Blackswan

"If you can keep your head when all about you are losing theirs...." – Rudyard Kipling

The media continues to paint this summer’s investment skyline red (just as it has every summer that I can remember since I started in this business over 30 years ago).

And it’s times like these when sitting still while others are running away becomes the most difficult thing that you need to do to build your wealth.

Sure, the headlines about trade antic skirmishes between the US and China can be as compelling as they are nerve-wracking.  And the predictions of terrible outcomes are as diverse as their authors’ imaginations.

But just as we warned, as we do every year, that the summer haze is a season for stressful movements in the markets, that annual expectation has already proven true.

In fact, as the experience levels on trade desks around the globe continue to fall as the experienced hands hit the beaches, and the journalists are forced to become even more creative in their apocalyptic mewling, expect the noise-levels and "threat readings" to be ratcheted up to “deafening.”

So, what should you do?

Be still.

"Where is that wrench and screwdriver?"

I use to joke about how these tidal waves of stock market and economic red ink makes you want to seek out that wrench and screwdriver in your office that open the windows so you can jump.

We’ve all made the mistake of pulling triggers from assumptions of terrible outcomes just to stop the pain.

Sadly, the pain is a necessary part of the investment journey. You can’t escape it. You just have to be strong through it.

And eventually, all that drama rolls off you like water off a black swan's back.

Think About It

It’s amazing how quickly North Korea fell out of the spotlight, eh?

Now it’s China – trade, borders, threats of economic reprisals, the whole shebang!

Not for long though. Rest assured the fire season in the west and hurricanes in the east are both just gearing up to become a headline near you.

"But Mike, China can....."

China can do what, exactly…?

I mean it sounds terrifying when you read some of the rhetoric, but what can "actually" do?

The bluff and bluster will go the way of Brexit, Chinese Yuan devaluation fears (Acts I, II, II, IV, V, VI and VII), Ebola outbreaks, the outrage at the Border (I mean the Janet Reno version - not the current remake), and everything else that was previously going to throw the globe into the pits of hell.

So, before we squirm out onto the ledge let's think through this for just a moment: Why can't China impose "countervailing tariffs?"

It's actually pretty basic math, and it supports what Trump is shouting about.

Assume President Trump slaps another $200 billion in tariffs on China, with the threat of another $200 billion as some have stated in fake headlines.

The first step would bring the total to roughly $250 billion, which is where the "fearful reckoning" departs from the simple math.

How?

Last year, the U.S. imported roughly $500 billion of goods from China. 

On the flip-side, China bought a tiny (relatively speaking) $130 billion worth of U.S. goods.

(Let me know when you figure out the punchline?)

China can't "retaliate in kind" because it just doesn't buy enough stuff from the U.S.

“Mike, you dummy. They can just devalue the Yuan."

Oh, yeah, I forgot about that…kidding.

They won’t.

That’s because the dirty little secret China doesn’t want plastered on every headline is that rich people (for the most part) in China are after two things: Moving to the US, and getting their money out of China.

So, if China actually did what so many others fear they will, it would very likely drive a significant surge in the appetite to leave, pushing massive capital outflows out of China's financial system. 

And you can’t play petty tit-for-tat games with your currency if you ever really believe it will rank as the global standard.

"But Mike You Forgot the Bonds..."

How many times have we heard that China seemingly has about $1.2 trillion of U.S. debt instruments ready to sell at a moment's notice?

First, where exactly would they put the proceeds of that sale? You mean, in their currency?  LoL! Eh, I mean, no.

If China were to sell all of that debt at one time, it would surely raise rates in this country…for about a month…maybe. 

And, of course, the entire world would shudder…for a week or two…and fear would shoot through the roof.

And when fear spikes what does everyone and their brother line up to buy?

Yep, treasury bonds – the very thing China thinks they can sell and damage us with.

And they know it.

But what they also know is that having the press rattle that sabre for them is a real plus; it leads the crowd to believe these dramatic tales of peril.

The doubled edge on that sword is that it fulfils the fear driver, which topples directly into the crowd’s demand for bonds. And that would soak up their supply faster than China’s leaders can say, "Wait, we sold all of our US treasury bonds?"

Black Swan CHart

And finally, yes they could just try to strike against US companies in China already.

But, that’s going to create more negatives at home than positives.  They have a history of doing so - but the tactics prove fruitless in short order.

Retaliatory measures against US companies might cause temporary damage to the targets, but the long-term effect would be lost jobs, degraded competition and reduced productivity at home. 

The effects for us are pretty limited, and the costs for them are high.

And the reality break here is that China has few attractive options other than making trade fairer.

So let the headlines roll in the waves of worry and fear.

The haze will clear once the summer has had its season.

Mike_williams
Author
Mike Williams
Founder and Managing Partner