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It's complicated

Last 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.

Information Overload

Sometimes when you’re faced with too many choices, the best thing is to do nothing at all. When I look at markets, I sense that many investors are thinking along the same lines. If true, I have sympathy for it. In the U.S. economy, the news flow has invited contradicting conclusions. The February NFP report in delivered a hawkish headline, but sluggish wage growth and a higher labour force participation rate suggest a goldilocks interpretation. It is similar in the global economy. We have the promise of a fiscal stimulus-boosted U.S. economy growing close to 4% adding further momentum to a synchronous global upturn. But data in the Eurozone have disappointed recently, and investors also have to count the risk of a tit-for-tat trade war in tariffs. Geopolitics, as always, loom on the horizon too. In FX markets, we are still debating whether reckless economic policies in the U.S. will drive the dollar lower or whether Make-America-Great-Again™ will revive the dollar bull. A wider twin deficit, in principle, could deliver both. We have also been discussing the Libor OIS spread, Italian politics, and of course, the ongoing tragedy of Brexit. I view markets through narratives, but I struggle to come up with one that captures all of the above.

Markets and Tradingclaus vistesenMarch 18, 2018bonds, equities, yield curve, growth stocks

#Tradewars

Markets 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.

Let's get the story right

I have trampled around in the same weeds recently, so I will keep it short this week. Equities are doing what they’re supposed to, trying to complete a V-shaped recovery from the swoon earlier this month. Last week was a corker, even for the portfolio, which benefitted from solid earnings reports. Bloomberg’s Joe Weisenthal had me one-on-one on Monday, where I duly warned that the S&P 500 remained overvalued relative to other asset classes. Even Gartman couldn’t have done it better. On this occasion, though, I am happy to double down. A V-shaped rebound to a new bull run looks like wishful thinking to me. Equities are the least of macro investors’ problems, though. The puzzle of the day remains the link between rising U.S. yields, a firming cyclical outlook and a falling dollar. In my last post, I asked the question of whether foreign savings would come to aid of a U.S. economy at full employment—with a record low savings rate—about to be jolted by fiscal stimulus. Open macroeconomics suggest that such an economy should open up a large external deficit, and Japan and Europe have the savings to make it happen. Alternatively I suggested that perhaps the rest of the world doesn’t fancy financing excess spending and investment in the U.S.

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