27 February to 5 March: Less is More

Last week we suggested recent low realised volatility across markets was the result of a standoff between strong economic data and political uncertainty. Investors’ response to Donald Trump’s surprisingly conventional presidential address to Congress on Tuesday, which lacked any real detail but importantly scaled back his usual hyperbole and combative tone, suggests this may be the case.

In particular, Wednesday saw the S&P 500 log its first move of more than 1% for 56 days (+1.37%).² It is therefore our interpretation that, rather than betting on Trump as a source of near-term stimulus, the market is simply keen that he does not “upset the apple cart”.

Elsewhere, incoming economic data and hawkish Fed-speak prompted a large sell-off in bonds, with a rate hike in the US later this month (15th March) now expected.

20 to 26 February: Let’s Be Having You

Our interpretation of post-election trading dynamics for US equities is as follows:

• Investors are reticent to reduce exposure because economic data is resilient, supported by a broader global rebound.
• Investors are afraid to materially increase risk because political uncertainty is heightened and valuations are challenging.

The result has been a consistent rally on record-breaking low volatility. We wonder, however, whether warning signs are now flashing:

• Bond yields have faded the “reflation” trade. The US 10-year yield has slipped some 30bps from its December peak.
• The Trump government is getting side-tracked from its growth agenda. Time and political capital has focused on immigration, staffing and Obamacare repeal, rather than investment and tax reform.
• The FED is getting closer to a 3rd rate hike. After the release of the February FOMC minutes, markets now price over a 60% probability of a May move.
• Technical indicators are suggesting caution. Insiders sold USD 7.8bn of stock in February (most in 6 years) whilst the 14-day RSI for the S&P 500 has breached 70.

On Tuesday the President has a chance to keep the show on the road with the State of the Union address to Congress. Markets will be looking for more detail.

13 to 19 February: The Honeymoon

Not everyone is finding the Donald Trump Presidency straightforward. Foreign leaders have struggled with his “ad-lib” style, the media have provoked his ire with “very fake news” and now the whole of Sweden wondered if they missed something (at a rally on Saturday Trump commented “Sweden, who would believe this?” referencing a non-existent terror attack, possibly confusing the country with Sehwan in Pakistan). However, for now markets like the cut of his jib.

Better sentiment towards emerging markets was also in evidence last week. After recent successful Eurobond issues from Egypt and Nigeria, Mexico’s state-controlled oil company (Pemex) brought the biggest euro-denominated corporate bond deal ever. The EUR 4.25bn transaction was 4x over-subscribed. Egypt’s currency also made substantial gains and has now rallied around 15% against the USD this month. With the help of the IMF, Egypt is making solid progress and represents one of our top picks for 2017.

US markets are closed for President’s Day today.

6 to 12 February: It’s Complicated

In our last issue, we talked about investors being “caught in the headlights”; struggling for conviction as strong economic data contrasts with heightened political uncertainty and (for developed markets) challenging valuations. Market moves this week suggest this dynamic continued – the S&P 500 hit 39 consecutive days without a move of more than 1% (a new record), whilst equities outside Europe climbed the “wall of worry”, moving higher.

Actually, there were potentially a few cracks in the status quo:

• Congenial Trump: after weeks of bashing Japan for currency manipulation, Trump went out of his way to extend a warm welcome to Prime Minister Abe, “The bonds between our two nations and the friendship between our two peoples is very, very deep. This administration is committed to bringing these ties even closer,” then later “When I greeted him today at the car… I shook hands but I grabbed him and hugged him because that’s the way we feel.”
• Mixed Data: although in aggregate still pointing towards continuing economic momentum (China trade data strong), US sentiment and European industrial production disappointed.
• Peripheral Roller Coaster: the Greek 2-year yield touched 10.23% (from below 6% a week prior) before consolidating around 8.5%.
• Central Banks “Internalising”: the RBI India did not cut rates as expected. Not significant in isolation, but following a broader trend of backing away from the monetary Kool-Aid (see also UK, Korea, Malaysia, Indonesia).

