If It's Raining in Brazil, Buy Starbucks

By Peter Navarro

Global financial markets are part of a much larger world, a world of fluid government policies, political unrest, and other unpredictable forces.

If It's Raining in Brazil, Buy Starbucks quantifies how far-reaching factors affect stock prices, and how investors can trade more effectively by understanding the links between these forces and the stock market. It focuses on specific macroeconomic forces and which sectors of the economy react to different indicators, providing investors and traders with clear signals on whether to buy, sell, or sit on the sidelines.

Unlike more targeted investing titles, Peter Navarro's insightful book contains benefits for all investors­­from day traders to long-term, buy-and-hold investors. Simulations and analyses, along with real-life examples and case studies, provide inside details on:

• How to profit from specific technological change
• Strategies to trade effectively in times of recession or inflation
• Which economic indicators to follow­­and why

• Language: English
• Publisher: McGraw-Hill Education
• Release date: Sep 10, 2001
• ISBN: 9780071416115

Peter Navarro

PETER NAVARRO (LAGUNA BEACH, CALIFORNIA) is one of only three senior White House officials who remained with President Trump from the 2016 presidential campaign to the end of his first term in office. Navarro was director of the Office of Trade and Manufacturing Policy, served as policy coordinator for the Defense Production Act during the pandemic, and was a principal architect of Trump’s tariff, trade, and “tough on China” policies. Navarro is a noted China scholar, sought-after public speaker, and award-winning professor emeritus at the University of California-Irvine. His numerous books include the bestselling Taking Back Trump's America, In Trump Time and The Coming China Wars, and he has delivered keynote speeches to audiences around the world. Navarro holds a Ph.D. in economics from Harvard University, a master’s in public administration from the Kennedy School of Government, and a B.A. from Tufts University. He has appeared frequently on ABC, CBS, NBC, CNN, MSNBC, Fox, Bloomberg, and CNBC. The author lives & works in the Los Angeles metro area. www.peternavarro.com

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Prologue

On March 10, in the year 2000, the Nasdaq stock market index burst exuberantly through the 5000 barrier and reached an all-time high of 5132. But even as the Nasdaq was reaching this historic peak, powerful macroeconomic forces were gathering to bring this raging bull to its knees.

The first macrowave blow struck was a regulatory one. It came during the weekend of April 2 when lawyers from Microsoft and the U.S. Department of Justice tried to hammer out an eleventh-hour compromise in the government’s antitrust suit against the software giant. The talks collapsed amid arrogance and acrimony, and when the Nasdaq market reopened on Monday, it wasn’t just the stock of Microsoft that went into the tank. The Nasdaq index plummeted a record 349 points.

The second macrowave blow came quickly on the heels of this Bill Gates debacle, and it was an inflationary one. On April 14, the Bureau of Labor Statistics released data indicating that the Consumer Price Index had taken an unexpected, sharp upward jump. This bleak macroeconomic news sparked a widespread market panic and caused the Nasdaq to plunge 355 points.

With the Nasdaq reeling, Federal Reserve Chairman Alan Greenspan came in with what, in hindsight, would be the knockout macrowave punch. On May 16, Greenspan’s Fed raised the discount rate by 50 basis points. This was not only the sixth Fed interest rate hike in 11 months, it was also the largest. For those traders and investors who had already suffered large paper losses but who still hoped against hope that the Nasdaq would shrug off its fears and quickly regain its lofty heights, this was a stake through the heart.

Indeed, the Nasdaq index would wind up falling over 2000 points in less than three short months. This massive, 40-percent decline not only erased billions of dollars in paper profits for millions of investors, it also completely wiped out thousands of investors who had ridden the Nasdaq wave up on a sea of margin buying and who had been caught without enough cash to cover their margin calls. In the process of this Nasdaq wipe-out, hearts were broken, homes were lost, dreams were shattered, and the biggest of chills descended over an entire generation of investors weaned on upward momentum and extravagant dot-com wealth.

