500 is rallying, these two things don't mix well together. When the economy deflates the stock market plunges.  

 

Investors hope the US and China will agree a trade deal. Any rally caused by government stimulus/deals will fade and the stock market will decline to new lows. The difficult bit is knowing when the decline will resume. These government interventions can support the market for longer than you expect.  

 

Inflation is falling which is in line with the start of deflation, I expect prices to fall in the months ahead, prices of goods, services and asset prices. Right now some people are talking about a possible recession in the US. It will take months before the recession starts and months before the depression starts.  

 

The dollar will continue to decline, which means gold and GBP/USD will continue to rally. At the end of the depression a new crisis will emerge, the dollar collapse. The economic crisis will have taken its toll on the dollar, this will probably prompt a run on the dollar and this will precipitate a collapse in bond prices. The result will be inflation and possibly hyperinflation. The dollar will lose purchasing power, the stock market will be considerably lower, it could take ten or fifteen years before the stock market reaches the bottom.

 

This won't happen in a straight line, governments will intervene along the way, in the process they will create some huge rallies like the current one. As you can see there is no hurry to short the market, what I have learned from previous bear markets is that you want to sell high, as high as possible, because there are always some huge rallies caused by government intervention.  

 

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Deflation is coming

The Fed has often said that inflation is low and many analysts are puzzled. Why is inflation so low after a massive money printing program by the Fed? The Fed has been worried by deflation since the last financial crisis, the purpose of QE was to create inflation, to boost asset prices and to create wealth and spending. The world economy is in the midst of a depression, this depression has been hidden by the Fed. If prices are falling by 3% and you create 5% inflation, real inflation is 2% which is where we are now.

Now the Fed is no longer doing QE, one would expect inflation to fall sharply. Indeed the depression is still underway, but the Fed is no longer creating inflation, this is why we see a global slowdown. China has been badly affected, what happens in China will spread to other countries. Analysts are now concerned deflation is taking roots in China after producer price inflation slowed sharply in December. In a deflationary environment prices fall including asset prices. The Chinese stock market has already collapsed, house prices are going down and commodity prices are declining. The same scenario will soon happen in the US, this is why the dollar is going down. 

Trump thinks the US can avoid a hard landing by doing a trade deal with China and the Fed thinks the economy is on track to perform well if they stop raising interest rates. But this won't change anything, the bear market and the depression were due long before Trump came to power, long before the trade war started and at a time when interest rates were at zero percent. A trade deal with China won't change anything, and lowering interest rates won't do much to the economy as they are already low. I remember in the 1990s when rates were near 10% and the economy was doing fine. If today the economy is struggling with low rates there is a problem.

We are in a global system where problems in a major economy spread to next major economy. Once the deflation process starts it is difficult to stop it. No wonder Trump is desperate to boost the stock market. Rising asset prices help inflation, this is the same story, we are told that if asset prices rise, not only inflation will go up but people will spend more as a result of increasing wealth. This has been tested with QE, I am afraid it has not worked. Deflation will come and the stock market will collapse. Trump and the Fed will do everything possible to boost the markets, but they will fail. There could be more upside in the short term, the re-opening of US government will help, but in the long term it's going down.

Sharp increase in producer price index

source: tradingeconomics.com

Producer prices for final demand in the US rose by 0.6 percent in October 2018, following a 0.2 percent advance in September and easily beating market expectations of 0.2 percent. This is bad news for the stock market. First the increase in the PPI is linked to rising inflation, we saw a rally in the dollar and a sharp decline in gold after the publication of the data. While the US economy is growing at a moderate pace, higher inflation will translate into higher interest rates / higher bond yields. Already the stock market reacted negatively to the 10Y yields at 3.20%, a move above that level would prompt investors to sell stocks. Other area of the economy will suffer too, we can expect lower activity in the real estate market as mortgage rate will rise. If interest rates go up consumers will spend less, this will affect the retail and auto sectors.

Labour cost in the U.S. is going up

source: tradingeconomics.com

 

Unit labour cost increased at an annualized 1.2% in the third quarter of 2018. The forecast was for an increase of 1%. The trend has been rising steadily since 2016, it is a leading indicator of inflation. This together with rising prices as a result of tariffs on imported products and a sharp increase in the money supply will cause the dollar to rally. Right now the dollar is going down, a simple pullback in the uptrend. Based on this information we could see a larger than expected rise in average hourly earnings today when the job report is released. This would boost the dollar.

UK consumer price inflation at 6-month high

source: tradingeconomics.com