Digesting or consolidating?

29 June 2018

A lot of digesting of changed realities seemed to be going on over the course of the week, and that is even before we start to talk football – which for obvious reasons I will refrain from!

Despite a lack of market-moving economic or political news, markets recovered some ground towards the end of the week, as concerns over an imminent trade war appeared to abate. It is emerging market equities and in particular China which have borne the brunt of the latest market sell off. It would be reasonable to blame all of this on the Trump administration’s playing with ‘trade war’ fire. However, that has only exacerbated the downward pressure that started with the mass repatriation of US$ following last year’s tax reform.

While the severe liquidity shortage in US$ started the headwind for emerging markets, it is China’s reluctance to counter through another massive stimulus which is sending investors reeling. We have a separate article this week that explains and discusses these dynamics. We suggest that this trend may have further to run and, despite having fallen substantially already, we are not yet tempted to buy back into emerging markets from the distinct underweight position we’ve had in portfolios since early March.

In terms of ‘Digesting’, we observe that businesses have started to plan or take evasive action in reaction to the uncertainty created by politics. They no longer seem to trust that politicians are generally pro-business and understand that their chances for re-election will suffer if the economy suffers. With only 9 months remaining until the UK officially leaves the EU, we are witnessing rare political interference from businesses. This appears to be driven by the realisation that the remaining time is no longer sufficient to execute significant change in management projects, as would be required should the UK’s economic links with the rest of Europe change fundamentally, causing significant logistical and process redesign. We believe that much of the political noise coming out of Westminster is caused by the realisation that only either a comprehensive ‘good deal’ with the EU or a procrastination of the status quo will keep significant harm from the UK’s economy. Not a great negotiating position – granted – but not businesses’ fault.

US multi-national firms are facing similar uncertainties and they too are beginning to act, as they (just like their UK counterparts) have no choice, due to their need to protect shareholders, other than to take evasive action against adverse political decision or non-decision. Mr Trump’s Twitter propaganda attacks will be just as ineffective against such corporate defence mechanisms as Boris Johnson’s use of swear words.

In the meantime, the economic data has remained steady. And the corporate earnings forecasts for the industrialised world would suggest that market declines are not yet fundamentally justified. What’s more, if Trump’s trade war threats were to lead to improved, not worsened trading conditions, then this consolidation could turn out to have created the springboard for the next leg up in markets.

As much as we would like to concur, we would need to see more evidence to support such a stance. For the time being, we think it more likely that the recalibration of market risks and valuations that started in February has not quite run its course, and may quite possibly lead to more volatility over the summer.