Churn is probably the best way to describe equity markets at the moment. Inter- and intra-day volatility have increased, which is great news for the traders—and investment banks, apparently—but it isn’t much help to the rest of us. It reduces the signal-to-noise ratio, which has already been stung by the persistent cloud of political uncertainty, the threat of trade wars and related themes. Everyone likes to talk about this, but these events have, so far, been of no consequence whatsoever to markets as far as I can see. All that moaning notwithstanding, I am happy to report that the portfolio had its first decent month of the year in April. I was beginning to wonder whether I could be that bad at picking my horses. My confidence is now restored slightly, although I am still behind the mighty Spoos. Also, the next calamity is never far away. Equity strategists are now telling me to worry about another thing: The multiple-crushing rise in oil prices. Looking beyond the idea that a higher oil price ought to result in divergence between energy and the rest of the market, the idea is simple. A sharp rise in oil prices drives up inflation expectations and bond yields, both of which are poison for valuations. Multiple-expansion turns into contraction, and equities struggle.
Read MoreFor all the talk about a flattening U.S. yield curve, it is ironic that it steepened last week, albeit slightly. The trend, though, is clear enough. The 2s5 and 2s10s have flattened 27 and 32 basis points in the past year, respectively. Another 12 months at this rate and the curve would invert by the middle of next year. This wouldn’t be odd. It’s normal for the curve to flatten as monetary policy is tightened, and it is also normal for the Fed to keep going until the curve inverts. If you believe that an inverted curve is a good recession indicator—which is debatable—this is tantamount to saying that the Fed will keep going until something breaks, consistent with what almost always happens at the tail-end of policy tightening cycles. This probably won’t prevent investors and analysts from continuing to pay close attention to the yield curve. I have sympathy for that, for two reasons. Firstly, it is not clear to markets whether the Fed cares about a flattening curve or not. Some members of the FOMC do, some don’t. Secondly, if the shape of the curve is important to the Fed, the recent pace of curve flattening challenges the prediction by economists and markets that the Fed funds rate will be hiked by 25 basis points three-to-four times in 2018 and 2019.
Read MoreA few weeks ago I provided a bird’s eye view of most of the major asset classes, what they did in Q1, and what they’re likely to do for the rest of the year. I neglected the most important one though; the dollar. I am convinced that other markets eventually will take their cue from what happens to the greenback. The bull case is simple. The U.S. economy is about to get a jolt of fiscal stimulus, propelling growth to above 3%. The labour market has plenty of hidden slack, and productivity is rising, which mean that the Fed won’t have to hike the economy into the stone age to quell inflation and wage growth. Trade wars aren’t a problem, and in the case of U.S. tariffs on imports, the dollar will appreciate offsetting a boost to competitiveness. If the shit hits the fan, the dollar will be the safe haven of choice as capital flees the more open and exposed economies in Europe and China. Mr. Trump might not get a lower trade deficit but he can “win” a trade war with the rest of the world. The contrasting bear case is equally straightforward. The U.S. twin deficit is about to widen significantly, and foreign investors need compensation to finance the party. Higher bond yields and a weaker dollar are a necessary adjustment to reach a new equilibrium.
Read MoreLast week I complained about information overload, but as we close the book on Q1, the overall story is relatively simple: It has suddenly become a lot more difficult for investors to extract value from markets across all major asset classes. My first chart shows what happened at the start of the year. Specifically, it shows the volatility-adjusted performance of the main asset classes in Q1 compared with their recent 12 month performance. The butcher’s bill for anyone who haven’t been sitting on piles of cash, and long volatility exposure, has been large. Equities have struggled, bond yields have increased, the dollar has weakened, again, while commodities and gold have outperformed.
The volte-face in equities has been extraordinary. The MSCI World, in dollar terms, was down 1.2% in Q1, while its 90-day volatility increased by about 55% compared to the 360-day trailing volatility. This is in stark contrast to the trend before the swoon at the start of February, when low volatility and a gentle rise in headline indices were the only the story that mattered. Across regions, emerging market equities have done relatively well, eeking out a small positive return in Q1. The S&P 500 is flat—the NASDAQ is up marginally—while European and Japanese equities have been underperforming—in local currency terms—primarily because these indices are very sensitive to FX.
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