Sometimes the logic of the financial markets eludes me

[Irvrobinson]

So President Trump surprises everyone and announces a 10% tariff on $300 billion dollars in Chinese imports to the US. The total cost of this latest tariff is about $30 billion per year to the entire US economy, and the US GDP is over $19 trillion per year. Today in response to this tariff the NYSE and NASDAQ markets were down 2.9% and 3.47% respectively. Since these are composite index calculations, let's make it simple and say that these markets on average went down 3%. Roughly speaking, the total market capitalizations of the listed companies on the two exchanges are (were) something like $32 trillion. So... 3% of $32 trillion dollars is just under $1 trillion, or over 30:1 on the tariff values. I understand that many investors consider this additional tariff and the Chinese response (weakened yuan and eliminating food imports from the US) might indicate a longer term trade war, but talk about a ridiculous snowball effect. And the markets are probably going substantially lower tomorrow (at the time of this posting, according to the futures markets), and I'm not counting non-US market losses, so by end of trading tomorrow it's entirely possible that worldwide market capitalization losses will easily exceed $2 trillion. And why are the markets projected to close lower tomorrow? Because now the market analysts are worried that China will start dumping the $1.1 trillion they hold in US Treasury bonds.

The Chinese debt dumping worry eludes me too. To put this into perspective, the US national debt is currently $14 trillion dollars, and the we're currently running an annual deficit of about $1T. So the Chinese holdings are not all that huge, but it probably would lower treasury bond prices considerably if they dumped a lot quickly, which effectively raises the interest rate the US pays on the portion of the debt that needs refinancing or new bonds issued. On the other hand, the interest on the Chinese bonds represents about $20B in annual income (assuming a mix of 10yr and 20yr bonds, I've assumed an average interest rate of 1.8%). Of course, where else will the Chinese stash the cash? In EU bonds? (I'd guess the only other AAA-rated market big enough to stash $1.1T in.). The EU pays mostly negative interest rates (yes, you pay them to hold your money), though a 30 year bond pays about 0.2%. And if the Chinese dump $1.1T of US bonds in a short time they'd lose their financial shirts on the selling price drop. It would be a relatively large loss of wealth to China. I'm concluding this would be a big price to pay just to kick Trump in the butt over $30B in tariffs, and they're unlikely to dump the bulk of their US debt holdings. (Not that I don't understand the sentiment; I get pretty annoyed by Mr. Trump too on occasion.)

So what in the name of everything that's logical am I missing?

 

[shadyJ]

So President Trump surprises everyone and announces a 10% tariff on $300 billion dollars in Chinese imports to the US. The total cost of this latest tariff is about $30 billion per year to the entire US economy, and the US GDP is over $19 trillion per year. Today in response to this tariff the NYSE and NASDAQ markets were down 2.9% and 3.47% respectively. Since these are composite index calculations, let's make it simple and say that these markets on average went down 3%. Roughly speaking, the total market capitalizations of the listed companies on the two exchanges are (were) something like $32 trillion. So... 3% of $32 trillion dollars is just under $1 trillion, or over 30:1 on the tariff values. I understand that many investors consider this additional tariff and the Chinese response (weakened yuan and eliminating food imports from the US) might indicate a longer term trade war, but talk about a ridiculous snowball effect. And the markets are probably going substantially lower tomorrow (at the time of this posting, according to the futures markets), and I'm not counting non-US market losses, so by end of trading tomorrow it's entirely possible that worldwide market capitalization losses will easily exceed $2 trillion. And why are the markets projected to close lower tomorrow? Because now the market analysts are worried that China will start dumping the $1.1 trillion they hold in US Treasury bonds.

The Chinese debt dumping worry eludes me too. To put this into perspective, the US national debt is currently $14 trillion dollars, and the we're currently running an annual deficit of about $1T. So the Chinese holdings are not all that huge, but it probably would lower treasury bond prices considerably if they dumped a lot quickly, which effectively raises the interest rate the US pays on the portion of the debt that needs refinancing or new bonds issued. On the other hand, the interest on the Chinese bonds represents about $20B in annual income (assuming a mix of 10yr and 20yr bonds, I've assumed an average interest rate of 1.8%). Of course, where else will the Chinese stash the cash? In EU bonds? (I'd guess the only other AAA-rated market big enough to stash $1.1T in.). The EU pays mostly negative interest rates (yes, you pay them to hold your money), though a 30 year bond pays about 0.2%. And if the Chinese dump $1.1T of US bonds in a short time they'd lose their financial shirts on the selling price drop. It would be a relatively large loss of wealth to China. I'm concluding this would be a big price to pay just to kick Trump in the butt over $30B in tariffs, and they're unlikely to dump the bulk of their US debt holdings. (Not that I don't understand the sentiment; I get pretty annoyed by Mr. Trump too on occasion.)

