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Prepared by Philip Gotthelf

December's January Effect

(December 8, 2016) Yesterday's stock market action was called a "crash up." This is to say that the dramatic one-day spike mimicked a market crash, but in the upward direction. There was no substantive news upon which Wednesday's rally was based, making it more of a presumed anomaly. Today's financial news reports enthusiasm for President-elect Trump as the rationale behind investor enthusiasm. Regardless of the reason, healthy equity markets are usually a good sign for the economy.

There is one technical warning worth keeping in mind… the "January Effect." I bring this up because a powerful December performance creates an extra challenge for the January Effect phenomenon which presumes that January's performance relative to the December 31st closing is predictive for the remainder of the year. Thus, if January's closing is below December 31st, the close of 2017 will end lower than the 2016 close while a higher January portends a positive net 2017 performance.

If, in fact, markets are being driven by the Trump Train, the January 20th inauguration is likely to support the markets through the month and the "effect" will be positive for 2017. A good stock market always lends boasting rights to a president. Already, Democrats are arguing that President Obama has set the stage for President-elect Trump's success. Whether valid or not, our first African-American leader of the free world is being drowned out by Trump's media buzz.

I have gone back into news archives to see if there was the same level of hoopla about cabinet picks and pre-inauguration actions by previous presidents. Essentially, it is not even close. We

might think that our first African-American President would have easily generated the greatest amount of coverage. Indeed, President Obama's media frenzy made the top of the charts, but he has already been trumped by Trump. Simply turn on CNN or FOX News… it's about Trump.

I believe it is safe to say that the "rules" have been broken for this election cycle. This suggests rules may also be violated regarding the January Effect. Consider that Trump entertained environmental activist and former presidential candidate Al Gore in the New York Trump Tower before picking Oklahoma's Attorney General Scott Pruitt to head the Environmental Protection Agency (EPA). Hello?!

The media is confused. I believe that is Mr. Trump's intention. Although the Gore meeting seems to be a conflict with the EPA pick, we know from Al Gore's post meeting statements that there was a positive and substantive discussion. Let me try to read between the lines here.

Trump and Gore probably agree that fossil fuel consumption should be reduced. Trump looks at this from an economic perspective and concludes that reliance upon carbon based energy represents eco-political exposure. Gore believes we must reduce CO2 emissions. While the goals may be different, the means to achieve them are the same. Trump probably wanted to reassure Gore that the new EPA head would not dismantle the "Green" agenda, but would scale down Federal regulations that stymie economic growth.

Trump has correctly pointed out that the Obama commitment to CO2 reductions does little to reduce the upward projection of CO2 emissions. This is because growth in CO2 will come from emerging economies as mature economies actually reduce output through greater efficiency. For sure, the environmental pact that includes China only commits the U.S. to definitive reductions while China is only looking at guidelines. I am sure Trump talked with Gore about an inclusive environmental accord that spreads the burden more economically across all participating nations.

If Trump is able to steamroller legislators and change using his government the same way he steamrollered his way to the presidency, the January Effect will be of little consequence. We can expect to see a 20% or even 50% gain in most equity indices. This sets the stage for other interesting developments.

Up On The Farm

Down on the farm things will be looking up. Do we remember Trumps first primary challenge in Iowa? He narrowly lost to Ted Cruz even after supporting ethanol to capture more of the corn farmers' votes. The media made a big deal out of the fact that Cruz' integrity and political experience was more important to Iowa voters than their self-interest in Federal ethanol subsidies. We see that the media experts and pollsters were wrong about Trump's agricultural agenda.

When talking about China and Japan, U.S. agriculture becomes paramount. Even to this day, non-domestic rice is not freely traded with Japan and China. Other commodities are restricted to support local farmers. This is not to say the U.S. doesn't engage in the same tactics. After all, U.S. sugar and peanuts receive subsidies. But import limitations are more restrictive and broader. Under free trade, the back & forth is supposed to be approximately equal to the extent that each nation can use the goods and services of a counterpart. When Japan can sell the U.S. cars, but the U.S. cannot sell Japan rice, the two-way street becomes a one lane highway. In 2016 agriculture and related business contributed just under $1 trillion to our Gross Domestic Product (GDP); about 6% of which 1% of GDP represented direct agricultural sales. In percentages, these are a fraction of the business U.S. farms did in the 1970s when the U.S. was the world's "breadbasket." The U.S. has exported farming know-how to the detriment of U.S. farmers. Even our farm equipment that was exported has been challenged by Germany, Holland, Japan, and even China. Poorly negotiated and policed trade deals have, in fact, gutted U.S. agriculture and equipment manufacturing.

