Fragile recovery

22 June 2018

The stock market correction of February and March already feels a long time away and most investors with globally diversified multi asset portfolios should by now have seen a return of positive returns for 2018. Despite the more amenable return environment, the ease and general optimism of 2017 has not returned to capital markets.

Initially this was caused by the fear that rising rates and bond yields would upset the fragile process of capital market normalisation. This was quickly followed by concerns that the general slowing of global economic growth is heralding the end of the ongoing, very long economic cycle. As summer has arrived, the only element that remains – based on economic data evidence – is a weakness in emerging market economies, driven by a US$ funding squeeze due to the mass repatriation of US overseas earnings following the tax reform.

With the slowing gradually turning into re-acceleration and central banks as well as bond markets continuing to behave sensibly, all could be well if it wasn’t for the increasing trade tensions. Trump’s threat of an escalating trade war at the global level and the prospect of a disorderly Brexit on a regional level. While stock markets finally appeared to take note over the past week and gave back some of their most recent gains, they have by no means reacted anywhere close to what could be expected given the potential economic activity decline a full-blown trade war would bring with it. There appears to be the conviction that a business-friendly president as Donald Trump proved to be in the first year of his presidency, would not risk outright recession in order to score points with his rust-belt electorate.

We would tend to agree with this notion, but are nervous whether the Trump administration will be able to get ‘the genie back in the bottle’ before real harm is done. It is also not quite clear whether he and his more dogmatic advisers grasp the potential harm that could come to the US economy, should China choose to fight back with a wider arsenal of counter measures.

One of them – the US$ 3 trillion they own in US government bonds – we discuss this week in a separate article. However, even before they resort to such extreme measures, China has the influence to scupper Trump’s North Korea peace initiative or bring harm to the vast operations and businesses the US corporate sector has established in China over 30 years of continuous investment. The extent to which the Chinese public boycotted Japanese products after a political spat a few years ago should provide ample warning.

The focus of this week, however, was far more domestic and Trump’s U-turn over his immigration policy, once the public uproar over the ensuing cruelty on children began to seriously threaten his cherished image, was an encouraging sign that he will bow to public pressure – eventually. Unfortunately though, with the autumn’s US midterm elections looming, we have to expect the trade war bluster to continue.

This brings the risk of more pronounced market scares over the course of the summer than the one we just experienced. This time it remained benign and came to a relative quick end, when markets rallied at the end of the week on the news that OPEC would endeavour to prevent an oil supply shortage through higher production quotas. The oil market may have expected bigger concessions than were given which led to a late oil price surge, but the direction of travel seems clear – OPEC is keen to keep a lid on the oil price.

On the Brexit side on the other hand, the non-progress is increasingly frustrating and the number of announcements that due to the lack of progress this or that aspect of an orderly post Brexit environment can now no longer be achieved before the March 2019 deadline tells us that a Brexit in name only (BINO) is slowly becoming a reality. Extended transition periods will take the place of ‘a deal’. At the moment it seems almost that the ‘divorce settlement’ is so fiendishly complicated that a reconciliation may be easier to achieve. Here, the pressure EU governments, especially Angela Merkel’s find themselves under to establish a more suitable immigration and migration framework across the EU is notable. It now seems possible that some of those hitherto red lines like ‘freedom of movement’ may disappear faster than Brexit negotiations can find ways around them. Perhaps extended transition periods are not such a bad thing after all.

To close on a political positive, I was very happy to learn that the EU had agreed a more sustainable debt management arrangement for Greece, than the painful bailout agreements of the past years. By extending repayment terms into the very far future, there is finally a real chance that this is the last time we have had to worry about Greece’s government debt posing a risk to the wider Eurozone. For Greece it means more financial stability and a chance to eventually outgrow the debt of old, even if for years to come Greek governments will have far less fiscal flexibility than any other EU nation.