Trade War 2.0

The week started with a debt downgrade and ended with a resumption of the trade war. In between, retail stock gamblers were buying the bond market meltdown with both hands. Therefore in this Idiocracy, it falls on us to consider, "what could go wrong?":

“Retail has learned the hard way, getting left behind during previous stocks recoveries supported by policy puts”

The buying extends a weeks-long streak of aggressive purchases of US stocks by small investors, who snapped up equities at a record pace"

The moral hazard caused by past Fed bailouts has led to an unquestioned faith in buying every dip.

However, in order to believe that this particular dip buying spree was profitable, one must presume that these same gamblers were short at the top or sitting in cash back in February when the trade war started. Because otherwise they are STILL underwater from the first round of trade war:

Step back for a moment to consider recent events: Back on April 8th Trump "paused" his reciprocal tariffs that had caused the global market crash, for 90 days. This allowed him to focus exclusively on his trade war with China. Last week (May 12th) he reached a (90 day) truce with China at a 30% tariff rate. This week, his tax cut bill finally passed the House and the next day he launched a new trade war on Europe. Coincidence? I think not. Meanwhile, how many days have elapsed since the global truce began? 45 days. In other words, Trump reneged on his 90 day pause agreement. A clear sign that his truces are meaningless. They are market manipulation gimmicks and bulls got sucked in.

Nevertheless, I believe that a pattern is emerging from these trade negotiations, which is a major escalation followed by market crash, followed by major de-escalation. The end result is a tariff level in the 25-30% range. In other words, I believe that 25-30% is Trump's overall target for this trade war. Currently we have auto tariffs at 25% and China tariffs at 30%. Unfortunately, at that level this trade war will not be adequate incentive to reshore production to the U.S. since Asian manufacturing is far more efficient than U.S. manufacturing. Case in point Apple - This week Trump threatened a 25% tariff on iphones - there's that number again - but even at that level Apple is far better off keeping production in China. An iPhone made in the U.S. is estimated to cost 300% more.

All of which is bad news for Korea and Japan and the rest of the world because those are the next countries that will be targeted for the escalation rollercoaster ride once this pump and dump ends for Europe.

Which gets us back to the casino, unfortunately markets were no way pricing in a resumption of the trade war HALF WAY through the 90 day pause. Recently, bullish pundits had been tripping over themselves to re-upgrade target stock prices and otherwise recommend over-allocation to risk ahead of the tax cut.

Which means that no one is positioned for what comes next week. On Twitter I said that a 1987 style crash is highly possible this coming week. I think that would be the best case scenario for bulls - a massive one day crash followed by a Fed bailout. The worst case scenario is another big slide lower and a resumed bear market that lasts weeks and takes the market to a new low. And the whole time the Fed will continue to be sidelined by the trade war threat of inflation.

In the chart below we see that in round 1, Tech was down 7 weeks in a row.

Regardless of how this plays out - fast or slow, just remember that "no one saw it coming".

Why? Because they ALL took Trump at his word.

Not Me.