30 January to 5 February: Dragging Feet

This week’s market moves, policy announcements and political news flow provided a very good summary of the current outlook. Coincident economic data is unequivocally positive, but investors and central banks are tentative because of a plethora of political risks:

• Trump on immigration, trade, fiscal stimulus (and more)
• Brexit
• French Elections
• Greece (again)
• Italy snap elections

Of course, valuations and liquidity don’t help either; the “inflation and growth scare” has already prompted a sharp repricing, with limited asymmetry in return across most assets. The exception is perhaps select emerging markets.

23 to 29 January: The Appetiser

Many questioned whether Donald Trump would follow through with the wide, and often controversial, range of promises made during the election campaign. His first week in office was busy, but leaves much to follow on the key areas of trade and fiscal stimulus.

Over the first 7 days, the new POTUS announced 17 “Presidential Actions”. These included:

5 Executive Orders – the most formal “actions” available to the President, which are recorded in the Federal Register and considered legally binding (subject to legal review).

• Obamacare Repeal; “Minimizing the Economic Burden of the Patient Protection and Affordable Care Act Pending Repeal”
• Infrastructure Fast-Track; “Expediting Environmental Reviews and Approvals for High Priority Infrastructure Projects”
• Immigration Enforcement; “Enhancing Public Safety in the Interior of the United States”
• Mexican Wall; “Border Security and Immigration Enforcement Improvements”
• Anti-Lobbying; “Ethics Commitments by executive branch appointees”

11 Presidential Memoranda – not legally binding but outlining the administration’s position on a policy issue. These encompassed:

• Defeating ISIS.
• Reducing regulatory burden on domestic manufacturing.
• Restarting construction of various oil pipelines (using materials sourced from within the US)
• Banning US aid to international health groups that promote abortions.
• Withdrawal from the TPP trade agreement (NB: this was never approved by congress).
• A hiring freeze for non-military Federal agencies.

There was also 1 Proclamation recognising January 22-28, 2017 as National School Choice Week.

It should be said that executive orders (where the President uses his personal authority rather than passing a measure through congress) have been implemented by all 45 US Presidents, including Obama on 276 occasions. Indeed, Obama delivered 9 in his first 10 days in office. However, the tone and scope of such orders was starkly different- including closing Guantanamo Bay, equal rights for women and same-sex couples and addressing climate change.² We therefore think the past week’s events confirm a change in paradigm.

However, equally, there was a lot Trump didn’t do. He didn’t impose tariffs or label China a currency manipulator, nor did he provide any clarity on fiscal policy (Speaker Ryan stated the House will have completed a tax reform package by the August recess).

So what to conclude? For the US, in the context of a labour market at full employment, we think there will almost certainly be higher inflation. In terms of growth, whilst there is probably a bias towards a short-term growth acceleration, this depends on trade (negative) and fiscal (positive) policy. Longer term, we are sceptical reduced regulation and infrastructure spend can overcome the forces of anti-immigration and structural stagnation.

For the rest of the world, some perspective is useful. In the special cases of Canada and Mexico, exports to the US represent circa 20% of GDP and the impact of any protectionist measures would therefore be extremely significant. The same dynamics could hold for individual companies and sectors in the US supply chain. However, for other major trade partners, the share of US exports to GDP is much lower (2-5% for China, Japan, Germany and the UK). Moreover, most of the rhetoric has been aimed at China rather than broader trade partners; we expect a series of bilateral negotiations with a more muted impact.³

This week is central bank heavy – BOJ on Tuesday, FED on Wednesday, BOE on Thursday.

16 to 22 January: When the Rubber Hits the Road

Since the 8th November US elections, there has been a sharp acceleration (and in some cases reversal) of asset price moves and market expectations; bonds lower and equities, sentiment surveys and inflation expectations higher (to multi-year highs). We don’t think this is all about Trump. The global economy rebounded in Q4, led by a manufacturing recovery, whilst the US is now arguably at full employment, which creates the potential for a faster FED rate hiking cycle. Nonetheless, as the Mexican Peso attests, Donald’s victory certainly played an important part. The first few weeks of his leadership therefore have the potential to be significant for markets.

