Friday, 8th of November 2019
“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.”
– Winston Churchill
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Equity markets this week were buoyant. US markets pressed ahead and printed fresh record highs. The reason for this renewed optimism stems from the fact that the US jobs report last Friday was quite good and allayed fears of a coming recession. Not only did the October payroll increase (+128’000) and come in better than expected, but the revisions of the 2 prior months added 95’000 jobs, bringing the 3-month average to a healthy +176’000. “This was certainly a very solid labor market report,” Fed Vice Chairman Richard Clarida said in a Bloomberg Television interview. “We have ongoing growth in the economy, we have inflation near our objective, so the economy is in a very good place”. European markets also followed suit with multi-month highs, and in the case of France, the CAC 40 reached a level not seen since the end of 2007.
The good economic news continued to buoy the Greenback, as expected, with the USD Index making a comeback above 98, and the EURUSD pair sliding back below 1.11 to stand now at 1.1040.
Then on Thursday, the US and China indicated that they had agreed to roll back tariffs on each other’s goods in stages as negotiations continue over resolving the more than yearlong trade war, officials on both sides said. “In the past two weeks, top negotiators had serious, constructive discussions and agreed to remove the additional tariffs in phases as progress is made on the agreement,” China’s Ministry of Commerce spokesman Gao Feng said on Thursday. White House economic adviser Larry Kudlow confirmed the advance in negotiations. “If there’s a phase one trade deal, there are going to be tariff agreements and concessions”. However, a signing ceremony as well as a venue for this signing remain quite elusive at this date and we have learned to be wary given the mixed messages seen over the 18 months or so that this trade war has been dragging on.
Following this optimism, the Bond market saw a big turnaround as the Treasury yield curve which was signaling recession over the summer has now turned to signaling growth on the back of positive trade developments and Fed easing. Thursday’s big move up in yields was the biggest one day jump in the 10-year Treasury since President Trump was elected president. The 2 to 10 years Treasury spread which raised alarm back in August because of its inversion (signaling a coming recession) moved back strongly to the positive side with a 25 basis points spread.
However, news was not completely positive as we noted 3 developments which we thought of interest and might disrupt this equity rally and renewed optimism.
First, Ray Dalio, the founder of Bridgewater, published an op-ed on Linkedin, titled “The world has gone mad and the system is broken”. He said that “Money is free for those who are creditworthy because the investors who are giving it to them are willing to get back less than they give”. More specifically investors lending to those who are creditworthy will accept very low or negative interest rates and won’t require having their principal paid back for the foreseeable future. They are doing this because they have an enormous amount of money to invest that has been, and continues to be, pushed on them by central banks that are buying financial assets in their futile attempts to push economic activity and inflation up. The reason that this money that is being pushed on investors isn’t pushing growth and inflation much higher is that the investors who are getting it want to invest it rather than spend it. This dynamic is creating a “pushing on a string” dynamic that has happened many times before in history. A result of this dynamic – prices of financial assets have gone way up and future expected returns have gone way down while economic growth and inflation remain sluggish. Those big price rises and the resulting low expected returns are not just true for bonds; they are equally true for equities, private equity, and venture capital, though these assets’ low expected returns are not as apparent as they are for bond investments because these equity-like investments don’t have stated returns the way bonds do. As a result, their expected returns are left to investors’ imaginations. Because investors have so much money to invest and because of past success stories of stocks of revolutionary technology companies doing so well, more companies than at any other time since the dot-com bubble have no pressure to make profits, or even have clear paths to making profits, in order to sell their stock. They can instead sell their dreams to those investors who are flush with money and borrowing power. There is now so much money looking to buy these dreams that in some cases venture capital investors are pushing money onto start-ups that don’t need more money because they already have plenty. Nevertheless, investors threaten to harm those companies by providing enormous support to their start-up competitors, so they have no other choice but to take the money on offer. So much for renewed investors’ optimism!
Then the EU cut its growth and inflation forecast for 2020, amid policy uncertainty, warning that the bloc’s economic resilience (!!) won’t last forever. The reason for their latest dire prediction comes from the fact that “adding to domestic economic shocks and policy uncertainty, the slowdown in global demand and weak trade has hit the EU economy quite hard”, according to the latest European Economic Forecast published by the Commission.
Finally, in the UK, the Bank of England surprised (negatively) the markets by having a split rate decision which took aback the Pound. Indeed, the Bank of England’s 7-2 vote to keep interest rates on hold at 0.75%, with two rate-setters voting to lower interest rates, has caught sterling and gilt traders off-guard, triggering traders to buy gilts and sell the pound. “The calls from some members for rate cuts come as something of a surprise,” says XTB’s David Cheetham. Yet “given the political uncertainty ahead of next month’s election it is not at all surprising that the central bank has decided to refrain from any change in policy,” he added.
Considering all these events, we continue with our 2019 cautious optimism, and remain invested in equities, albeit with protections in place due to all the uncertainties still abounding.
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