Friday, 8th of February 2019
“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know,”
― Rolf Dobelli, The Art of Thinking Clearly: Better Thinking, Better Decisions
What is it with the change in risk appetite from January to February? Perhaps it is the realisation that all those New Year’s resolutions made after too much food and wine will remain unfulfilled for another year at least; or perhaps it is simply investors taking profits to capitalise on the ‘January Effect’, the seasonal boost to equities from market participants who have engaged in tax-loss harvesting at the end of the year buying back in. Last year there was a market melt-up in January built on exaggerated optimism about the dawning of a new era of ‘synchronised global growth’, followed in early February by an unprecedented spike in volatility and a brutal correction reminiscent of the 1987 flash crash. This year we have also seen an impressive January rally which, if this Thursday is anything to go by, could now end just as abruptly. However, there is reason to be cautiously optimistic about the outlook for equities this year. Not least because markets are cheaper than they were at the start of 2018, while investors are simultaneously much more bearish. Many investors are convinced that a global economic slowdown will lead to equity under-performance because fundamentals drive stock market returns. But one might reasonably ask where they have been living for the past 10 years, when anaemic growth coincided with a decade-long rally in risk assets. If there is one lesson from the post-crisis era it is that Central Banks can – and rather like to – disrupt the relationship between asset prices and the real economy in order to support the former whenever the latter stalls. Draghi et al. have hinted that if data continue to weaken then this time will be no different and monetary policy will be tailored to reduce the cost of capital for businesses and households. In Europe, where zero or negative policy rates prevail, the only option for the ECB is to restart its asset purchase programme; in the US, the Fed has already made noises about a potential pause in the present rate hiking cycle. The Draghi/Powell Put is alive and well. Still, there is no doubt that trouble is brewing in Europe. Italy is in recession, France is in revolt and EU Council President Donald Tusk seems to think that the best way to rally support for Mrs May’s Brexit deal is to speculate on what that “special place in hell looks like for those who promoted Brexit without even a sketch of a plan”. Anxiety over Brexit and the possibility of backsliding on Italian and French fiscal reforms is widespread. But all is not well in Germany, either, where industrial production figures released this week showed an unexpected contraction in the fourth quarter of last year. The heavily export-oriented German economy is perhaps the most vulnerable to slower global growth and escalating trade tensions, the latter courtesy of a belligerent US President with a dim view of Mutti and her open society. Few countries have committed to economic globalisation and the ‘liberal international order’ more enthusiastically than Germany – in part to compensate for its problematic national history – and few now have more to lose from the rising clamour to address trade imbalances. According to the World Bank, exports of goods and services account for some 47% of German GDP, as compared to 31% and 12% for the UK and US, respectively. Germany also has large and persistent current account surpluses with all of its major trade partners, including the US who are using the threat of auto tariffs as leverage in negotiations with the EU Commission. However, it is not just BMW and Volkswagen that stand to lose out from trade protectionism and a contraction in external demand. Among the Mittlestand, the traditionally family-run SMEs that form the backbone of the German economy and dot the picturesque valleys of the country’s south and west, there are many niche manufacturers of high-value products for sale abroad. During the European sovereign debt crisis, exporting such goods to China and the US was a boon, keeping Germany afloat. But the economy’s over-reliance on foreign appetite for German goods may yet come to a head if China continues to slow, the US loses patience with EU negotiators or warnings about customs checks, tariffs and hard borders in the event of a no-deal Brexit turn out to be more than bluff. We end this week’s newsletter on a cheerful note. I know what you must be thinking, but no, not on the decision by the US and Russia to suspend compliance with the Intermediate-Range Nuclear Forces (INF) Treaty, a 1987 arms control agreement to eliminate nuclear-capable land-based ballistic and cruise missiles from European soil. Something with marginally less radioactive consequences. Bedrock is fortunate enough to have been listed among CityWire Switzerland’s Top 50 Independent Asset Managers for Alternative Investments. We are all very pleased.