Marko Papic, Chief Geopolitical Strategist, BCA Research assesses the risks that trade war, NAFTA, and U.S. midterm election could pose to equity markets markets.
So just why have the markets been so immune to these grumblings? We're going to be talking a bit about that. It is great to have you here. That is what you said, I know, at the beginning of the summer. And you fast forward today, and I feel like the list has gotten longer, and longer, and longer in terms of, obviously, Trump and China, and NAFTA, and everything we're dealing with. And, yet, the markets are still near all-time highs.
So let's start with-- we're just coming off the back, I have to say, of President Trump has had a presser where he's actually been saying all sorts of interesting things-- let's talk about some of the things that you think are key to watch right now. Let's start with the Fed, first off.
Rate increase today. 25 basis points, completely as expected.
At the same time, President Trump saying that I don't like the fact that the Fed raised rates. What is interesting to you about this?
Well, I think what's interesting to me is that most investors just ignore those comments. The view is, well, he can't really influence the Fed. Ultimately, what's going to influence the Fed is the economy. The problem, however, is that I think investors forget that the Fed has 550,000 Twitter followers and President Trump has 55 million. So at some point, this could actually become really serious.
And we just had a conference here in Toronto, BCA Research, and this was actually really significant. A lot of investors from abroad didn't take it lightly. They didn't think it's something to brush off. And the reason for that is, I believe, that they understand that with the next recession, if it is caused by Fed tightening, as many recessions in the past have been caused, President Trump will actually pursue the next election, he will campaign against the Fed. And that could have long-term implications for the independence of the central bank in the United States.
I know that people who follow the markets closely are going to go-- you're going to say that, and they stood up in their seat a little bit when you said it. What do you mean campaign against the Fed?
Well, think about it. President Trump has been campaigning against institutions filled with establishment elites that he has argued they're not held to any democratic standards. And the Fed is a great example of that. In a way, it's exactly how it's set up. It's an anti-populist institution whose independence is there to guard against democracy, to be really blunt.
You don't want the interest rates being set by the population of the country. So that sets it up for a typical Trump attack. He campaigned against trade. He campaigned against the WTO, against NAFTA, against NATO. He has been campaigning against institutions, such as the Fed, quite successfully for some time. And he could do so in the future.
Wow. OK. Let's talk a bit about some of the other things that are going on. And, again, in the face of all-time highs on the markets, NAFTA, we heard from the President earlier today. And, again, nothing new I'd say here but just that it doesn't look like there's going to be a deal with Canada unless there is.
He barks and then we wait to see what's going to happen. What does this actually mean, though, for Canada if we get a deal now or wait two years to get one? This can't be good for the country.
No. Of course, it's not good for the country at all, especially the automotive sector. However, it seems that he really doesn't like NAFTA, by which I mean the letters, N-A-F-T-A. He doesn't like the name NAFTA. So I think that's a good start for negotiations. Offer him a different name. I'm not joking at all. This is, clearly, what's a problem. He just wants to deliver to his base, I changed NAFTA.
The other thing is, obviously, Canada's going to have to make concessions. And he has signaled to Canada that the concession that will be appropriate to him is this milk tariff business. And at the end of the day, that's what Canada's going to have to do. There is really no way around it.
But, ultimately, polls from Pew Research, very, of course, a respectable polling company, in June of 2018, showed that a vast majority of Americans believe the trade with Canada is fair. So the bang for the buck, the return on the investment for President Trump of being a bully to Canada, is actually quite diminished after the midterm elections.
China, you wrote last week that the trade war is now official. I saw even pieces-- I'm not saying these are all the same weight-- but I saw US ships not being allowed to go into Hong Kong, and all sorts of things that are starting to bubble up. What are we talking about two years from now?
I don't think, really, last week was when it was official. I might have written it, but it's really been official for a while. I think it's fair to say it is not clear that it's going on, and, most importantly, that China's retaliated already, not through the tariffs, but through the currency. This is what investors have to watch.
If China continues to retaliate against American tariffs by depreciating renminbi, which they've said they wouldn't do, but it did from April to August by 10%, if they do another 15% to adjust to the 25% tariff that might come into place in December, that's going to just be terrible for emerging markets. And that's how the market has been treating the trade war, by the way. So your point is the markets are at all-time highs in the US. Outside the US, it's a bloodbath.
And I think that's what's really relevant about all these risks. Ultimately, the US is a safe haven. Even the US equity market has become a safe haven for investors, global and domestic. And I think that that could continue going forward. But the rest of the world is going to be really negatively impacted if China continues to choose to retaliate against a trade war through its currency.
