Geopolitics expert George Friedman describes an interesting cycle in which a world-dominating exporter emerges, peaks and then declines every 40-50 years. The last three examples are the US, Japan and China, which is now entering the “decline phase.” But in this context, decline doesn’t mean doom.

Key Points:

  • The US entered an industrial revolution after the Civil War and by 1900 produced half the word’s manufactured goods. Its domination ended when World War I wrecked its export customers.
  • Post-WW2 Japan’s educated and disciplined workforce, combined with low labor costs made it the world’s exporting giant by the 1960s.
  • The end of Maoism opened the door for China to replace Japan. Now the business cycle is ending its dominance.
  • This process seems to be built into modern capitalism. Wealthy countries demand low-priced manufactured goods they can no longer afford to produce domestically.
  • China is entering a period of change but will remain economically powerful after it stabilizes.
  • The fantasy China would somehow take over the world will have proven wrong.

If this cycle repeats, some other country will soon take China’s role as the low-cost manufacturing leader. Who will it be? We don’t know, but most of the plausible candidates are in Asia.

Jeffrey Gundlach’s 10 Economic Predictions

  1. The Economic growth we are seeing is not growth, it is just spending.
  2. The Fed will likely start tapering off QE.
  3. The Fed Funds Rate will remain at zero for the foreseeable future as we unwind QE.
  4. There are fewer Americans employed than during pre-pandemic peak. The economy has not completely recovered.
  5. A wave of foreclosures will hit the US economy.
  6. Consumer confidence is high but future expectations are not.
  7. He remains neutral for the US Dollar, for now.
  8. Inflation will remain a concern
  9. Commodities will continue to do well, except for Gold
  10. TIPS look too expensive right now

10 Potential Tax Changes in Congress

  1. The top ordinary income rate goes back to 39.6%, up from 37%
  2. The top rate of 39.6% applies to AGI above $450K
  3. It may make sense to accelerate income in 2021 (Roth, IUL, etc)
  4. A new LT Capital Gain rate of 25% would be effective immediately
  5. Incomes of $400K+ would see the higher capital gain rate
  6. There’s a new 3% surtax for incomes above $5MM
  7. Back-door Roth IRA conversion strategy may be history.
  8. Larger RMDs for clients with incomes over $450K and assets in IRAs of $10MM+
  9. Unified credit for estate and gift taxes has been reduced back to $5MM per person
  10. The expanded child tax credit would be extended

Jared Dillian Calls a Market Top

(Brian’s note:  This is very rare. Most people know it is insane to call a market top.  Nobody can do it.  Few have even tried so when it happens, I want you to see it.)

I think the long bull run in stocks has finally come to an end.

Keep in mind that I say this at great personal peril, because if I’m wrong, well, there is no room to be wrong as a market pundit. Once something goes on the internet, it’s forever, and people will link back to it for years. Look at this idiot who was wrong. Forecasting is hard, especially about the future.

Anyway, here are some bulleted thoughts on why stocks may have peaked:

  1. Inflation is honest-to-goodness out of control. It shows no sign of getting better. And yes, supply chains are fouled throughout the world, but it’s not all supply chains. It’s a profound shift in psychology, and the Fed is powerless to stop it.
  2. Speaking of the Fed, this trading scandal involving Kaplan and Rosengren is a big deal. There are people who have never been happy that the regional Fed presidents are chosen by the respective banks’ boards of directors. The Fed will be pressured to influence the replacement of Kaplan and Rosengren, who were two of the more hawkish members of the Fed. Soon, the entire Fed system will be filled with progressives—just when inflation is going parabolic.
  3. China will be the source of the next crisis, as President Xi Jinping views capitalism as a threat to his power. He’s been kneecapping billionaires and successful internet companies, and that will continue. I think Xi wants a closed society, much like the 1960s Soviet Union. I wouldn’t be surprised if China didn’t have capital markets in 10 years. There are big implications here.
  4. The bond market looks vulnerable. Rates ticked up a little bit—and it has caused a lot of problems in the stock market. I’ve been doing this a while, and I’ve never seen a stock market that was so sensitive to tiny changes in interest rates. If 10-year yields go back up to 2%, there are going to be some big problems. I’m downplaying that a little bit. It is going to be a disaster.
  5. And finally, sentiment. I’ve been watching sentiment carefully, and I was really freaked out by the meme stocks back in January, followed by bitcoin and dogecoin, then the NFT market and collectibles. Most of this calendar year has been an orgy of speculation, and it is starting to feel tired. This is the most important reason to sell stocks—it’s a big secular top in bullish sentiment.

