The Weekly: Crying Wolf

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17/09/2018
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There is a growing body of bear stories out there at the moment, all clamouring to call the end of this bull market. The biggest global issue appears to be Emerging Markets and the Asia-Pacific region as Donald Trump continues to push ahead with his tariffs against China. Meanwhile, for the UK investor, Brexit is never far from the media headlines, which all serves to deliver a tumultuous environment for investors.

We at Rowan Dartington have also been advising clients to be careful and perhaps not be too eager to buy sectors with strong momentum such as US Technology or sell the unloved such as tobacco or telecoms. Those of a certain age can remember the extreme polarisation ahead of the TMT bubble and the associated technology sector euphoria and old industry revulsion that existed at the time. Neil Woodford made his name at this time for sticking to his guns, as did Anthony Bolton of Fidelity whilst others such as Tony Dye of UBS, called the top too soon and fell on their sword, as impatient investors and managements demanded blood. Making bold market calls is a dangerous game in pursuit of guru status.

Crying wolf about market levels is an easy viewpoint for a commentator to take, from a personal damage perspective. If you are wrong, profits are foregone but nobody loses anything substantial. However, if you promote a bullish stance and you get it wrong, losses are experienced and investors are at least twice as emotional regarding losses as they are about gains. Markets have ignored the sirens over the last few years and powered ahead regardless with temporary hiccups along the way, such as Brexit, Trump, Chinese growth, US wage growth and now trade tariffs. As each potential market crisis comes over the horizon, investors are inclined to discount it and move on very quickly indeed. Take the August scares around Turkey, Argentina and Venezuela. Weakness in Emerging Markets has more to do with the strengthening US Dollar than any fears about contagion from these countries. However, they could be symptomatic of a far bigger issue involving Emerging Market debt, which is being exposed as the US Dollar appreciates and US Dollar denominated debt becomes more expensive.

However, it should not be forgotten that the whole reason the phrase ‘crying wolf’ exists is because eventually a wolf arrives and everybody ignores it due to historical false alarms which have caused complacency. Past performance becomes an assumed guide to the future and at the time, the new worry is discounted and we all move on. Many an investment career has been tarnished due to a fund manager taking a bearish position, moving to risk-off or even shorting the market, only to be proved wrong over time and pilloried in the media – Crispin Odey springs to mind. One thing we can be sure of is that there is a correction coming, there will be a market crash in the future and that there will be a black swan event that scares everyone into panic. The problem is, the market could rise by another 20% before that happens and it may not happen for another 3 years, during which time, any professional investor who positions for it now will lose their job. Following the crowd and positioning with the herd never leads to unilateral career destruction. Being moderately bearish with bullish caveats in case you are wrong is the current order of the day and all current bears are guilty of this as they don’t want to be the next Crispin Odey, who incidentally is having a much improved year in 2018 with the return of volatility.

That said, the degree of monitoring and 24/7 communications that we enjoy today mean that when potential issues emerge, they instantaneously spread around the globe for all to analyse and assess. When Lehman’s went bust ten years ago, it took a few days and weeks for the true ramifications to be fully understood. The most useful lesson from that whole debacle was that no strategically important financial institution will probably be allowed to fail again. In addition, at the time, policy makers hadn’t invented the policy of Quantitative Easing, the ultimate recapitalisation action, of which the mere existence puts a floor under financial meltdown fears. Mario Draghi only has to utter his phrase of ‘doing whatever it takes’ and everybody knows what he means and relaxes.

