The Weekly: Trump's Apple Cart

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29/10/2018
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The familiar headlines are back in the news with ‘billions wiped off stock markets’. This reminds us that we never did see the other headlines talking about the billions added in recent years, but then that doesn’t grab headlines. The factors behind the recent market falls are not new. Rising interest rates in the US, trade tariffs and the resulting potential for slower global growth are the key ones, but there is also an under-current of political disruption. Given the factors are not new, why are they biting now?  

Markets had for a while waved away concerns over global trade tariffs, and of course these take time to impact, however we suspect they are now being felt at the company and economic level. There had been plenty of warnings about the inflationary impact, but there is also the uncertainty created, something markets really don’t like. This in turn points to a likely slowdown in global growth. Inventory stock piling ahead of the tariffs appears to have been happening which will preserve profit margins for a while. However, some time next year, US manufacturers will have worked through their imported tariff-free steel and aluminium and have to either take the profit margin hit or raise prices.

US interest rates have risen steadily, something the Federal Reserve Bank had been keen to do, and a further rise is planned for this year and three for the next. On the one hand, rising rates is a sign the US economy is doing well but it means costs rising across the board for consumers and businesses. Globally, debt issued in US Dollars is more expensive to service. In Asia and the Emerging Markets where there has been a lot of US Dollar debt issued, it is going to suck liquidity from the system. Also sucking liquidity out is the rising oil price – although it’s fallen back over the past few days, it’s still a lot higher than in January and this is not helped by the Saudi consulate issue in Turkey.

US corporates have been buying shares back and enhancing their income, which has helped buoy share prices. This has been funded by tax cuts and the repatriation of cash held overseas. This is a one-off technical factor and not repeatable long term. So there is growing concern over future earnings, and the market is not in a mood to be kind to those who undershoot as we saw with Google and Amazon last week. Most administrations either tax more to spend more or the opposite. However, Trump is proud to promote the biggest tax cuts and the biggest spending plans to deliver on his populist campaign pledges. Not surprisingly this will have to be funded by the biggest government debt issuance but of course, he won’t announce or celebrate that one. His concern should be focused on who will buy the colossal issuance – surely not the Chinese as before. Perhaps this will be how they play their long game by starving the US of funding capital. Either way, as a politician, you have to promise what you believe you can deliver without upsetting the apple cart. Trump’s apple cart is accelerating away at a speed beyond that of the original design with an ever increasing chance that the wheels will come off.

In the wings we have Brexit, although on the global stage this isn’t a big issue for most investors. There are Italy’s financial woes, and as their economy is much bigger than Greece’s, there has been talk about the EU/IMF not being able to bail them out. More positively for Italy, the government has said it has no intention of exiting the EU and Euro – we suspect a compromise will be reached after some degree of brinkmanship.

Looking forward, the question is whether this is a time to buy the dips or are we in for more serious falls? Unsurprisingly the crystal ball is clouded. As said earlier, none of the factors at play here are new, and interest rates remain low as is inflation with the US perhaps being an exception. Forward looking economic indicators for most countries are in positive territory although they have been weakening. Trade tariffs are having an impact and re-shaping some relationships, but some have been resolved quickly, observing Canada and Mexico. China/US trade issues may take a little longer but ultimately a deal should be done. However, China can afford to play the long game as it has no democratic political pressure to deliver a solution.  

Asia and emerging markets have taken the biggest hits, but on a valuation basis look increasingly attractive.  In a similar way, we may see stocks which have been out of favour becoming popular again, a boost for value investors. Of course the Fed can change its mind about raising interest rates and will do so if US growth really does start to slow. However they will not want to be seen to bow to pressure from Trump, but ultimately he has set them up to be the fall guy if the US economy stalls.

After a long period of strong market growth it’s normal for consolidation to happen, but it’s never comfortable, and we think this is what we’re seeing. Our expectation is for more volatility, and potentially more falls, but not a bear market.  Consequently, we think buying the dips may prove a good strategy, but catching the bottom is nigh on impossible. These fears are not likely to be forgotten quickly as the China/US trade war rumbles on, as does Brexit and the rise of European populism. On this last point, Angela Merkel’s announcement opens the door to the inevitable within Europe – more populist and nationalist influence. However, most countries want the stability the Euro provides but want the flexibility to decide their own fiscal fate. Talk about the UK wanting its cake and eating it!

So, at times like these, focus on the long game and try to rationalise the headlines into a balanced view and a future when Trump and Brexit are consigned to the history books.

Market slide continues despite US growth data

Most major equity markets lost further ground during a week that saw US economic growth data surpass most forecasts. The FTSE 100 index succumbed to a weekly decline of -1.6%, whilst the US S&P 500 dropped an eye-watering -3.9% (1).

Economists’ expectations for Q3 GDP were for a slower rate after Q2’s 4.2% growth and whilst the pace did moderate to 3.5%, this was comfortably above most forecasts (1). This advance reading of gross domestic product is largely based on incomplete datasets and is subject to revision with two further estimates over the next two months. Business investment was shown to have slowed substantially, whilst consumer spending levels were more resilient. Current market concerns stem from the impact of trade tariffs, rising rates and a strong US Dollar starting to impact US corporates. Earnings season for Q3 has shown a slide in revenue growth and an increasing number of companies pointing to the above headwinds. US 10-year Treasury yields, having risen as high as 3.26% during the month, drifted 13 basis points lower last week to close at 3.08% (1).

European markets were also not immune to the market slump; Germany’s DAX 30 index slipped 3.1% whilst the French CAC 40 fell -2.3% (1). European Purchasing Managers Index (PMI) data, a measure of business activity levels, broadly speaking showed falling levels across Manufacturing and Services sectors. The eurozone composite index now stands at 52.7 and whilst this still represents growth, it is a 25-month low (1).

With little word from either the UK or the EU on a workable solution to the Irish border issue, most investors appear to be accepting an increasing likelihood that the UK will seek an extension period in which the UK remains in the EU customs union.

Commodities endured a mixed week, the price of oil slipped back -2.7% to $77.62 per barrel at Friday’s close (1). Gold meanwhile showed resilience as the precious metal’s safe haven properties shone through in difficult markets, climbing +1.3% for the week (1).

Source:  Thomson Reuters DataStream 2018 (1)

Week Ahead

UK investors this week will of course focus on the Budget, delivered by Chancellor Phillip Hammond this afternoon. The Bank of England is also scheduled to hold its latest policy meeting this week, (Thursday) however there is little appetite for policy change as economists’ consensus forecast suggest a 9-0 vote in favour of no change. Furthermore, Manufacturing and Construction PMIs due on Thursday and Friday respectively, will measure activity levels in these sectors during October. 

Overseas, the first Friday of a new month brings the latest US Labour Report. Non-farm payroll data, the unemployment rate and wage growth numbers will as always form the bulk of the report. Meanwhile, the Bank of Japan holds its own monetary policy meeting, scheduled for Wednesday, whilst a flash GDP estimate is the highlight for European investors on Tuesday (2).


Source: Forex Factory 2018 (2)