Daily Comment (March 1, 2019)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s a risk-on Friday with little news to account for the strength. World PMIs (see below) remain rather soft, although several (including China) came in above depressed expectations. Here is what we are watching this morning:

MSCI lifts China: The index provider MSCI has boosted its allocation of Chinese mid-cap stocks (the A-shares) in its broader emerging market indices.[1] Chinese stocks will generally now represent about 40% of the index; adding the Taiwanese stocks, which tend to be influenced by China, the index is approaching 50%. This strong weighting of China in the index will almost certainly lift investment flows into Chinese equities this year. At the same time, it raises questions about index investing when one entity has such a large share.

Brexit: There isn’t too much new today. We do note that inventories jumped in the PMI data as firms appear to be stockpiling just in case there is a hard Brexit.[2] It is looking increasingly likely that Brexit will be delayed. On March 12, Parliament will vote again on PM May’s deal. Given that it lost in historic fashion earlier this month it will likely fail again. The next day, Parliament will vote on whether it supports a hard Brexit. That is unlikely as well. On the 14^th, a third vote supporting an extension of the deadline will be before legislators. That will almost certainly pass (if the two earlier votes are rejected, it is the only logical conclusion).[3]

One of the hopes of Brexiteers is that the U.K. will be able to negotiate its own trade agreements and do better than it would inside the EU. Perhaps this is true but it should be noted that trade agreements are a function of relative power. The fact that the U.S., up until the Trump administration, usually engaged in multi-lateral trade agreements is evidence of America’s benevolent exercise of hegemony. Given U.S. power, all nations are disadvantaged in bilateral agreements. This administration’s shift to bilateral trade deals is evidence of a shift in U.S. hegemonic policy.[4] The U.S. has put the U.K. on notice that the former will bargain from a position of strength and force the latter into uncomfortable concessions.[5]

Venezuela: The U.S. proposed a UNSC resolution that would support new elections and unfettered access to foreign aid in Venezuela. Both China and Russia vetoed the resolution.[6]

Tax news: There are reports that 127 nations are near a pact to tax tech firms’ cross-border income.[7] There is a bill in Congress that would tax all equity transactions 10 bps. The goal of the legislation is to thwart high-frequency trading activity.[8]

China news: For the first time on record, China’s employment population declined, and for the seventh consecutive year, its working-age population (aged 16-59) fell. It is 2.8% lower than it was in 2011.[9] There are reports that Chinese investors are pulling out of overseas property markets. It appears that regulation is the primary factor curtailing outbound investment.[10] We may see a decision from Canada on the Meng Wanzhou extradition hearing today; if the court decides it has the authority to proceed, extradition proceedings will begin.[11] If she is extradited to the U.S., it could affect trade negotiations.

PM Trudeau’s woes: A growing corruption scandal is threatening to end PM Trudeau’s administration.[12] Perhaps the best signal that the PM is in trouble is that his foreign minister (and likely successor), Chrystia Freeland, has expressed “100% faith” in the PM.[13] Although usually such events have little impact on U.S. markets, given that the NAFTA/USMCA deal hasn’t passed through Congress, a change at the top of the Canadian government could complicate negotiations.

Robots can’t intuit: Algorithmic trading models appear to have great promise as they can scan for past patterns much more effectively than humans can. What they can’t do is understand that former patterns may no longer hold when initial conditions change. Recent performance of these models has been abysmal as they struggle to manage money in an environment that is changing rapidly.[14]

And, finally:There are now more $100 bills in circulation than $1 bills. The “Benjamin” is the favorite currency of the black economy, but also may have become popular with European households dealing with negative interest rates.[15]

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[1] https://www.ft.com/content/2ce24a94-3ba5-11e9-b856-5404d3811663?emailId=5c78c51dc096ac0004382981&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22 and https://www.cnbc.com/2019/03/01/msci-to-quadruple-weighting-of-china-a-shares-in-global-benchmarks.html

[2] https://www.reuters.com/article/uk-britain-economy-pmi/uk-factories-slash-jobs-stockpile-at-record-pace-before-brexit-pmi-idUSKCN1QI46F?stream=business&utm_campaign=newsletter_axiosmarkets&utm_medium=email&utm_source=newsletter

[3] https://www.ft.com/content/7d973c06-39c5-11e9-b72b-2c7f526ca5d0 and https://www.washingtonpost.com/business/economy/trump-trade-official-says-a-us-china-deal-wont-fix-all-of-beijings-anti-trade-policies/2019/02/27/aeb569b0-3a11-11e9-aaae-69364b2ed137_story.html?utm_term=.102b4b94f888

[4] See WGR series, The Malevolent Hegemon: Part I (11/26/2018); Part II (12/3/2018); and Part III (12/10/2018).

[5] https://www.ft.com/content/09bfe7ca-3bae-11e9-b72b-2c7f526ca5d0?emailId=5c78c51dc096ac0004382981&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[6] https://www.nytimes.com/2019/02/28/world/americas/russia-venezuela-veto-united-nations.html?emc=edit_mbe_20190301&nl=morning-briefing-europe&nlid=567726720190301&te=1

[7] https://www.reuters.com/article/us-france-tax/france-sees-global-tax-deal-on-digital-giants-in-2019-minister-idUSKCN1QH282?feedType=RSS&feedName=technologyNews

[8] https://thehill.com/policy/finance/432022-senate-dem-planning-legislation-to-tax-stock-trades

[9] https://www.caixinglobal.com/2019-02-28/chinas-employment-population-shrinks-for-first-time-ever-101385483.html

[10] http://www.ecns.cn/cns-wire/2019-02-27/detail-ifzezqac5077458.shtml

[11] https://www.reuters.com/article/us-usa-china-huawei-tech/canada-seen-approving-extradition-hearing-against-huawei-executive-idUSKCN1QI3MI