2018 is not turning out to be a good year for investors. A balanced portfolio may have eked out returns to match inflation but not much more. Taking the disaster scenario of an escalating trade war leading to global growth slowing rather more than expected, the reality is that interest rate expectations will correspondingly fall. This will be taken positively by the equity markets and even if growth is stunted as the tariffs work through, we are not talking about a recession as such. Trump’s policy of America First to reduce the trade deficit to create jobs is somewhat misguided when the economy is already operating at full employment levels, with wage growth starting to come through. Businesses will hardly relocate back to the US if they can’t get the skilled workers they need. Globalisation is almost impossible to stop, as is the natural evolution of manufacturing moving to the cheapest location. Whilst Trump’s focus may be on rebalancing the trade deficit with many countries, in order to win votes from his heartland, his mission against China may be rather different in that he wishes to restrain their economic rise to becoming a superpower to rival the US. This includes US paranoia about Chinese military ambitions, as shown by their military expenditure approaching 75% of that of the US. Last week’s Chinese war games with Russia, which followed the cancellation of those of the US with South Korea sends a strong message.

So, rather than chasing the technology darlings, which should be retained to some extent as the likes of Amazon and Apple continue to grow and deliver profits, emerging markets and other economies surrounding China are likely to benefit as Chinese exports to the US get more expensive. Even in the UK, as and when a grand Brexit fudge deal is announced, there is value if you can look through the current fog of negativity to a post-Brexit world. Just maybe, when many are crying wolf over Brexit, the infamous wolf won’t arrive as anything other than frictionless trade borders is as unpalatable to the EU as it is to the UK. Quite how we work that one through remains to be seen but many seem to agree that the prospect of a ‘no deal’ scenario is a little like the EU allowing Greece to crash out of the Euro. The potential damage to the motherland is too scary to contemplate and so a compromise will be found, but it will be a drawn out process of brinkmanship, political infighting and posturing. On the bright side, at least there isn’t much left to endure.

Inflation Softens Ahead of Fed Meeting

Last week’s headline US CPI figure revealed a modest reduction in the pace of inflation, the first time that it has pulled back this year. It reduced to an annualised +2.7%, 20 basis points below the decade high set last time with Core inflation, which remove energy and food prices from calculation falling by the same amount to 2.2%. Whilst both numbers remain ahead of the level targeted by the Federal Reserve, several key Fed members, including former Chairwoman Janet Yellen put out dovish statements last week. The Fed is expected to raise rates once again at next week’s FOMC meeting, although the unexpected change in inflation certainly gives the Committee something to consider.

With trade tensions between the US and China showing some signs of easing towards the end of the week, global equity markets were in buoyant mood last week. The standout came from Japan where the Nikkei 225 spiked by more than +3.5%. European equities also rallied strongly with the French CAC40 and German DAX30 rising by +1.9% and 1.4% respectively. In the US, the S&P50 closed the week +1.2% higher whilst closer to home, domestic equities were more subdued with the FTSE100 closing the week +0.4% higher.

Sterling had another positive week, creeping higher against both the Euro and the Dollar. The biggest gain was seen against the Greenback, rising by just shy of +1.0% to take it back above the $1.30 level. Against the Euro, it was +0.2% higher at €1.12. Meanwhile, sovereign debt yields ticked higher on both sides of the Atlantic. 10-year gilt yields were 7 basis points higher at 1.43% with the treasury equivalent climbing by 5bps to 2.99%.

In the commodity markets, oil had another volatile week with the US focused WTI briefly rising above $70.00 a barrel. Brent pushed back above the $78.00 threshold after a weekly gain of +1.6%. Gold had a largely uneventful week with the precious metal virtually flat at just under $1,197 an ounce.

Week Ahead

August’s retail sales data on Thursday morning is likely to draw attention from UK investors this week as the stand-out economic release. The latest Consumer Price Index (CPI) reading on Wednesday will gauge inflation and this is the only other dataset of note on home soil.  Europe will also see updated CPI data as well as the latest set of Purchasing Managers Index (PMI) numbers on Friday, providing a measure of business activity levels in the Manufacturing and Services sectors.

There is limited economic data from the US this week and most eyes will be on the ongoing trade war with China which looks set to evolve further this week. President Trump’s administration plans to unveil new tariffs on an additional $200bn of Chinese exports to the US.

In Asia, the Bank of Japan is scheduled to hold its latest monetary policy meeting this week with a statement expected in the early hours of Wednesday morning – no change to existing policy is forecast.