Friday, 3rd of May 2019
“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
– F. A. Hayek
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Equities fell this week after the Fed published a statement on Wednesday which was rather less dovish than investors expected. Gone was much of the prevarication over the outlook for growth and the interpretation of recent data: economic activity was strong and the labour market robust; inflation had come in well below target (so rate hikes were not immediately back on the cards) but the factors responsible were temporary. The result was a drop in the futures-implied probability of a rate cut later this year, a rise in the discount rate used in DCF models, and a corresponding fall in US stocks.
Assuming that the Fed’s bullish outlook affects expectations for economic fundamentals beyond interest rates, equities should recover and push through the all-time highs reached in April. Animal spirits have been weak since the sell-off in Q4 last year, but a more positive tone in US-China trade talks, a pause in the US rate hiking cycle and some better data out of China have begun to turn the tide. Rather ominously, hedge funds have been piling back into leveraged bets on continued calm as sentiment improves. Indeed, they have taken out the highest net short position against the VIX Index, which measures S&P 500 volatility, since before the blow out in February last year. Given that the volatility spike was to a large extent related to the unwinding of these exposures we do not welcome their reappearance. However, we are prepared for any flash movements and recognise the benefits of growing optimism even if that optimism breeds complacency in some.
Throughout the turmoil of recent months, we have maintained a clear view that the correction was an overshoot, Central Banks would respond, and the US and EM would see strong returns heading into the New Year thanks to a mix of fundamental and relative value factors. Positive data released on Thursday, which showed a surge in US productivity growth, lends further support to our assessment. Meanwhile, as earnings season comes to a close and with the bulk of companies having now reported, we can happily report that 75% of S&P 500 constituents have beat Q1 expectations. This is a strong showing and cannot be ignored by the bears who held sway at the start of the year. We therefore continue to believe that US corporates deserve your special attention. And so too does the US currency, which offers a decent carry in a world largely devoid of the stuff. In our opinion, US economic outperformance, a weighty interest rate differential with other major currencies, a positive technical environment and few alternatives close the case for the greenback.
The political crisis in Venezuela entered a new and violent phase this week. On Tuesday morning, at dawn, opposition leader Juan Guaidó stood alongside rebellious National Guard troops at an army base in the heart of Caracas and called for a popular uprising against the socialist government with the aim of ousting strongman president Nicholas Maduro. Across Venezuela, people have taken to the streets in some of the most violent protests since Maduro came to power in disputed elections following Hugo Chavez’s death in 2013. In the intervening years, the country has suffered an economic meltdown as an inefficient and corrupt centrally-planned system propped up by the profligate and politically-motivated spending of petrodollars has collapsed, along with the oil price. Close to 3 million people (from a population of just over 30 million) have fled to neighbouring countries so far amid spiralling inflation and unemployment, shortages of food and medicines and a complete breakdown in law and order. The ruling party has sought to blame ‘bourgeois criminals’, the ‘Colombian oligarchy’ and ‘US imperialism’ for the crisis, not to mention the opposition who they accuse of treason for voicing any dissent. The criminalisation of political difference has been accompanied by a steady erosion of what few checks and balances remain and the marginalisation of institutions over which the regime cannot exert its control.
Despite the rampant disorder, Maduro has managed to buy the support of the military leadership (so far) by paying army salaries in dollars rather than in the near-worthless bolivar. However, cracks are beginning to show and Guaidó’s call for an uprising suggests some may be close to breaking point. If the military do switch sides, this would represent a major geopolitical victory for the US who have supported the opposition for decades but only embarked on a maximum pressure campaign last year when they sanctioned Venezuela’s state oil company and employed an ultra-hawk anti-communist, Elliot Abrams, as Special Envoy for Venezuela. Russia and China, meanwhile, have close ties to the regime and lucrative contracts with the state oil company and have pushed back against US efforts to topple Maduro. In a move that has infuriated the US, Russia have even sent soldiers to Venezuela. Nevertheless, Russia would lose out to Uncle Sam in any game of brinksmanship over Venezuela given the vital strategic importance that America attaches to maintaining its hegemonic status in the Western hemisphere. Stay tuned.
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