Monthly Observations
January 2019 Issue 

As we look forward to 2019, the threats of tighter financial conditions, less fiscal stimulus, and trade tension linger. Despite these forces, markets staged a rip-your-face-off rally to resistance area where they stalled out. We tend to view rallies like this as suspect. Yes, the Fed has caved and expressed patience in further rate hike, effectively giving us a Fed put and lengthening the business cycle. Investors recalibrated their world view and bid up prices to summer 2018 levels as a result. But earnings, while strong, are slowing down. The sentiment shift to the upside is a bit overdone near term, but a consensus seems to have emerged that a recession is not imminent.
Trade war negotiation with China is progressing. Both Trump and Xi appeared to be unnerved by the ferocious negative market actions of late. A breakthrough is highly unlikely but China still has tremendous capacity to apply counter-cyclical stimulus if things fall apart. The direct impact of tariffs on US GDP is low, but the second order effect by way of reduced business confidence, reduced investment, reconfiguration of supply chain, and reduced capital flow is not to be underestimated.


Oil has been highly correlated to the stock market since 4Q18. Drivers for both at the moment are worldwide economic/demand growth. Since Trump played OPEC for a fool in early November by granting sanction waivers to Iranian customers, oil has suffered the extra blow of oversupply. Situations in Venezuela are deteriorating fast and there could be a fairly quick collapse, but any decline from the current 1.4mbpd production and the subsequent recovery appears to have been baked in market expectations. Saudi Arabia has cut production faster than expected partly to offset Russian difficulties of reducing output in the dead of winter. In the US, there is early evidence of oil producers cutting rigs (5% reduction expected for 2019) and exercising capital discipline in response to investor pressure, but a flood of West Texas Crude is coming with the completion of Permian Basin takeaway pipelines in 4Q19. All in all, oil is likely to stabilize.

Gold is grinding higher thanks to the asymmetric risk setup as explained in our December letter – lower interest rates prompt investor demand; higher interest rates prompt safe haven demand. Even in the face of muted inflation and strong demand for US treasuries, we think precious metals still have upside from here.
In January I read Goldman Sachs’s 2019 Outlook which gives a great perspective on the resilience of the US economy. Since 2007 the US economy took less of a hit during the great recession, recovered faster, and then grew far more than Europe, Japan, and other advanced economies. Relative to faster growing emerging markets the US has also narrowed the growth gap. Even per capita GDP, nominal or at PPP, has outpaced other developed and emerging economies. This has happened in the face of far greater private sector deleveraging than all major economies. Given the size of the American economy, this is truly extraordinary. Reflecting on the chaotic state of our politics, one is led to believe that Washington gridlock is actually a net positive for the economy. Addressing the social contract however, is a different issue.
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Jeff Lee, CTA

Kronos Management, LLC
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