We think the global economy has positive momentum that should provide a tail-wind over the next few quarters. However, with respect to the US, additional fiscal stimulus is priced and concrete steps towards government investment (at a 60 year low as a percentage of GDP) and corporate tax review (3rd highest rates in the world) are required to justify the excitement. Moreover, we reiterate our concern that the new Presidency will instead be associated with on-going unpredictability and a primary focus on a divisive ideology. NYU Professor Nouriel Roubeni this week tweeted “Trump Carnage: Protectionist, Nationalist, Isolationist, Unilateralist, Xenophobic, Nativist, Chauvinist, Angry, Depressing “America First”, whilst ex Treasury Secretary Larry Summers commented “My objection is not to disagreements over economic policy. It is to enabling if not encouraging immoral and reckless policies in other spheres that ultimately bear on our prosperity.”

Certainly, politics is likely to prove an increasingly important determinant of relative performance across asset classes, sectors and regions. In terms of the aggregate picture, then it seems to us still more likely that we are seeing a “growth and inflation scare” rather than the start of a full-blooded change in economic paradigm. This is to say, we certainly do not see enough to persuade us of a fundamental shift away from structural stagnation (lower growth). There is perhaps slightly more risk of inflation (both from cyclical positioning and protectionism) – albeit on balance, we expect the dominance of easy monetary policy to continue.

9 to 15 January: Waiting for Donald

Markets hoped President Trump might deliver details of his stimulus agenda last week, but instead witnessed a dis-jointed press conference focused on protectionism and his personal agenda. As highlighted last week, markets face the dichotomy of a better near-term growth outlook and higher political risk across the globe. We tend to think volatility is under-priced (the VIX index sits at 11.54; it has been higher 97% of the time since 1990).

This week US markets are closed for Martin Luther King Day today, Teresa May outlines her Brexit strategy on Tuesday, there is an ECB meeting on Thursday and Donald Trump is inaugurated on Friday.

2 to 8 January: Fast and Furious

Taking 2016 as a whole, growth came in below expectations almost across the board – with the notable exception of China. However, as we start 2017, the global economy is performing better. In particular, after a period of stagnation, manufacturing data has markedly improved; the Markit-JP Morgan global manufacturing PMI rose to 52.7 in December implying the fastest pace of activity since February 2014. Indeed, Greece is currently the only developed nation with a manufacturing PMI below 50 (indicating contraction). This economic strength is relatively broad-based; aggregate economic data “surprise indices” are in positive territory for all regions and headline inflation is also generally rising (and not only because of higher oil prices).

Of course markets have already partly reflected the better data. The MSCI World has gained around 7.5% since the beginning of November, cash holdings for US mutual funds are at 5 year lows and the outperformance of cyclicals over defensives is at extreme levels. But the judgment for investors is not just tactical. There is obvious heightened political risk and great uncertainty as to how markets and the economy will be able to deal with any turn in the interest rate cycle.

As a starter, this Wednesday Donald Trump will hold his first news conference since his election, ahead of his 20th January inauguration.

12 to 18 December: The Importance of Being Earnest

Frequent readers will know of our great interest in the plethora of reforms announced by the Modi government in India since 2014 – and of our positive assessment of the economy over the next few years. The most controversial policy, amongst the raft of changes, has been demonetisation. 86% of cash has been removed from circulation in order to help formalise the economy and increase tax revenue (only 1% of Indians pay income tax). Whilst this has created a significant short-term drag on activity, the policy has remained popular and we see consistent evidence that the negative effects will be transitory, with permanent long-term benefits.

Following the Indian example, on the 11th December, Venezuela attempted a similar exercise. President Maduro announced the 100 bolivar note (worth about 15 USD cents and used for 77% of transactions) would cease to be legal tender within 72 hours. However, unlike the Indian example, the measure has descended into farce. New replacement notes were not ready for circulation and there have been riots and looting across the country (which has the highest rate of inflation and one of the highest rates of violent crime in the world). The exchange has now been delayed until the 2nd January.

We think the contrasting outcomes highlight two important features of the Indian economic story. First, for all the criticism of demonetisation, a hugely abrupt change to day-to-day life in India was implemented in complete surprise and with extremely limited social disruption. Whether you believe the strategy is well-placed or not, the government is showing an ability to execute. Second, the Venezuela parallel stresses the great importance of trust and social cohesion in completing structural reform and monetising underlying growth drivers. To the extent the Modi government can remain earnest, retain the faith of its people, and therefore avoid corruption and self-interest, India has the potential to unlock the largest youth population in the world.

The Global Market Update now takes a break for 2 weeks, returning on the 9th January. This week there is a Bank of Japan meeting, with results due on Tuesday.