Note September 12,2018: Foggy Clarity- As this market cycle has lengthened and as in many prior ones, foggy clarity protestations appear such as suggesting near term corrections could occur but also about being bullish for the long term. They arguably appear as throwaway. Afterall, few would be in an endeavor which they felt was doomed to failure. Some U.S. diplomatic discourses have been attributed as being from Foggy Bottom, originally for reasons of location and now for reasons of clarity or lack thereof about worldwide diplomatic commentary. Diplomacy and markets are not often discussed in one breath but obfuscation can often underscore complacency. It should be of more than passing investor interest. Politics, trade wars, massive war games and actual conflict like in the LeVant indicate a political economy environment not seen for decades.
Misjudgment in political matters or for that matter over trade has often presage heavy costs. Remembrances of 9/11 almost two decades ago and credit crisis a decade ago give pause this week In the markets, excess valuation or assumptions about unchanged ample liquidity thereof have often led to the broadening of sharp volatility and bear markets. In market systems, pretending their non-existence is suboptimal as purging excess serves to readjust expectations. Time and again in managed systems of any hue, ignoring readjustment needs has left them wallowing in inefficiency. Currently, there been lack of clarity on the final achievable objectives of the U.S administration in its political and trade policy interactions. The rise in rightwing populism in Europe may have crested but not peaked. Meanwhile amid prolonged skewed distribution of benefits, there appears again a rise in leftwing populism such in Latin America. We see aspects like political economy tensions not easily modelled but with relevance in markets appearing complacent but which are likely to violently adjust risk premiums.
Markets have seen a bruising in the erstwhile momentum favorites such as equity and fixed income emerging markets as well as in social media and concept manufacture equities. The same can be seen in the bifurcation in Financial Services. So far in 2018 as well, freewheeling Hong Kong markets have been in significant downdraft and have a well-deserved reputations for being especially sensitive to change. Tighter Federal Reserve policy is corroborated by data and its September 12 2018 Beige Book. We see aspects of foggy clarity as being at work in global political and business discourse. We favor quality as well as need for cash reserve accumulation for redeployment later.
Politics, trade wars, actual conflict like those in the LeVant and several massive war games indicate a political economy environment that has not been seen for decades. Misjudgment in political matters or for that matter over trade have often led to heavy costs that perforce emerge later and prolongingly so. Remembrances of 9/11 almost two decades ago and of credit crisis a decade ago give pause this week. Both tragedies had immense human and financial costs. They also underscored that quantitative and qualitative aspects require balances that are often subtle. In the political economy environment of today that arguably last reared its head decades ago, trade and tariff wars have appeared to being willfully ratcheted upward. It appears so between large entities like China and the United States as well as individually versus smaller nations. As before, tariff impositions have commenced across products, ostensibly on national security, appear under challenge at the World Trade Organization and have expanded into direct as well as indirect retaliation. Meanwhile, violence and tension remain strong across the crucial Levant. Actual war games appear, involving hundreds of thousands of troops and equally vast arrays of equipment. Furthermore in early September 2018, the United States can be considered now to be in election mode that is likely to be especially bitter. Change of control of Congress appears at stake alongside the investigations of Russia interference in the 2016 U.S. elections. In Europe, right wing populism has appeared throughout in 2007/18 to date in elections from Sweden in the north to Germany at center to Italy in the south of Europe. Ahead of impending change in European Union leadership, sanctions have appeared against Hungary and populist pressures in the east to cherry pick EU policies. In Latin America amid economic angst, there appears a rise in left wing populism among countries large and small but notably including Argentina, Brazil in election mode and post-election Mexico.
We believe that aspects not easily modelled such as political economy tensions have relevance. Based on prolonged and massive quantitative ease, markets have often appeared complacent but which are likely to violently adjust risk premiums. The markets veneer of stability has been most pronounced in U.S. equities and in European fixed income benchmarks but changes do also appear. The continued strength of U.S. economic data and the corroboration accorded by the September 12, 2018 Federal Reserve Beige Book accentuate the issues surrounding being data driven in Federal Reserve policy. As easy money ebbs in the U.S. dollar, it is so irrespective of domestic U.S. politics that have turned self-congratulatory on economic matters and irrespective of unmistakable signs of stress worldwide. We believe that the Federal Reserve may already be behind the curve and at minimum needs to continue its stepwise Fed Funds rate increases as well as for stability, needs to continue to shrink its balance sheet in order to build policy reserves for future uncertainties.
In the global fixed income markets so far in 2018, one of the noteworthy developments has been the rise in U.S. Treasury yields amid their ample liquidity compared to other sovereign alternates. Beyond being one of isolated cases and instead replete with indications of illiquidity, there has also been an ancillary increase of yields in BBB corporate spheres and in yields of emerging market aggregates, sometimes violently so. Curiously as momentum investing also stretched for yield, CCC corporate spheres have appeared for some time to be immune to such pressures of change, excepting energy when crude oil prices dropped sharply. Lately and almost unnoticed, CCC corporate yield aggregates have now crossed the 10% threshold, are still under half their peaks but are likely corroborating the winds of change seen earlier elsewhere. The same can be said about the rise in Italian yields, irrespective of the stature of the European Central Bank. As well, other central banks ranged from several in Latin America to some in Asia have faced currency pressures not responsive to rate increases. It has been so even in the case of China and India despite economic growth close to 50% above global averages We believe credit quality assessments are starting to increase..
In the equity markets, valuation is a function of both growth prospects and of interest rate based risk premiums. In the present cycle, massive quantitative ease replete with manipulated low administered interest rates have generated a sense of complacency based on momentum. However and in addition to changed central bank policy led by the Federal Reserve, other changes within the equity markets have been emerging. Freewheeling Hong Kong markets have a well-deserved reputation as being especially sensitive to change. On easing conditions, the light touch of Hong Kong regulators and attractions thereof for listings from around the world have been early upward stimulants due to business acumen there about global and China events. However, one of the more salutary downswings also took place in October 1987 when early in the crisis, ill-conceived portfolio insurance exposed Hong Kong to closure and liquidity assumption fracture. So far in 2018 amid global change, Hong Kong equities have been in significant downdraft. Real estate could be more volatile due both to internal considerations like ferreting out genuine listings and flattening out in other financial centers like London. Furthermore in global markets, in the implicit momentum assumptions about little change in the basic components of this cycle, namely over quantitative ease and easy money, early 2018 expectations have not worked about lower valuation multiples in aggregate Japanese and European equity markets resulting in performance rotation into their leadership from that of U.S. equities. We detect changes in equity market behavior as being more widespread than generally accepted.
Markets have experienced a bruising not just in the erstwhile momentum favorites of equity and fixed income emerging markets but also in the advanced markets in social media and in concept manufacture equities. Old fashioned concerns about the risks of borrowings in foreign currencies despite their low interest rates and about credit quality generally have arisen in emerging markets including in those with otherwise above global average growth. The same can be seen in the bifurcation in Financial Services that for fundamental and weighting reasons are crucial in many markets. Despite a strengthening domestic economy and unlike consensus, we believe that the ability has still to be tested of the S&P 500 to consistently deliver 12% annual earnings growth over the long term and valuation seems extended. Sector wise as well, momentum favorites such as social media have come under both business model and political scrutiny. Separately and not just related to trade and tariff tensions, concept and real manufacturing acumen in the automobile manufacturing industry are also under scrutiny to an extent unseen earlier in this cycle.
We see aspects of foggy clarity as being at work in global political and business discourse. We favor quality as well as the need for cash reserves to be accumulated for redeployment later.
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.