Almost 20 years ago in Barron’s, Minneapolis-based market strategist Larry Jeddeloh cited the start of a credit cycle, not a business cycle. “Now, 20 years on, this is exactly where we are,” he said in a recent interview.
Today, much of the country’s prosperity depends on the Federal Reserve, which cut interest rates recently, having been backed into a corner by the European Central Bank’s rate cutting and the lack of resolution to the U.S.-China trade dispute. To Jeddeloh’s mind, that means U.S. rates will fall to zero, the Fed will start buying Treasury paper, and the credit easing will launch another bullish move to equities that eventually will return Donald Trump to the White House. (Jeddeloh was one of the few strategists to predict that Trump would win the presidential election in 2016.)
Jeddeloh’s clients include an array of institutions across the globe, whom he visits assiduously to inform his own views about the markets. As stocks lurched in the past two weeks following a U.S. rate cut, and as the trade war escalated, Jeddeloh shared his views about the outlook for the U.S. markets and where to find opportunities today. An edited excerpt of the conversation follows.
Q: Is it too late to sell now?
A: Larry Jeddeloh: I don’t think it’s too late to sell U.S. equities. Originally, we had a target of 2750 on the S&P 500 index (.SPX). But the way the market behaved on Monday suggests there’s more downside. We likely will fill in a gap between 2750 and the December 2018 lows of 2300 to 2350. Nasdaq is slightly more vulnerable than the S&P 500: A government-directed antitrust investigation seems unhelpful for tech-company valuations. The China trade (dispute) is what’s driving the current bout of selling. One side or the other or maybe both reach a pain point and decide it isn’t worth it.
Q: What do we need to see?
A: From the U.S., probably a sharp, disorderly fall in stocks, a sharp roll-down in the economic data, and alarm at the Federal Reserve as a result of that fall that might lead to emergency measures. That would lead to a truce on the trade front. From the Chinese side, I’d like to see their economic data roll over sharply. The stock market isn’t that important to them. What’s important to watch is the renminbi. They are trying to hold the renminbi up. If there’s enough downside pressure on the renminbi that causes them to run short of dollars, and if the markets became disorderly, that would lead everyone back to the bargaining table. We’re not there yet.
Until recently, you said you didn’t think there would be a trade deal between the U.S. and China until after the 2020 U.S. election.
That is what (China) has predicated their behavior on. I don’t think they want President Trump for another 5½ years, so part of their strategy was to elongate the trade talks and have a deal with a new president down the line. The U.S. has figured this out. Now, the probabilities are rising almost parabolically for pressure points to be applied from both sides to get the upper hand in negotiations. Someone will get hurt. The odds of (a deal) happening before the end of the campaign season have improved quite a bit.
Q: What are you expecting from the Fed?
A: My expectation is that we’re going to be down to zero rates out to two years, primarily for funding reasons. Foreign buyers have basically stopped buying Treasuries for five years. They have been modest sellers. The primary dealers are stuffed with government-bond inventory. They need a new buyer. That is going to be the Fed. The budget deficit was $1.2 trillion last year, $1.3 trillion the year before, and will be at least $1.1 trillion next year. They have to fund it. Fed Gov. Lael Brainard gave a speech in Richmond, Va., about buying Treasury debt out to one year and possibly to two years on the yield curve. The Fed will buy them all.
The Fed is now starting to look at a more forward approach to making policy. They’re looking at using Big Data. (Fed Chairman Jerome) Powell can’t really forecast that. He talked about the balance of risks, which caused (him) to begin to support the rate cut. The goal is aimed at avoiding a recession, because the economy is geared across so many levels that a mild recession could turn into something much worse. If there is no China deal, that puts additional pressure on the Fed to cut rates. That accomplishes several things. It alleviates some of the upside pressure on the dollar. With rate cuts, you get a better equity market, and it supports the U.S. economy.
Q: Is it enough to get Trump re-elected?
