It’s easy to trip over trying to formulate a market narrative at the moment. One interpretation of the dramatic decline in global bond yields is that the smart money is de-risking their portfolios ahead of global slowdown and a rout in equities and credit. The ramp-up in the global trade wars, and still-soggy economic data seem to confirm this version of the narrative, but it is also a somewhat naive story. The global economy is not in perfect shape, but it is hardly on the brink of a recession, especially not since it is usually coordinated tightening by central banks that push the major economies over the edge in the first place. The market is now pricing-in one-to-two rate cuts by the Fed this year, and three in 2020. The money market curve in the Eurozone is even starting to price in the idea that the ECB will further scythe its deposit rate below -0.4%. The argument in the U.S. is particularly delicious. Last year, the consensus was angling for a recession in 2020 based on the idea that the Fed was in search for a “neutral” FF rate at about 3%. Now that the Fed has thrown in the towel, the idea is that it will cut rates to prevent the recession that it itself was supposed to have sown the seeds for in the first place, by hiking interest rates.
Read MoreLet’s spare a few moments of symphathy for the equity bears. The Q4 rout was supposed to have been an appetizer for a more sustained bear market, and by most accounts, the major narratives are still on their side. Excess liquidity indicators—chiefly real M1—and other leading macro-indicators look dire, and the hard data have predictably rolled over. They gave up the ghost in Europe a long time ago, and are now softening in the U.S. Even better for the bears, earnings growth is now slipping and sliding, a logical consequence of the sharp drop in the rate of growth in almost all main hard macroeconomic indicators and surveys.
Despite such a perfect set-up from the macro data, the equity market has rallied strongly at the start of the year, and is showing few signs of rolling over mid-way through February. There is still hope for the bears. If you are just looking at the headline data, it is relatively easy to dismiss the rebound at the start of the year as a reflexive rebound from the horror show in the latter part of 2018, a bear market rally to suck in the naive bulls before the next deluge. The idea of a bear market rally is still alive, but equity bears also now have to contend with a revival of their greatest foe to date; the global central bank put.
Read MoreMarkets were mulling familiar themes last week. Will a wider U.S. twin deficit change the rules for the dollar and treasuries and is elevated volatility here to stay in equities? Judging by last week, the answer would be: probably and yes. The contemplation over these stories, though, were interrupted by politics. Mr. Trump announced his intention to apply tariffs on steel and aluminium—25% and 10% respectively—and Mrs. May attempted to give clarity on the U.K. government’s Brexit position.* I was unimpressed with both. Before I have a dig at Mr. Trump, I ought to provide an example of someone who supports it. I have great respect for Stephen Jen, but his argument here is like endorsing the idea of a diet by advising someone to eat nothing but kale and carrots for a decade. The analysis of Mr. Trump’s tariffs requires a distinction between the principle and the concrete measures. I concede that China is bending the rules of global trade, but Mr. Trump is stretching the fabrics of macroeconomic policy if he starts imposing tariffs on industrial goods. He is presiding over an economy close to full employment, a low domestic savings rate, and a medium-sized twin deficit. To boot, he is about to let fly with unprecedented fiscal stimulus.
Read MoreOn a headline level, 2018 has started exactly as 2017 finished. Stocks are up, U.S. short term rates are up—but the dollar has traded heavy—and economic data continue to tell a story of a synchronised upturn in global growth. The bears are furious, or perhaps just confused. Hussman recently published a prepper’s guide to a hypervalued market. And value investor extraordinaire—and famed bear—Jeremy Grantham from GMO invokes the “highest-priced markets in US history,” but also proclaims that we’re now in the “melt-up phase” of the bull market. I am all for holding opposing views at the same time, but markets demand a view and a position. So which is it Mr. Grantham? Long, short, or flat? I am not holding my breath for an answer. I have long since left the extremes behind. Picture a spectrum with Hussman and GMO at one end, and the wet-behind-the-ears trader, who have never experienced a sizeable drawdown in Spoos, at the other end. Hint: You want to be somewhere in between.
Separating signal from noise is an important skill in this game, and markets currently are throwing a number of curve balls at investors. What better way to kick off 2018 than by highlighting the ones that matter.
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