Sad to say, the macrowave worst was still not over. Not by a long shot. For six months more, the market tried desperately to rally—even as thousands of equally desperate traders and investors hung on for dear life. But every time the Nasdaq tried to pull its bloodied and beaten index off the canvas, another roundhouse macrowave punch would come along to slam it back down.

First, there was an avaricious OPEC cartel and a sharp spike in oil prices. This particularly battered transport and technology stocks. Next, there was a severely weakening euro and a dollar far too strong for its own good. This lethal combination not only hit America’s export industries and trade deficit hard, it also threatened to provoke an international currency crisis. Finally, even as Greenspan’s ever-higher interest rates began to take a heavy toll on the earnings of virtually every big-name stock, the nation was hit with the ugliest of presidential election controversies. The ensuing storm cloud of legal and political uncertainties over whether George W. Bush or Al Gore would ultimately be president turned out to be absolutely toxic for both the economy and the stock market.

The result was nothing like the elegant soft landing that Alan Greenspan had futilely tried to engineer. Rather, it was a harsh recession, a Nasdaq sliced in half, a whole army of New Economy stocks left garroted along the information superhighway, and a whole new generation of online traders and investors left gutted by the roadside.

Out of this cataclysmic experience, one lesson has emerged with crystal clarity: Any trader or investor who ignores the power of macroeconomics over the world’s financial markets will, sooner or later, lose more than they should—and perhaps more than they have.

The purpose of this book is to help you become a macrowave investor. This is an individual who not only can learn to jump out of the way when the macroeconomic freight train is coming, but who can also jump on that train and ride it for a profit—whichever direction it is going.

Introduction

The Federal Reserve hikes interest rates, consumer confidence falls, war breaks out in the Balkans, drought shrinks the coffee crop in Brazil, oil prices spike sharply in Rotterdam, Congress passes new Medicare legislation imposing price controls on prescription drugs, and the U.S. trade deficit reaches a new record high. Each of these macroeconomic waves—some of them thousands of miles away—will move the U.S. stock market in very different but nonetheless systematic and predictable ways. If you come to fully understand these macrowaves, you will become a better investor or trader—no matter what your style of investing or trading is. That’s the power of macrowave investing, and that’s what this book is about. Let me show you what I mean with just a few examples of some fictional microinvestors in very real situations.

• Jim Fleet is a day trader and a very good one. Typically, he follows a momentum strategy to scalp teenies. That is, he buys or shorts large volumes of a stock based on a stock’s up or down momentum. He never holds the stock for more than a few minutes, and he makes his money when the stock goes up or down by a teenie— of a point—or more. With working capital of $50,000, Jim usually rakes in about $2,500 a week. Yesterday, however, he lost $20,000 on a Wal-Mart stock play after a computer glitch cut off his access to the market for a few minutes. During that time, the Conference Board released data showing a very sharp and unexpected drop in consumer confidence. Minutes after CNBC reported this news, stocks in the entire retail sector swooned. By the time Jim got back online, Wal-Mart was way down and Jim was out a month’s profits.

• Jane Ellington is a swing trader who typically buys or shorts a stock over a one-to-five-day period. Her strategy is to use technical analysis to identify higher-volume and moderately volatile stocks that are trading comfortably in a range. Then, she buys on the dip and sells on the peak. Over the last year, Jane has used this strategy to make about $500 a week, which is a very nice supplement to her regular salary as a marketing executive. However, last week, she lost $8,000 on one trade after the government released the monthly Consumer Price Index data. These data showed the core rate of inflation spiking sharply upward. The entire market promptly tanked, and Jane—oblivious to the news—got caught in the downdraft.