A: Gee, I get one right, and now I’m a political guru. In my lifetime, if you have a good economy and a good stock market, and you’re running for re-election, the chances of being re-elected are very, very good. But to my great surprise, when I’m overseas, the same people who told me 2½ years ago that Trump could never win are now telling me he will win, for precisely those reasons. I don’t disagree with the reasoning. Yet U.S. voters are funny in some ways. Every once in a while when our coffers are full, people have work, the markets are up, wages are rising, and the economy is good they’ll vote for something else. They’ll vote to fix some problems they perceive in society. If I were a betting man right now, I’d say he probably does win. But look at the polling of some of the important groups.
Q: You’re disappointing us, Larry. You ignored the polls in 2016.
A: Well, suburban women, for example, don’t like his aggressive behavior, and they’ve been huge beneficiaries of his policies. They want the behavior changed. Right now, we don’t know who he’ll be running against, so it’s too much of a wild card. In the last election, there were people who voted for Trump because they couldn’t or wouldn’t vote for Hillary Clinton. We don’t have that this time. Having said all that, virtually everyone I’ve spoken to in our client base has said to me that if Trump were to lose, the entire business environment in the U.S. would change. Just watch the Democratic debates. They’re talking about an economic system that isn’t just different, it’s completely flipped over. People don’t know how to price that. When you don’t know how to price, you don’t price up, you price down.
Q: What will happen to the market in the coming months?
A: One big question is whether the European system functions on negative rates. By the way, the ECB almost forced the Fed to cut rates. If the Fed had sat where it was, the dollar would have gone through the top end of its chart pattern, causing a problem in the markets.
One of the large Swiss banks is going to start charging accounts over $2 million a fee of 0.75% a year. No country has tried to operate in this kind of system on a long-term basis. We’re going to get some unusual movements in asset prices. Are you going to put your money in there, or somewhere else where you don’t lose?
Volatility is going to pick up. Anything with a dividend yield on it probably attracts capital. We are entering a phase where the acceleration toward growth is going to go parabolic. I’m sure you’ve talked to value managers who are on the floor.
Q: What is the outlook for precious metals?
A: Gold gets a huge boost. Europeans are telling me they don’t know how the system can function, so they will buy gold again. We’ve held the VanEck Vectors Gold Miners exchange-traded fund (GDX) all year. It has done well and has further to go. Gold is rising in most currencies, which is a bullish sign. For gold to really work, the U.S. dollar should decline. If the euro were to fall sharply, gold purchases by Europeans might well accelerate.
Q: What else do you like?
A: For four or five years, I’ve been saying just buy defense stocks on every dip. We like the iShares U.S. Aerospace & Defense ETF (ITA). I’d try to refocus on cybersecurity, because the scale of the problem is mind-boggling. We like the First Trust Nasdaq Cybersecurity ETF (CIBR). United Kingdom assets are interesting. Now that Boris Johnson is prime minister, I’m quite convinced they’re going to have a hard Brexit on Oct. 31. (In a hard Brexit, the U.K. would leave the European Union and the single market without a trade deal.)
Sterling is weakening fast. The hard Brexit could present an interesting opportunity for U.K. assets, because the currency is going to be down. In the 2015 U.K. budget, they put in a phased 1%-a-year reduction in corporate tax rates. By next year, corporate taxes in the U.K. will be about 17%, the lowest in the G20. The property market in London has been softening for three years. The key to London is property, and the key to the country’s economy is London property. If that takes a final dip, it could look like a V, where the economy just turns very quickly as capital comes in. If they cut taxes, get the currency down, deregulate, make capital welcome again, the U.K. could have a boom.
Q: What about the Continent?
A: We’ve had no exposure there for a couple of years, which was fine until this year. The markets did well in the past two quarters. The problem for us is the banking sector, which is such a big weighting in the indexes. This negative rate environment just doesn’t work for them. Technology is interesting in Europe. There are technology hubs surfacing in Berlin. The crypto center in Switzerland is in Zug. The East End of London has a lot of tech start-ups and fintech names. Europe took the world lead in forming a framework for how privacy might work in the digital economy.
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