Friday, 7th of June 2019
“Speak softly and carry a big stick; you will go far.”
– Theodore Roosevelt
As one trader said to another – “sell in May and go away”. In 2019 so far, the first half of this well-worn financial adage has proved to be spot on. May was ugly, with the S&P 500 down -6.6% for the month after US-China trade talks ended in acrimony rather than agreement as many had begun to hope they would. Other markets followed the US lower, but the biggest drawdown was suffered by the Chinese Mainland CSI 300 Index which collapsed almost 10% in dollar terms. There are few signs that either superpower wants to re-open talks anytime soon and we are edging ever closer to the summer period of thin trading volumes and higher equity market volatility. So, should we simply take profits, pack our bags and head to the beach? It is tempting, not least given the strength of the stock market rally since the end of 2018. But June looks rather different from May, with walls of green greeting investors on most mornings so far this week. Market sentiment has changed despite the war of words between the US and China, which has continued unabated, and a distinct lack of positive fundamental developments or economic data to report. Indeed, today’s US payroll data was surprisingly soft. Responsibility for the recent market mood swing can be traced to the increasingly dovish statements emanating from Central Banks on both sides of the Atlantic. Fed officials have started briefing that a rate cut – perhaps as early as mid-June – is not off the table, while the ECB promised on Thursday to keep rate hikes on hold for another full year at least. Investors have hailed the prospect of further easing and easy beta-driven returns, as Powell and Draghi show once more their eagerness to please the market.
This week marks the 75th anniversary of D-Day, when British and US forces first landed in Northern France to liberate the continent from Nazi occupation. Thousands were killed as they sprinted for the beach, having disembarked under heavy gunfire in the shallows just offshore. However, the operation ended in a decisive Allied victory and proved to be a turning point in the war. When the dust had settled, the Allies were able to establish several permanent beachheads on the Normandy coast from where they could press deeper into France. D-Day remains the largest seaborne invasion in history and its success was a crucial step in the effort to roll back the tide of fascist terror that had swept through Europe four years earlier. To commemorate its anniversary, ceremonies were held in Portsmouth in England on Wednesday and close to the landing grounds in France on Thursday. British, American and French leaders and veterans were in attendance, as well as leaders from Canada, New Zealand, Australia and nine other European countries, including Germany. Such events are a reminder that not so long-ago people fought and died in Europe for the rights we take for granted.
Before commemorations got underway, President Trump was on a State Visit to the UK, where he had a lavish dinner with the Queen, inspected various ornate objects and royal artworks, saluted countless lines of military personnel in ceremonial dress, and indulged in a twitter feud with the Mayor of London and “stone cold loser” Sadiq Khan. All in a day’s work. But the extravagant jolly had another more practical purpose: to cement the ‘special relationship’ and to discuss and advertise the prospect of a US-UK trade deal post-Brexit. On this latter point, Trump managed to ruffle a few feathers when he suggested that the NHS would be ‘on the table’ in any future negotiations. However, he rowed back from these comments when someone advised him about its cherished status in the eyes of most Brits.
A comprehensive US-UK trade deal is seen as the biggest cherry on the Brexit cake by many Leavers and Trump’s support for just such an agreement is music to their ears. The US is Britain’s largest trade partner outside the EU, buying 13.3% of UK exports. Bilateral trade is growing strongly, even without a deal, but a major agreement post-Brexit would significantly increase flows and FDI between the two countries (particularly if new barriers with the EU divert trade previously done with Europe). Whether this and other deals can make up for the loss of Single Market access after the UK leaves the EU is a moot point, as it depends in large part on what agreement finally emerges from the Brexit negotiations morass and how deep a partnership the Trump Administration (who are tough negotiators and hardly avowed free traders) really have in mind. However, it does suggest that regardless of the growth netting effects of Brexit, the UK will become an increasingly Atlantic economy in its wake, tied more closely to the US and less so to Europe. Given the economic malaise and sense of permanent political crisis that still pervades the EU, diversification may be no bad thing in the years ahead, but the UK remains an island off the Normandy coast no matter how hard its inhabitants try to paddle in the other direction.
A more contentious topic that President Trump broached with his European counterparts while in the Old World this week was Iran, where the US and Europe do not see eye-to-eye. Since leaving the JCPOA (i.e., the Iran nuclear deal), the US has pursued a maximum containment strategy to isolate the country internationally, decimate its economy through strict extra-territorial sanctions and intimidate it militarily by deploying hardware to the Gulf. This pressure campaign is having its desired effect, causing Iran significant economic discomfort and robbing them of the financial resources necessary to support regional proxies in Yemen, Iraq, Syria and Lebanon. The country is being backed into a corner with few cards to play, having sealed its nuclear centrifuges, abandoned its stockpiles of enriched uranium and destroyed the critical Arak nuclear reactor under the terms of the JCPOA. (These concessions were front-loaded, while the benefits of the deal to Iran were more nebulous and long-term.) In response, Iran are threatening the Gulf states, US interests in the region and the Gulf oil industry to deter US military action and encourage Trump to ignore his most hawkish advisors. Iran needs time to build a stronger negotiating position ahead of future talks and will not sit down with the US without the leverage necessary to make such talks worthwhile. As with North Korea, this leverage can only be generated by escalating tensions and playing brinksmanship then rowing back after talks in which they have secured concessions. To get back on the front foot, Iran may soon leave the JCPOA and restart enrichment, exit from the Nuclear Non-Proliferation Treaty (and openly test non-nuclear components of a device to ramp-up pressure) or threaten to close the Strait of Hormuz. Brinksmanship is a high-risk strategy, particularly when elements of the Trump Administration are looking for a pre-text to attack Iran (or targets associated with its nuclear program), but Iran have few alternatives. Moreover, regime hardliners will not countenance another failed attempt to strike a lasting deal with the US by entering into talks from a position of weakness. There will be plenty of opportunities for the situation to spiral out of control in the coming months. In terms of the oil market, there is further downside for Iranian oil production and exports, but ample OECD inventories, growing US production, and OPEC spare capacity will help to contain any short-term price shock. As the global mood soured in May, Brent Crude fell -16% and now sits close to cycle-lows; this despite the backdrop of a stronger US economy and a leaner global oil industry than when prices were last hovering at $50 a barrel. As such, we feel that the balance of risks is to the upside on oil, even if the crisis in US-Iran relations does not halt traffic in the Gulf. Buckle up.