Note May 2,2018: Uncomfortable Light of Being Belligerently Brusque –
In geopolitics over North Korea and Iran policy, the risks are those of lost credibility in being belligerently brusque and then being weak in follow through. Iran especially is far more diverse than North Korea. In appearing capricious in both the claims and the application of its tariff claims, the U.S. administration would risk inadvertent fallout from retaliation from allies and competitors alike, such as Europe and China as well as crucial smaller powers. Being hectored and sent packing after all is a strange negotiating tactic with powerful figures also with domestic imperatives.
From the central banks, the commentary appears enigmatically obtuse from both the ECB last week and today May 2,2018 in the Federal Reserve’s FOMC statement , perhaps due to uncertainty. The uncomfortable light is that central banks missed systemic risks at the cusp of the unfolding of credit crisis in 2007. They then received little scrutiny amid massive quantitative ease. Now, from reports of insider flipping in Vancouver of incipient new condominium completions (with shades of Miami in the mid-2000s also on supposed foreign interest) to the expansion of subprime lending in the U.S. and globally to low coupon, lower covenant fixed income, conditions seem boisterous. In the FOMC statement of May 2 2018, we believe the Federal Reserve missed raising rates by 25 basis points and needs to have measured Fed Funds rate increases in place, not least due to strong growth and large deficits in the United States. We target Fed Funds at 3.50% and 10 year T- Note yields at 4.50% as appropriate by Q1/2019.
At present S&P 500 P/E multiples, there seems little margin for error in expectations or slippage in corporate delivery. Internationally, emerging markets have outperformed on growth, with the U.S. at mid-point. Despite lower multiples, Japan and Europe sway back and forth on relative performance. Furthermore on interest rate stress, while U.S. Treasury, emerging country and BBB corporate fixed income yields are close to 12 month highs with more to go, those of CCC corporate fixed income are still closer to 12 month lows. Uncomfortable light is needed over the summer of 2018 on both political economy risk and also on whether central banks are behind the curve. Equities worldwide would benefit from a catch up overall in earnings as well as specifically, in a shift from a momentum and quantitative ease gorged investment phase to one driven by more selectivity.
In geopolitics, an uncomfortable light awaits being belligerently brusque. The meeting on South Korean soil of its president and that of North Korea was met with laudable praise. Including results from a forthcoming meeting of the Presidents of North Korea and the United States and beyond rhetoric, tangible follow through now seems necessary to truly reduce tensions over a nuclear Korean peninsula, not least for Asia. At the other end of Asia at the outskirts of ongoing conflagration engulfing the LeVant, it needs recalling that Iran is not another North Korea. Iran has resources, projections of regional power and trade links alongside a highly trained diverse labor force. Any renegotiations with Iran over all matters and not least its nuclear policy are hence likely to be tough. The risks of being belligerently brusque and then being weak in follow through are those of lost credibility.
The same would apply on trade policy from the United States with its adoption of bilateral balance and security of supply rhetoric over trade. After all, from the altruism of the Marshall Plan for a prostrate Europe to the sequential GATT and WTO treaties, multilateral freer trade agreements that have been accompanied by improved prosperity individually and collectively. By contrast, bilateral and barter trade historically in not just the 1930s globally but also for the Comecon countries in the Communist bloc from the 1950s to 1991 (when compared for instance to the neighboring European Union) resulted in a lag far behind in standards of living, amid low quality goods. In appearing capricious in both the claims and the applications of its tariff claims, the U.S. administration would risk inadvertent fallout as a result of retaliation from allies and competitors alike, such as from Europe and China as well as from many smaller powers that are often critical suppliers in specific areas. Being hectored publicly and being sent packing is after all a strange negotiating tactic with powerful figures also with domestic imperatives like President Macron of France and Chancellor Merkel of Germany, both recent visitors to Washington. President Xi of China has already demonstrated an ability to engage forcefully in lateral retaliation amid a domestic shift of emphasis. Stringing out neighbors like Mexico and Canada seems to us also problematic for the credibility of the United States.
In capital markets and on systemic risk at large, we expect a changed environment awaits central banks. Their task would likely to be one of demonstrating not being behind the curve of change and building policy tool reserves for the next crisis, whenever it occurs. From the central banks, the commentary from both the ECB last week and today May 2,2018 in the Federal Reserve FOMC statements appears enigmatically obtuse, perhaps due to uncertainty. The uncomfortable light today is that central banks missed systemic risks at the cusp of the unfolding of credit crisis in 2007 and then received little scrutiny amid massive quantitative ease. Now, from reports of insider flipping in Vancouver of incipient new condominium completions(with shades of Miami in the mid-2000s also on supposed foreign interest) to the expansion of subprime lending in the U.S. and globally to low coupon, lower covenant fixed income, conditions seem to us boisterous. The ECB last week after its meeting was circumspect to the point of asking for patience till its June 2018 meeting which is also likely to have substantive council member changes. Both the People’s Bank of China and the Reserve Bank of India have relatively new leadership amid potentially slowing growth replete with a built up credit excess in place. In the FOMC statement of May 2 2018, we believe the Federal Reserve missed an opportunity to raise rates by another 25 basis points and needs to have measured Fed Funds rate increases in place, not least due to strong growth ( including employment at target and inflation just below 2%) and large deficits in the United States. We target Fed Funds at 3.50% and 10 year T- Note yields at 4.50% as appropriate by Q1/2019. The critical focus on central banks is likely to rise into June at minimum and through the summer of 2018.
Equities likely do not usually and will not discount the same information twice, even on individual earnings reports. Furthermore on interest rate stress, we find it noteworthy that while U.S. Treasury, emerging country and BBB corporate fixed income yields are close to 12 month highs with more to go, those of CCC corporate fixed income are closer to 12 month lows. Despite being half way through a strong U.S. year-over-year earnings growth season but with revenue stress, equities have been in pause. At present, P/E multiples for the S&P 500 as benchmark leave little margin for error in expectations or slippage in corporate delivery. Internationally, emerging markets have outperformed on growth, with the U.S. at mid-point. Despite lower multiples, Japan and Europe sway back and forth on relative performance. We believe markets would benefit from a catch up in earnings overall as well as specifically, a shift from a momentum and quantitative ease gorged phase to one driven by more selectivity.
StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e.