So what in the name of everything that's logical am I missing?

Maybe what your missing is that you are assuming these decisions are being made with logic rather than egotism. But maybe, if there is a rational strategy in China's decision making, it will be to damage the US economy in order to hurt Trump politically so that the political opposition gets the white house in 2020 which will probably have a less hostile economic policy regarding China.

 

[Irvrobinson]

Maybe what your missing is that you are assuming these decisions are being made with logic rather than egotism. But maybe, if there is a rational strategy in China's decision making, it will be to damage the US economy in order to hurt Trump politically so that the political opposition gets the white house in 2020 which will probably have a less hostile economic policy regarding China.

I think there's merit in this position. Xi and Trump are both egotistical, and Xi knows that the current US policy is aimed at getting corporations to move their supply chains out of China and into other countries that aren't a strategic threat. And it's working. But I'm still mystified by the magnitude of investors' responses. After some thought I'm thinking the illogical plunges might be due to programmed trading. There's a lot of that these days in an attempt to get in front of market gains and losses.

As for the Democrats... if Biden wins he might be more of a pacifist, if he can remember which country we're having a trade war with. Sanders and Warren are projected to be tougher on trade than Trump, based on their platforms. So I'm not sure that if Trump loses the environment for China will be less hostile. And Sanders and Warren seem to care little about investors.

 

[GO-NAD!]

It all baffles me, too. First of all, the phrase "wisdom of the markets", meaning - as I understand it - that the pooled knowledge of investors results in the proper valuation of stocks individually and collectively. I think it's been proven time and time again, that wisdom goes out the window at the most minor hint of trouble, or when markets heat up. Collective wisdom may work when there is a common goal in mind. But, when you're trying to beat the other guys, the pooling of wisdom is pretty limited.

What stands out to me, though, is for a person who is supposedly such a great businessman to display such a poor grasp of economics. Has he never heard of the Smoot-Hawley Act and its consequences?

 

[KEW]

Yeah, I'm inclined to believe that China is playing the long game and not using "capitalist logic" in their decision-making.
It is expensive, but so is subsidizing Chinese exports so as to capture the manufacturing sector for long term gains..
The Chinese are smart and recognize that this is war! It is not a military war, but a war of economy and IMHO, their subsidies decades ago were the first salvo and the current disregard for laws of intellectual property definitely makes it clear that they are as much about taking from us as partnering with us!

IMHO, once US military power clearly surpassed the Russian's military, it became a fools errand to challenge the US militarily in any direct fashion. China is, however, in an excellent position to challenge us on a economic level and Russia is doing it through eroding our (western democracy) internal culture - using social media to exacerbate any conflicts and cyber attacks to compromise our confidence in our elections in conjunction with select efforts to increase the yield of third world refugees to present a burden on our economy/culture. I'm no expert on this (especially I am not clear on exactly the extent and nature of Russian "refugee involvement" in South America), I am simply thinking out loud, but I suspect the logic of China's economic actions is based on more than the economics alone (at least the "two-year payback" thought structure common here).

 

[Irvrobinson]

It seems like the Chinese decided that devaluing the yuan below seven to the US dollar was going a little too far, so they backtracked and said they are supporting the yuan. So this morning the market futures are up instead of being down. Not a recovery of yesterday's losses, but I'll take it.

 

[KEW]

It all baffles me, too. First of all, the phrase "wisdom of the markets", meaning - as I understand it - that the pooled knowledge of investors results in the proper valuation of stocks individually and collectively. I think it's been proven time and time again, that wisdom goes out the window at the most minor hint of trouble, or when markets heat up. Collective wisdom may work when there is a common goal in mind. But, when you're trying to beat the other guys, the pooling of wisdom is pretty limited.

What stands out to me, though, is for a person who is supposedly such a great businessman to display such a poor grasp of economics. Has he never heard of the Smoot-Hawley Act and its consequences?

There may be a "wisdom of the markets" among select groups or over longer spans of time, but if the market is public, it is dependent on the wisdom of the public!
We see it often with IPO's where the IPO is for "the next great thing" and people pile on without any wisdom! Of course if you have preferred trading status and can buy into these "celebrity" IPO's as soon as they open then sell after the value has been driven up beyond reason, then you essentially have a low-risk, high yield investment! My point is that these people who are playing off of the psychological momentum are not introducing any more wisdom than the people who are immersed in it. Overall, I have a hard time seeing where wisdom really applies. Ultimately, the market is self-regulating, but it casually allows for (and arguably rewards) unwise situations!