• Ed Burke is an ex–Navy petty officer and a retired petroleum engineer. He’s a pretty conservative buy-and-hold investor who likes to hold a large portion of his portfolio in blue-chip oil stocks like Chevron and Exxon. Last May, in the space of just three weeks, he made $40,000 in paper profits when the price of a barrel of oil rose steadily from $26 to $39, and Jim’s oil stocks moved up sharply. However, after the OPEC cartel met in June and relaxed its production quotas, oil prices began to fall back down. By July, when oil prices had sagged to $20 per barrel and dragged oil stocks down with them, Ed’s $40,000 paper profit had turned into a $10,000 paper loss—a swing in the value of his portfolio of some $50,000.

Now obviously, these three investors are as different as night and day in both their trading strategies and investing styles. However, they all share one thing in common. They all lost money because they chose to ignore the powerful impact that macrowave forces can have on the stock market.

Sure, it was bad luck that Jim had computer problems. However, Jim also knew, just like any good day trader knows, that computers can crash at any time. Knowing this, Jim could have easily avoided trading a retail sector stock on a day when data on a major economic indicator like consumer confidence were to be released—if only he had been thinking like a macrowave investor.

As for Jane, the worst thing a technical trader can do is to ignore broader macroeconomic signals like a possible inflationary spike or sharp rise in the unemployment rate. This is because it is precisely such macroeconomic shocks that can throw all stocks abruptly out of their trading ranges and, at least temporarily, render technical analysis meaningless.

Of course, Ed may have been doing the right thing—at least for Ed. That’s because, by temperament, he is a long-term investor who likes to buy and hold blue-chip stocks with strong fundamentals and not worry about fluctuations in paper profits. On the other hand, if an investor like Ed is going to have a portfolio that is so heavily weighted in a particular sector like oil, rather than be diversified, it borders on foolishness to ignore macrowaves that can strongly influence that sector. Indeed, in this case, if Ed had simply been paying attention to price movements in the world oil market, he’d be $40,000 richer rather than $10,000 poorer.

The broader point of these examples—and the ultimate point of this book—is that regardless of what kind of trader or investor you are, a deeper appreciation of the systematic effects of macroeconomic events on the stock market can help you in your trading and investing decisions. Moreover, such a macrowave perspective can help you in two very specific and very profitable ways.

First, by adopting a macrowave perspective, you will be much better able to predict and anticipate broad trends in the market. Will the stock market be up or down today? Or next week? Or even next year? This is powerful information to arm yourself with because you never, ever want to trade or invest against the trend. That was Jane Ellington’s mistake, and it cost her dearly.

The second way that a macrowave perspective can help you is equally powerful. As we shall soon see, even in an up-trending bull market, some sectors like computers or electronics may rise much faster than others like chemicals or autos. Moreover, in a bear market, some sectors like housing and technology may fall much farther and faster than other so-called defensive sectors like food and pharmaceuticals that can provide you with much safer investing havens.

The good news here is that a macrowave perspective will help you identify the key sectors to trade in—or stay away from!—given particular kinds of macroeconomic news. In this sense, a macrowave perspective serves as a powerful trading compass, and it is just such a compass that both Jim Fleet and Ed Burke in our examples above could have used to a very profitable advantage. Here’s the roadmap we will be following:

Part One lays down the analytical foundations of macrowave investing. This begins in Chap. 1, where we will systematically work our way through the various kinds of macrowave forces that can bear down, buffet, or buoy the various U.S. and global financial markets. These macrowaves range from inflation, unemployment, and slower economic growth to earthquakes, wars, and international currency crises.

In Chap. 2, we turn to what should be both an entertaining and very useful history of the warring schools of macroeconomics. These schools range from Keynesianism, monetarism, and supply-side economics to the latest school of new classical thinking, which is based on the controversial idea of rational expectations. This chapter is important because so many of the decisions on macroeconomic policy that are made in Congress and the White House and at the Federal Reserve are driven by which particular school of economics happens to be in vogue at any particular time.

