Ignore politics at your peril
1 June 2018
It has been one of the more unnerving weeks in financial markets and judging by some of the questions from advisers and clients, the media was effective in using the commotions to sell copy through exaggeration. While new puns – Italexit, Parmageddon and QuItaly – were created to heighten the sense of drama, stock and bond markets made a roller coaster ride to end the week more rather than less were they had started. Contrary to the headlines, it was the risk-off rally in bond markets that was far more notable than what with hindsight looks more like another hiccup in stock markets.
Attributing all the blame for the week’s ructions at Italy’s (somewhat usual) drama of forming a government rather than sending voters back to the polls and that this revived fear of a Eurozone breakup seems rather unfair. We would agree with Ian Harnett of our research partners ASR, who noted “…not since the last Eurozone crisis, in 2010-11, has so much turmoil been blamed by so many on so few.” It is far more plausible that the constitutional frictions in Italy became the catalyst for another leg in what feels to many as an ‘incomplete correction” and began with the February stock market sell-off. This latest episode can be seen as a manifestation of an increased sense of financial risk as Global liquidity tightens as a result of a gradual return of more ‘normal’ monetary policy, while at the same time the acceleration in Global economic growth is slowly fading back to a more durable, less exciting rate.
The rush back into fixed interest bonds has on the one hand brought bond valuations more in line with the lower growth expectations that had already been reflected in the reduced equity valuations, and on the other hand has lowered yields enough to ease much of the liquidity concerns that had of late entered the economic outlook ‘worry agenda’. The downward pressure on the highly valued €-Euro versus the US-$ which was also curtesy of Italy triggering the debt market re-ordering, will become welcome stimulus for the Eurozone’s exporters whose diminished price competitiveness from the strong €-Euro carried much of the blame for the sudden growth slowdown across Europe.
On the economic data flow side, the week provided more support for the thesis we floated for the first time in last week’s edition, that the period of negative economic surprises may be coming to an end with forward looking activity indicators stabilising at lower, but still comfortably positive levels. This also explains the return of a positive return picture for 2018 across most asset markets in May, as can be seen in the asset class return table at the top.
It would therefore be reasonable to suggest that it still holds true that investors should not let their longer-term investment decisions be overly influenced by short term political noise, given it is the economic growth perspective first and foremost that determines corporate profitability and hence the direction of travel of asset price valuations.
Unfortunately, this wisdom only holds true to a point. For example, various indicators for the UK’s economic progress have begun to show a drag on business activity levels and asset price valuations which are seen as directly linked to the lingering lack of clarity of Britain’s post Brexit trading position. The Trump administration’s imposition of considerable tariffs on input factors and products from erstwhile close allies have so far been discounted by stock markets as mere pre-negotiation posturing which will not actually lead to a highly counterproductive trade-war but instead result in more open trade conditions before the imposed tariffs have caused lasting damage.
After the experience of the past week, we beg to differ. Bi-lateral and multi-lateral negotiations between sovereign nations are not governed by quite the same rules and dynamics that Donald Trump may have experienced as successful in the commercial property sector. In Global diplomacy, there is only one China, one Europe, one Iran and therefore not an abundance of alternative partners down the road should one counterparty leave the negotiating table for good. Establishing trust and forming alliances between a limited number of parties is therefore of a much higher order in Global politics than in Global property development.
With trust and predictability being almost the juxtaposition to “Trumplomacy” we see a higher probability for his style to result in a diplomatic car crash than capital markets appear willing to admit. With growth leadership firmly back with the US economy, any inkling that Trump’s gamble may be failing to succeed and consequentially lead to collateral damage to the US economy would be a nasty disappointment of currently anticipated growth expectation. The combination of the signs of financial stress or at least nervousness that became apparent this week and that we continue having to live with an ‘incomplete correction’ makes it in our view fairly likely that this correction has not run its course yet.