 

Chinese Technology stocks

 

To give you an idea of how hated they are today, I turn to the Invesco China Technology Fund (CQQQ), an exchange-traded fund (“ETF”) that tracks them… It’s down more than 20% so far this year. And another China-tech-focused ETF, the KraneShares CSI China Internet Fund (KWEB), has declined even more… It’s down roughly 40% in 2021.

That’s a double-digit loss in a year during which the tech-heavy Nasdaq Composite Index has risen about 13% and continued to set new all-time highs. When you put that performance side by side with the losses for Chinese tech stocks, it’s a difference of 33 to 53 percentage points… That’s a lot!

Even worse, some of the biggest individual stocks in this group have lost more than that this year alone… For example, e-commerce giant Alibaba (BABA) is down almost 50% in 2021.

The declines have been so significant that more than a handful of well-known investors are telling people to stay away from these companies in order to avoid losing even more money.

The government under President Xi Jinping has begun regulating the technology sector – starting with the biggest players.

It began in November 2020, when Alibaba was forced to shelve its blockbuster initial public offering of its fintech arm, Ant Financial, whose services were used by nearly 1 billion Chinese people.

Then, the State Administration for Market Regulation (“SAMR”) – China’s version of the Federal Trade Commission – began scrutinizing monopolistic business practices by the country’s leading Internet companies.

It resulted in a record-breaking $2.8 billion fine against Alibaba, largely for its practice of forcing merchants to choose its platform over the competition.

But the SAMR didn’t stop there…

It then barred Internet companies from acquiring competitors without its approval. It also called out the practice of companies burning cash to win over market share because, the thinking goes, it’s not fair to underfinanced companies.

The Chinese government says children under the age of 18 will only be allowed one hour of online gaming on Fridays, weekends, and holidays, and that hour will begin at 8 p.m. local time and end at 9 p.m.

Finally, earlier this month, Beijing ordered both Alibaba and online-gaming behemoth Tencent (TCEHY) to make their payment platforms open to one another… Previously, they could block users from accessing a competitor’s service within their app.

 

US Economy

 

  • Cargo delays remain acute and trucking companies are doing very well.
  • More apartment owners report rent increases
  • The Conference Board’s consumer confidence index surprised to the downside. Analysts blame it on the Delta variant – in which case we should see an improvement soon.
  • The labor differential (“jobs plentiful” – “jobs hard to get”) remains elevated, pointing to robust hiring activity.
  • The divergence between home prices and wages is nearing extremes, making the housing market more vulnerable to higher mortgage rates.
  • By the way, mortgage rates increased this week as Treasury yields climbed.
  • The Richmond Fed’s manufacturing index slumped this month.
  • The Evercore ISI business survey diffusion index shows softening activity for industrial firms.
  • Supply bottlenecks remain extreme, but the index of vendor lead times appears to have peaked.
  • Price pressures have been getting worse.
  • And factories expect to keep hiking prices in the months ahead.
  • Companies now see supply chain issues as persisting for some time.

 

 

 

  • The Atlanta Fed’s GDPNow model forecast for Q3 GDP growth continues to move lower.

 

 

  • Pending home sales surprised to the upside, suggesting that the housing market remains strong. Consumers complain about houses becoming more expensive but keep buying.
  • US exports of goods hit another record high in August.
  • Rent inflation:

 

 

 

Debt

 

The US global economy has a lot of serious problems. The most important of which is that we’re excessively over indebted. And we’ve taken on a great amount of new additional debt in the past year to try to ameliorate the consequences of a pandemic. And while this debt can be deemed as politically popular and socially irresponsible, it’s going to have a very deleterious effect on economic growth for a long time to come. In addition to that, because we’ve been on this high debt path for so long, the trend rate of economic growth has fallen dramatically below what we were achieving up until the late 1990s (when we became so over-indebted). And each year that goes by we, we move further below the curve.

 

Market Data

 

  • The Russell 2000 index remains range-bound.

 

 

  • US Stocks are substantially more expensive than global peers.

 

 

  • Beijing decided to make all crypto transactions illegal.
  • Bond yields are rising globally, which tends to put pressure on growth stocks.
  • Stocks that respond positively to higher inflation have been outperforming.
  • The correlation between growth and value stocks remains near multi-year lows.
  • Companies with substantial sales in China continue to struggle
  • Equities as a share of household financial assets have surpassed the Dotcom peak

 

 

 

  • Large growth stocks continue to underperform, pressured by higher bond yields.
  • Bank of America’s private clients are holding more equities than they have over the past 15 years.
  • The S&P 500 is only 4% below its peak.

 

Thought of the Week

 

“No matter what, it’s our reaction that counts”

 

Picture of the Week

 

 

 

 

All content is the opinion of Brian J. Decker