 

[Irvrobinson]

There may be a "wisdom of the markets" among select groups or over longer spans of time, but if the market is public, it is dependent on the wisdom of the public!
We see it often with IPO's where the IPO is for "the next great thing" and people pile on without any wisdom! Of course if you have preferred trading status and can buy into these "celebrity" IPO's as soon as they open then sell after the value has been driven up beyond reason, then you essentially have a low-risk, high yield investment! My point is that these people who are playing off of the psychological momentum are not introducing any more wisdom than the people who are immersed in it. Overall, I have a hard time seeing where wisdom really applies. Ultimately, the market is self-regulating, but it casually allows for (and arguably rewards) unwise situations!

IPOs are an exception, Kurt. Roughly 80% of US equities are owned by institutions for mutual funds or corporate investment (e.g., Berkshire Hathaway). And according to the NY Times, 84% of equities in individual hands are held by only 10% of the population. So that means a lot of rich people seem not to have the wisdom GO-NAD expects.

 

[KEW]

As for the Democrats... if Biden wins he might be more of a pacifist, if he can remember which country we're having a trade war with. Sanders and Warren are projected to be tougher on trade than Trump, based on their platforms. So I'm not sure that if Trump loses the environment for China will be less hostile. And Sanders and Warren seem to care little about investors.

Just playing the game of "why would China prefer Dem's to Trump?":
I don't know the politics behind it, but the fact that China and Russia do not seem able to coordinate well with one another (against the US) may be a reflection of Chinese concerns about Russia's influence. (Russia is not in a position to really challenge us, but they are doing a great job of distracting us to domestic matters while they are having a much easier time with questions of human rights violations and furthering their own interests). However, it is certainly clear that a Trump win in 2020 would be a major victory for Russia.
As far as China's direct benefit, I agree that Sanders/Warren would not be great for them. They may be banking on Biden and slow incremental decisions against China vs Trump and strong actions surrounded by tremendous uncertainty.
I'm not sure they would see Sanders or Warren as a step down. Compared to Trump, they may take stronger actions, but they will take those actions with more stability. I could see the possibility that China would rather have stronger actions with confidence and stability as opposed to uncertainty and impulsive decisions. Trump has always mentions uncertainty as a negotiation tool he uses, and there is a lot of truth to it. However, at the end of the day, any institution (both, us and them) is healthier when uncertainties are reduced, so it is a double edged sword!
Like I said, just playing the game of "why would China prefer Dem's to Trump?"

 

[Hobbit]

I saw this last night, the title is a little sensationalized, however:

https://edition.cnn.com/videos/world/2019/08/05/intv-amanpour-u-s-china-trade-minxin-pei.cnn/video/playlists/atv-road-to-the-white-house-automated/elements/ui/header-wrapper/header-wrapper.component.jsx

 

[Irvrobinson]

Just playing the game of "why would China prefer Dem's to Trump?":
I don't know the politics behind it, but the fact that China and Russia do not seem able to coordinate well with one another (against the US) may be a reflection of Chinese concerns about Russia's influence. (Russia is not in a position to really challenge us, but they are doing a great job of distracting us to domestic matters while they are having a much easier time with questions of human rights violations and furthering their own interests). However, it is certainly clear that a Trump win in 2020 would be a major victory for Russia.
As far as China's direct benefit, I agree that Sanders/Warren would not be great for them. They may be banking on Biden and slow incremental decisions against China vs Trump and strong actions surrounded by tremendous uncertainty.
I'm not sure they would see Sanders or Warren as a step down. Compared to Trump, they may take stronger actions, but they will take those actions with more stability. I could see the possibility that China would rather have stronger actions with confidence and stability as opposed to uncertainty and impulsive decisions. Trump has always mentions uncertainty as a negotiation tool he uses, and there is a lot of truth to it. However, at the end of the day, any institution (both, us and them) is healthier when uncertainties are reduced, so it is a double edged sword!
Like I said, just playing the game of "why would China prefer Dem's to Trump?"

I think the Chinese must be banking on Biden. Warren and Sanders are so pro-labor unions that they advocate pulling out of free trade agreements, and Warren advocated that the US should be a currency manipulator. I wonder if either one of them has ever been a union member? I have (the AFL-CIO),and the experience profoundly changed me. I really doubt they have.

 

[Trell]

Just playing the game of "why would China prefer Dem's to Trump?":
I don't know the politics behind it, but the fact that China and Russia do not seem able to coordinate well with one another (against the US) may be a reflection of Chinese concerns about Russia's influence. (Russia is not in a position to really challenge us, but they are doing a great job of distracting us to domestic matters while they are having a much easier time with questions of human rights violations and furthering their own interests). However, it is certainly clear that a Trump win in 2020 would be a major victory for Russia.
As far as China's direct benefit, I agree that Sanders/Warren would not be great for them. They may be banking on Biden and slow incremental decisions against China vs Trump and strong actions surrounded by tremendous uncertainty.
I'm not sure they would see Sanders or Warren as a step down. Compared to Trump, they may take stronger actions, but they will take those actions with more stability. I could see the possibility that China would rather have stronger actions with confidence and stability as opposed to uncertainty and impulsive decisions. Trump has always mentions uncertainty as a negotiation tool he uses, and there is a lot of truth to it. However, at the end of the day, any institution (both, us and them) is healthier when uncertainties are reduced, so it is a double edged sword!
Like I said, just playing the game of "why would China prefer Dem's to Trump?"