Chapters 3 and 4 then tackle the crucial task of examining the major tools of macroeconomic policy, principally fiscal and monetary policy. In these chapters, which complete Part One, we will come to understand not only how these policies work but also what their often far-ranging effects can be on global financial markets. For example, when Chairman Alan Greenspan sneezes at the Federal Reserve, Europe very often catches a cold—along with the stocks of U.S. companies that export heavily to Europe. We need to understand why. Similarly, when the OPEC oil cartel raises prices or the Japanese economy goes into a tailspin, the U.S. economy is likely to falter and pull the stock market down with it. Again, we need to understand why.

In Part Two, we get down to the nuts and bolts of macrowave investing. This begins with Chap. 5, which examines the major principles of macrowave investing. Here, we illustrate how a firm grasp of these principles generates profit opportunities. Then, in Chaps. 6 and 7, we examine the stock market from the macrowave investor’s perspective. In these key chapters, we will see that when the macrowave investor looks at the stock market, he or she not only sees companies like Chevron, Compaq, or Wal-Mart. He or she also sees market sectors like energy, computers, and retailing. This is because many of the biggest moves in the stock market are sector-driven rather than company-driven. Quite literally capitalizing on the systematic differences between the various market sectors is at the core of the macrowave investing approach.

In Chaps. 8 and 9, we move on to the crucial topics of protecting your trading capital and managing your investment risks. Then, in Chap. 10, we reaffirm one of the major themes of this book, namely, that any kind of trader or investor can benefit from the power of macrowave investing. This chapter does so by illustrating how macrowave investing can be applied to different styles and strategies of trading and investing.

To complete Part Two, Chap. 11 presents the macrowave investor’s checklist. Here, we see that just as a good pilot methodically goes through an extensive checklist before every flight, so too does the macrowave investor go through a checklist before every trade.

In the third and final part of this book, we turn to the all-important task of illustrating macrowave investing in action. Each of the chapters in Part Three focuses on a specific macroeconomic force such as inflation or recession or productivity. Importantly, the architecture of each of these chapters is the same.

We first learn about which economic indicators like the Consumer Price Index and the Jobs Report are the most important to follow and when the data for these indicators are regularly released. Then, we move to the crucial task of examining how each particular macroeconomic force might affect different sectors of the stock market. This analysis is the heart and soul of this book; it is from this analysis that you, the savvy macrowave investor, are most likely to profit.

For example, when we look at inflation in Chap. 15, we will see that interest-rate sensitive sectors like banking, brokerage, and retail typically react the strongest to inflation news, while defensive sectors like utilities, energy, and consumer staples react the weakest. Using this kind of information, you can buy into the strongest-reacting sectors on good inflation news or short-sell on bad news—or simply flee to the defensive sectors for shelter.

It is important to note that each of the chapters in Part Three is modular. That is, each stands alone and, in fact, the chapters can be read in any order. Because of this, you should find this book to be a very useful reference volume for your financial market shelf once you’ve read it. This is because you’ll be able to consult the book every time you want to refresh your memory as to how the markets are likely to react to the latest piece of impending macroeconomic news.

With this, then, as our roadmap, let me provide you with one cautionary note. Because Part One of this book lays down our macroeconomic foundation, it may, at times, be a very challenging section to read. But take heart. Once you get to Parts Two and Three, it will be all smooth sailing. And all that hard work you did getting through the important conceptual material in Part One will pay off for you many, many times over. That’s my promise to you, and it’s a promise based on my years of experience developing the ideas in this book. So with that said, let’s get started with the power of macrowave investing!

PART 1

Laying the Foundation

CHAPTER 1

RIPPLES AND MACROWAVES

Despite excellent management and a solid fundamental outlook, Starbucks’s stock has dropped more than 8 points in the last several months. At this point, the savvy macrowave investor notices a small article on the back pages of the Wall Street Journal indicating that the rains have come to break a deadly drought in Brazil—the world’s largest coffee producing nation.

On this news, the savvy macrowave investor buys several thousand shares of Starbucks. She’s betting that the rains will save the Brazilian coffee crop, that this will cause coffee prices to fall dramatically, and that this, in turn, will drive up Starbucks’s profit margins as well as its stock price.