The good news is that global food demand is rising while capacity is not expanding at the same rate on a projected basis. For sure, improvements in genetics, chemicals, and other technologies have substantially increased yields while protecting against disease, insects, drought, and freezes. Still, there is only so much land and farm capacity that can be effectively placed into production. This means the U.S. can reassert itself as the global producer once Trump actually executes on renegotiating trade deals. Interestingly and coincidentally, Trump's timing might not be better because China's middle class is rapidly expanding… as is India's, too. An expanding middle class means expanding demand for an upgraded diet that includes more luxury items like red meats, and pork. Leaving environmental issues aside for the moment, the U.S. has considerable capacity to produce more of what China needs moving toward 2020 through 2025. Until China and India can expand meat production, the U.S. can step in with exports. China, Japan, and India are ready to deal and Trump is stepping in just at the right time.

American farmers may be in for two decades of added prosperity because agriculture is the obvious first step. It makes everyone happy and fulfills an important need for expanding economies. This means higher prices for grains, meats, and even lumber if the U.S. begins to level the playing field across the board. This does not mean we should all pile into the long side of futures. Near term prices will still be more responsive to near term fundamentals. My point is that we must pay close attention to exports when evaluating market fundamentals. Alas, I am old enough to remember the Russian Wheat Deal that drove prices from under $2.00/bu to more than $6.00/bu in 1972. I am not sure the Trump team will exercise caution in limiting deals to prevent a blowout for U.S. consumers.

Trump's potential pick for Secretary of Agriculture has been shadowed by the debate over Secretary of State. Last month Sam Brownback, the Kansas Republican governor was a potential pick. I am not sure Brownback wants to give up his governorship, but we see the type of individual Trump is seeking; someone who knows farm economics at the micro and macro levels. Don Villwock, the retired Indiana Farm Bureau president is another possibility along with Ted McKinney, Indiana Department of Agriculture director. Mike Pence is familiar since he is Indiana's Governor. The other possibility might be former Texas Governor Rick Perry, a more political and managerial figure. I would lean toward an Ag man.

I hope farmers are paying close attention to this. Farm policy over the next four to eight years is likely to be dramatically different and it is important to prepare for all the possibilities. The good news is that the incoming administration is already very farm friendly. Farming states represent a large part of the Trump constituency. For example, most people don't know the Pennsylvania Farm Bureau is second in size to Iowa. Farming drives a good portion of state economies and a revitalization of farm exports will have a broad impact on "Trump states."

Strong U.S. Dollar

One impediment to U.S. exports is the strong U.S. Dollar. Some perspective is appropriate. In the 1970s the U.S. Dollar dominated with an indexed value well over 100. The only stronger currency on a ratio basis was the British Pound. Keep in mind that the world weaned off the Gold Standard and moved to floating exchange during that decade. By the 1980s we saw a full scale currency "competition." It wasn't quite a "war," but close. Japan manipulated the Yen to half a Dollar and quickly began decimating U.S. electronics manufacturing. Everything was "Made in Japan." Within the next decade, Japanese cars and light trucks were eating U.S. auto manufacturers. It was Japan's efficiency combined with currency manipulation that encroached upon the American model more than cheap labor.

Today, it is a combination of currency differentials and cheap labor that stacks the deck against Made in America. There is nothing Trump can do about cheap labor, but he can try to negotiate better currency parities. His problem is that currency parity depends upon financial incentives more than trade. Currency has become a speculative commodity subject to changes in interest rates rather than trade. I mentioned the "circle game" where the U.S. buys Chinese goods and China buys U.S. Treasury debt in previous REPORTS. This will play into an overall strategy that faces far more complex challenges than the "talking heads" in the financial media are presenting.

I mentioned that Trump accepted gold bar as security deposits for some of his rental properties. Look at his Tower and penthouse apartment. Gold's his favorite color. Of course, gold is in the dumps right now and I would not rush out to speculate on the long side of futures. On the other hand, gold can be the stabilization factor in a Trump strategy moving forward. So, we must be very careful! If you haven't accepted it by now, let me reiterate… Trump is highly unpredictable! DUH!

Part of leveling the playing field must be addressing currency differentials. This gimmick has to be neutralized. As said in the "Untuckit" shirt commercial, "…not so easy to do!" Here's the thing; recent wild swings in currencies are a global problem. It is out of hand. The European Central Bank (ECB) is realizing that the European Union (EU) experiment may very well unravel because of the common currency relative to uncommon member economies. This means they are ripe for negotiating a regulatory mechanism. At the same time, China knows they are dealing with a changed political environment. Trump has sent a clear message with his Taiwan phone call.

Even with the political experts crazed about "the phone call," China cannot afford to abandon Western markets. In reality, Trump holds the better hand. China needs the U.S. and European markets. But, China also needs to expand its imports to unload accumulated foreign surpluses. Now may be the most expeditious time to begin converting stored paper currencies into usable assets. Whether you were for or against Trump, we're all in the same canoe now, and we had better keep an open and agile mind if we want to float with this new President!

December 8, 2016
Philip Gotthelf
Commodity Futures Forecast
P.O. Box 566, Closter, New Jersey

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