China also aspire to be a military superpower and has been aggressive in their expansion of military capabilities, and continue to do so. This makes their neighbours and USA apprehensive, and with Trump as Commander-in-chief there very well could be military conflict, even just by accident in tense situations. USA have now formally retreated from a cold war era treaty with Soviet Union (Chine was never a part of this) banning some types of nuclear capable missiles that USA now wants to place out to counter China.

You can be assured that China is not happy with this development.

 

[Midwesthonky]

Keynes is a guiding principle for most economic theory. However, we know markets are not efficient nor do they act in a purely logical fashion. Add in the fact that in the last 40 years, the vast majority of stock trading moved from human based decision making to rapid fire trading done by computer algorithms designed to find that fraction of a penny in profit. The trades are only as good as the logic in the algorithms. So they will not act logically and can swing wildly depending on the input.

As for the political side, China wants to be the big dog globally and is not hindered by such things as morals, laws, democracy or accountability. China will do what China wants to get what China wants.

 

[pewternhrata]

Keynes is a guiding principle for most economic theory. However, we know markets are not efficient nor do they act in a purely logical fashion. Add in the fact that in the last 40 years, the vast majority of stock trading moved from human based decision making to rapid fire trading done by computer algorithms designed to find that fraction of a penny in profit. The trades are only as good as the logic in the algorithms. So they will not act logically and can swing wildly depending on the input.

As for the political side, China wants to be the big dog globally and is not hindered by such things as morals, laws, democracy or accountability. China will do what China wants to get what China wants.

Off a whim, but my 401 seems to benefit when the dow average drops. It takes a few weeks between, but my gains are epic right now, I'm up big time...I took a 7% loss in December but doubled since last year. Whatever nonsense is going on, I'm loving it.

 

[Irvrobinson]

Off a whim, but my 401 seems to benefit when the dow average drops. It takes a few weeks between, but my gains are epic right now, I'm up big time...I took a 7% loss in December but doubled since last year. Whatever nonsense is going on, I'm loving it.

What are you invested in? Gold and Bitcoin?

 

[pewternhrata]

What you invested in? Gold and Bitcoin?

Bitcoin, never gonna touch that. However, roughly 10 yrs ago a guy offered me $1k in bitcoin for my logan montage. I turned it down. I still dont understand that currency and have no interest in it. Apparently I made a bad call as bitcoin was like -35 cents at the time so i could have cashed out big time...

 

[charmerci]

The variable factors in the stock market are greed and fear. These guys often panic and sell off if they think that they might lose a ton of money. (Remember if you have 2 million shares of a stock, having it drop by $1....) Also there are many people out there betting on stocks tanking.. short selling. People constantly buy and sell.. huge amounts of transactions take place daily (mutual funds, etc.) ... this is not average Joe buying stock in GM and holding it for 20 years to let your nest egg grow.

 

[Midwesthonky]

The variable factors in the stock market are greed and fear. These guys often panic and sell off if they think that they might lose a ton of money. (Remember if you have 2 million shares of a stock, having it drop by $1....) Also there are many people out there betting on stocks tanking.. short selling. People constantly buy and sell.. huge amounts of transactions take place daily (mutual funds, etc.) ... this is not average Joe buying stock in GM and holding it for 20 years to let your nest egg grow.

agree. People panic and sell to cut their losses when it's only paper loss. You only lock in the losses when you sell. I like to buy when the market goes down. I just don't have lots of free cash right now. Bummer for me.

 

[Ponzio]

Understanding the markets is like, pardon my sexist statement to follow, understanding women or your wife. Who knows what posses them at times.

I increased my investment in bonds when the Trumpster announced his decision to go hard after China with tariffs six months ago, come a conventional war or an open ended trade war, both of which would cripple the economy.

Plus these wild fluctuations in the stock market since the tax cut for the top 5% scare's the bejesus out of me, as a small investor.

I'll be happy to just tread water right now, while the top 5% play with their extra Monoply money they were gifted. What have they got to lose?

I'd be rolling the dice too with house money or in this case the government's money.

 

[davidscott]

Way beyond my pay grade. However my ETF GLD is way up and I do realize that we have been in a nearly nonstop bull market since 2010 so a serious correction or bear is way way overdue. I don't get why people seem to think the market should always go up and are shocked when it doesn't. Anyone remember 2001 or 2009? 50% losses can and do occur. Just sayin...