Over the next week, Starbucks’s stock falls 2 more points, but the macrowave investor sits tight. Finally, the stock begins to rise—and quickly—10 points in three days. She sells her shares and is out with an $8000 profit.

Every time a new macroeconomic wave hits the economy, its impact ripples through the U.S. and global financial markets in both systematic and predictable ways. For large and unexpected macroeconomic events, these ripples can turn into a tidal wave.

One example of a small ripple is offered up by our Starbucks example: Rain in Brazil leads to lower coffee prices in the wholesale market, and coffee retailers like Starbucks enjoy higher profit margins and a rising stock price. On the other hand, one example of a macroeconomic tidal wave might be something like the Asian financial crisis of the late 1990s, which was sparked by the collapse of Thailand’s currency. This crisis not only sent both the Dow and the Nasdaq markets reeling, it also brought down stock exchanges around the world—from the Nikkei in Japan and Hang Seng in Hong Kong to the London Footsie, Frankfurt Xetra DAX, and Bombay Sensex.

In this chapter, I want to introduce you to the major macroeconomic waves that bear down on any economy. These macrowaves range from inflation, recession, and falling productivity to war, drought, and burdensome government regulations. In this chapter, I also want to show you how you can use a powerful tool known as macrowave logic to help you calmly navigate your portfolio through any rough macroeconomic seas.

THE POWER OF MACROWAVE LOGIC

Macrowave logic is about being connected to the markets. To understand this kind of connection, consider these questions: If inflation increases, what will happen to interest rates? If interest rates rise, will the value of the dollar go up or down? If the dollar goes up, what happens to the level of exports, imports, and the trade deficit? If the trade deficit increases, which industry sectors and company stocks will be winners to buy and which will be losers to avoid or sell short? These are precisely the kinds of questions that the savvy macrowave investor seeks to answer daily as new macroeconomic events unfold. The primary tool in this thought process is macrowave logic.

For example, the macrowave investor knows that if inflation increases, the Federal Reserve is likely to raise interest rates. If interest rates rise, the value of the dollar will, in turn, go up because higher interest rates will attract additional foreign investment. The important link in this particular chain of macrowave logic is that in order for foreigners to invest in the U.S., they must first exchange their foreign currencies for dollars. This increased demand for dollars will bid the price of the dollar up.

Now, what will a stronger dollar do to the trade deficit? The macrowave investor knows that the deficit must increase. This is because a stronger dollar will increase the price of U.S. exports and make foreign imports cheaper. So U.S. companies will export less, U.S. consumers will buy more imports, and voilà, the trade deficit swells.

So who wins and who loses in the stock market? Certainly, export-dependent sectors like agriculture, pharmaceuticals, and steel are likely to see lower profits as their exports fall, so loser stocks like Nucor and Merck may well be ones for the macrowave investor to avoid or sell short. On the other hand, foreign-based companies like BASF and BMW and Ericcson that import heavily into the U.S. market may see their profits rise. These winners from the stronger dollar may be good stocks to buy.

The broader point, of course, is this: Macrowave logic draws upon well-established relationships between key macroeconomic variables such as inflation, unemployment, and interest rates. It uses these relationships to visualize the often-lengthy chain of events that begins with a new macroeconomic event such as inflationary news and ends with a major move in an individual stock’s price. Using this visualization process, the macrowave investor forms expectations about the direction of the market trend, movements among the market sectors, and the direction of stock prices themselves. These expectations form the heart and soul of his or her trading decisions or macroplays.

Our introductory Starbucks’s macroplay was a relatively simple application of macrowave logic. Here are several more macroplays:

• The U.S. Justice Department announces plans to break up the Microsoft monopoly. While the microtrading herd rushes for the exits and Microsoft stock plunges, the savvy macrowave investor quickly realizes that the share prices of both Sun Microsystems and Oracle should benefit from the news. This is because these companies are two of Microsoft’s main rivals. So the macrowave investor quietly buys several thousand shares of each. Several weeks later, he exits the position with a $12,000 profit.