All right. Stay with us. Fascinating conversation here with Marko Papic. We're going to talk a bit about the midterms and take a look at what happens to markets after the midterms. If you're bullish, you're going to want to see this chart. Stay with us.
Welcome back. We are here with Marko Papic. He is chief geopolitical strategist at BCA Research. OK, Marko, you were just saying that, given what's happening, the dynamic right now, you could see the world using the US equity markets as a safe haven, they continue to go up. You said blood bath everywhere else. That's got to transmit to the US, at some point, doesn't it? Or does it?
Absolutely. Yes, through the dollar. The US has two central banks-- the Fed and the dollar. And if the dollar goes up, at the time when the Fed is tightening rates, it will tighten financial conditions domestically. And that, definitely, translates to the US market.
This is what happened in '97, '98. By '98, the Fed had to cut rates three times. And, of course, that gave us '99. When the Fed backed off, we had great performance by global risk assets. We actually outperformed even the massive run-up in the S&P 500 and NASDAQ.
And then beyond '99.
Well, and then it has to end.
Nothing lasts forever.
Yes. OK. Let's talk about US midterm elections six weeks from now. What do you think is going to happen?
Well, we're in a very small camp at BCA, we're a very small camp of basically forecasting the Democrats could take the Senate if the current momentum takes them. So, definitely, the House, I think the Democrats are going to get it.
Take that apart for me a bit. We have a bit of time here. Tell me why you think that's the case.
Well, because the Democratic candidates in the Senate are actually quite centrist. So you have someone like Bredesen, the former governor of Tennessee. He was a Democratic governor from 2003 to 2011, centrist, almost conservative on some social issues. And he's actually up in Tennessee. And so you have, also, Democrats in Arizona and Nevada stealing some Republican states. And that's a big problem for the Republicans.
Now, a lot of folks out there, including Republican strategists, believe that well, the economy is doing good, so, of course, Republicans will do well. But the economy only matters-- people only vote with their stomach when they're hungry. When they're full, they actually vote with their heart, with their head. And so that's something to keep in mind. The economy is not going help the Republicans.
You've got a chart here, which I think is pretty fascinating, and I said going into the break that if you're bullish in these markets, you're probably going to like this chart. Let's bring it up. This is a chart showing the S&P 500 average performance post-midterms at the historical range. So just parse this out for a bit. What are we seeing here?
Well, what you're seeing is that-- so first of all, it starts at t equals 0, which is the midterm election itself. And then, basically, how many days later, what is the performance of the market with the historical range, of course, being in green. Now, great chart. Beautiful. Super happy looking at it.
However, we do have to isolate for Fed policy and the economy. If you control for those two variables, the impact of the election, actually, is difficult to discern. And the other issue is that if you actually looked at post-market results in gridlock elections--
I was going to say that.
--that produce gridlocks, and you, again, control for the Fed policy and economic growth, it's actually negative. Slightly negative. It's not really statistically significant. But the point is, who knows? Beautiful chart. We can end on a bullish note if you want.
No, no, no.
Yeah, yeah, yeah.
--there's more to it. And so, in my view, though, if Democrats take the Senate and the House, very difficult for them to actually pass any legislation that would upset the markets. There's going to be a lot of noise.
But the Democrats are like a dog chasing a car. They don't know what to do when they catch it. So they will, perhaps, catch the Senate and the House, but then what? You could have impeachment. You could have a lot of congressional hearings. They don't have an impact on earnings.
Would you, if-- and, again, this all prognostication, who knows, but this is what you do for a living-- if the Democrats take the Senate and the House, what does that mean for the next election, do you think?
That's a great question because, of course, this is the election where the Republicans should do really well in the Senate. They're actually defending only a third of the seats. Democrats are on the hook for 2/3 of those seats. So if the Democrats win the Senate this time around, it's going to be a real problem for Republicans in two years.
What is the one thing, do you think, the retail investor needs to keep in mind over the next year, just given everything that's going on? Again, because the one thing I was going to say is there's lots of chaos going on, but the markets are still moving up.
Right. Well, I think the most important thing, especially for us here in Canada, is what's going on in the Middle East and with Iran. I don't think we pay enough attention to it. And I think that the likelihood of some really upside risks to oil prices are quite significant, which could be positive for Canada, on one way. On the other, when the Fed is tightening rates and oil prices rise significantly, recessions occur that way. So something to keep in mind is that if the 2020 is the consensus view of the recession, I might take the under on that.
Marko, always a pleasure. Come back again?
Of course. Thank you so much, Kim.
Marko Papic. He's Chief Strategist Geopolitical Strategy at BCA Research.