I have been somewhat out of the loop on the market over the past 2 months, partly due to work and partly due to a general apathy towards trying to understand the current market reasoning. I am very much in a risk off mode on a personal basis having moved mainly into cash since April to protect YTD gains (and take the hit on YTD losses!). At the end of April, I posted my thoughts about the equity market (with the S&P500 being my proxy for the “equity market”). Since then, the equity market has sea sawed 7% down in May and 7% up June to date, now in sight of new all-time highs. The volatility has primarily centred around the China trade talks and the economic outlook.
With the 10-year US treasury yield now just above 2% compared to around 2.5% at the end of April, clearly market expectations have changed. At its meeting last week, the Fed highlighted an increase in uncertainties to the global economy and stated that “in light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion”. The market is loving the new Powell put rhetoric (he does seem to be overcompensating for the year end 2018 “error”) and some are taking language such as “we will act as needed, including promptly if that’s appropriate” to mean multiple cuts this year, as many as three this year have even been advocated. Equity markets seem to be missing the point that multiple rate cuts will mean the economy has deteriorated rapidly, with a recession a real possibility. Hardly a reason for all time high equity markets!
There’s also the issue of the Fed’s current benchmark rate of 2.25% to 2.5% which is not exactly at normal economic boom levels given it historically has taken cuts of 3-4% to reverse recessionary slowdowns. Powell may be counting on the shock therapy of an early and relatively large cut (50 bps?) as an antidote to any rapid worsening of the trade war with China (or the outbreak of a real war with Iran!). In such an outcome, it is inevitable that talk of QE will re-emerge, providing yet more distortion to this millennium’s crazy brand of monetary policy.
A whole host of other things are bothering me – I highlighted high valuations on the hot business software stocks (here), Slack’s valuation (now over $18 billion. It had $135 million of revenues last quarter!!), a bitcoin rally, the fantasy-land UK conservative party leadership contest (the UK used to lead the world in the quality of its political debate, how did it get to this?), and, last but not least, the Orange One and Iran and well everything else to do with Trump. Sorry, that turned into a bit of a rant.
And so, we come to the G20 meeting of the world’s greatest leaders this week. Maybe it’s my mood but I found myself agreeing with the analysis (here) of Dr Doom himself, known as Nouriel Roubini to his friends. Roubini highlights three possible scenarios on the US China talks – an agreed truce with a negotiated settlement by the end of the year, a full-scale trade & tech & cold war within 6 to 12 months, or no trade deal agreed but a truce whereby tariffs agreed to be capped at 10% to avoid escalation. The third option is in effect a slow-burn trade war or a managed trade escalation.
I would agree with Roubini that either the first (but without the settlement this year) or third options are the most likely as both sides have reasons to avoid a rapid escalation. China needs time to prepare its economy for a prolonged conflict and to see how Trump fairs politically. Trump can portray himself as the John Wayne figure his man-child self longs to be in standing up to China and can pressure the Fed to stimulate the economy from any short-term impacts. Unfortunately, a managed escalation of a trade war is exactly like a managed Brexit. Impossible. You are either in or out. Have a deal or don’t have a deal. Could a grand deal be struck with this G20 meeting proving the turning point? Its possible but unlikely in my view (I’m referring to a real deal, not a fantasy/pretend deal). I hope I’m wrong.
Against this backdrop, forgive my lack of insight into the current collective wisdom of the market but an all-time high equity market makes little sense to me. And that’s me being polite.