• United Airlines announces the acquisition of U.S. Air to make it the largest carrier in the world. While speculators are trampling over each other trying to get on the U.S. Air bandwagon, the savvy macrowave investor quietly buys Northwest Airlines. She knows that within days Northwest must become an acquisition target of either Delta Airlines or American Airlines—the main rivals to United. A lucky 13 days after the merger announcement, the macrowave investor exits her Northwest position with a 10-point gain.

• Tomorrow, the savvy macrowave investor knows that the government will release the latest Consumer Price Index data. Tame CPI numbers will likely have little impact on the market. However, if the CPI shows an inflationary spike, the market will drop sharply on fears that the Federal Reserve will hike interest rates. This looks like an excellent macroplay to the macrowave investor—one with a small downside risk and a very big upside. So just before the market’s close, he shorts 2000 shares of QQQ—a stock that tracks the Nasdaq index. At 8:30 the next morning, the CPI numbers are a horror show, and the Nasdaq plummets. The macrowave investor cashes in half his position for a 10-point gain by noon. Three weeks later after the Federal Reserve hikes interest rates another 50 basis points and QQQ has dropped another 15 points, the macrowave investor cashes in the rest of his position for a total profit of $35,000. Time for a week in Maui. Thank you, Alan Greenspan.

I hope these macroplays have made the point that macroeconomic events move the markets. What we want to do next is briefly review each of the major macrowaves that you will want to follow closely as you plan your trading and investing decisions and strategies. These macrowaves are listed in Table 1-1 along with some of the major economic indicators or information sources used to track these waves.

TABLE 1-1. Major Macrowaves and Their Indicators

THE INFLATIONARY TIGER

U.S. stock markets ended a volatile week with record single-day plunges in the Dow Jones Industrial Average and the Nasdaq Composite Index.… The free fall was ignited by the early-morning release of a monthly Labor Department report on inflation.… The inflation report raised fears that the Federal Reserve…would raise interest rates higher than an expected quarter-point increase at its upcoming session in May.

WORLD NEWS DIGEST

The inflationary tiger is the scariest cat on Wall Street. When this big, bad cat is on the prowl, the bears come out and the bulls run for cover. So what is this beast and how do we know when it has crept into our economic village looking for prey?

Technically, inflation is defined as an upward movement of prices from one year to the next. It is typically measured by the percentage change in price indexes such as the Consumer Price Index, the Producer Price Index, or the Employment Cost Index. In stalking the inflationary tiger, you must first be aware that there are at least three species of this very dangerous beast. There is the demand-pull variety that comes with economic booms and too much money chasing too few goods. This tiger is perhaps the most easily tamed—although with inflation, nothing is ever truly easy. Then, there is the cost-push variety that follows supply shocks such as oil price hikes or drought-induced food price spikes. This inflation moves with deadly swiftness, inflicts great pain, and often gives the Federal Reserve fits. Finally, there is wage inflation. It can be the most dangerous of all, slow and plodding though it may be, and it is often triggered by both demand-pull and cost-push pressures.

If you are unable to quickly and clearly distinguish between these three species of inflationary tigers, you will be prone to misinterpreting the real messages of economic indicators like the Consumer Price Index and Producer Price Index. The likely result will be that one of these inflationary tigers will eat your trading capital for lunch, belch loudly, and then move on with nary a thank-you. This will be true for one very simple reason: In the face of inflationary news, both the Federal Reserve and Wall Street are likely to react quite differently depending on which species of the inflationary tiger they actually fear.

For example, while the Fed is likely to raise interest rates very swiftly when demand-pull inflation is pushing up the core rate of inflation, it is likely to be much more cautious when supply side shocks like energy or food prices are creating cost-push inflationary pressures. If you get caught on the wrong side of such reactions, you will be doomed!

THE RECESSIONARY BEAR

The nation’s unemployment rate, the most politically sensitive economic indicator in an