Friday, July 21, 2017

What would Otto and Hugo do...?

[Background - Otto Von Bismarck was the first Chancellor of  a unified Germany from 1871, and a master of manipulating geopolitical rivalries and weaknesses in furtherance of his goals. He made regular use of the external "war scare" to distract from domestic political squabbles and to unify public opinion. Hugo Chavez, although from a radically different political perspective, used exactly the same techniques to push forward with his "Bolivarian Revolution" in Venezuela. The relevance of this comparison becomes clearer lower down, so bear with me...].

The first half of 2017 has been a good one for stockmarkets which continued to rise on ever expanding risk appetites; the returns (in USD's) were led by gains in Asian (not including Japan) and Emerging Markets (up an average of 20%), Europe (+16%) and the US (+8%). For USD based investors, that was a happy outcome, helped as it was by a 6.4% drop in the USD. For investors in other currencies, the returns were a bit less exciting, since the weaker USD offset some of those gains.

As we look into the second half, the prospects look more challenging.

Obviously valuations for markets are now higher than they were at the beginning of the year, and if markets are to rise further, these gains will be on the back of either a higher earnings base (better company profits), higher dividends and continued share buybacks, or because investors continue to see value and are therefore prepared to pay more than they did at the start of the year. In practice, if markets gain, it'll likely be as a result of a combination of these factors acting in concert to drive share prices higher.

As we've noted before, much of the reason why markets have risen is largely because there are few attractively priced alternatives - least ways, not ones that would encourage you to allocate a big slug of your portfolio to them.

Bond markets look more expensive, and unless you're holding a bond to maturity, they are vulnerable to changes in interest rate expectations. These vulnerabilities become more acute the further away the maturity date or the lower the quality of the bond issuer.

Cash seems a no-no given low or non-existent yields and the high volatility of currency markets.

Hedge funds have had a lackluster year, and playing the commodity markets is often difficult and expensive.

Although the rise in stockmarkets to ever higher valuations does make them vulnerable to short term changes in sentiment (particularly if those changes in sentiment reflect a more systemic change of view), thus far, there has been nothing on the horizon to suggest that such a thing could happen soon.

However, since the most violent storms are often those that appear out of a clear sky, the part of the horizon we are watching warily is in the political one, notably in the US, where the Trump administration nears its 6 month milestone, with little to show in terms of legislative progress.

The risks of a knee jerk reaction from a now notoriously sensitive administration are rising. The desire for a populist win - and hang the consequences - looks like a growing possibility that can no longer be discounted. What could that look like? [Cue references to Bismarck and Chavez with their focus on confected external threats as a means of rallying disaffected domestic support]

It seems that it's either going to be focused on something like tax reform - which markets would like (a lot) - or trade - which markets would not (a lot).

Tax reform would be universally applauded globally (and by stockmarkets especially), although not so much by Trump's core supporter base. It would, however, require a high degree of focus on detail and execution that has so far been largely absent from the Trump White House.

Renegotiation of trade - particularly if triggered by pre-emptive tariffs - might generate a few short term political points in the US. It would, however, be viewed with serious alarm on a global basis, raising as it would the spectre of a major trade war from which there would only be losers. Read John Mauldin's recent piece on the subject http://www.mauldineconomics.com/frontlinethoughts/trade-war-games (and bear in mind, while you read, that John is a card carrying Republican).

The trouble with trade is that it seems the political calculation being made by Trump's team is that it's a zero sum game: for me to win, you must lose. If I'm importing more from you than exporting to you, then I have a deficit and I must be losing, so I need to do something about that to level the playing field. Trump has been particularly vocal about China and NAFTA as major examples of trading partners who have benefited at the US's expense in this binary relationship.

Maybe John Mauldin (along with the FT on June 22nd) is right, and the first battle on trade might be launched over steel.

Having missed a self imposed deadline of last Friday, the Trump administration is supposedly due to make an announcement any day now about whether or not cheap imports of steel into the US represent "a threat to national security", thereby allowing the US to take unilateral action under WTO rules. If that were to happen, then obviously the reaction of the US's trading partners would be swift and would likely spread beyond steel very quickly. The irony here is that China (Trump's main trade antagonist) despite it having built a glut of manufactured steel, does not even make it into the list of the top 10 countries from whom the US imports its steel.

The last time the US imposed steel tariffs was in 2002 under George W Bush. These were removed within 24 months in the face of an almost global backlash from the US's trade partners.

Whether or not the result is the same this time, depends on the political calculation of whether Trump and his team think it makes more sense to pander to a domestic political audience that likes such things - or to do what is best for the US and the global economy. In previous years, the calculation would have come out in favour of the latter: pragmatic, logical and focused on the long-term, producing much bluster but resulting in no trade war.

However, as Hugo Chavez showed in Venezuela when domestic politics are a factor, and when the ruling elite feel under pressure to produce a political "win", the short-term calculations can dictate a completely different and much more damaging response.

We hope that reason will prevail, and that politics will continue to produce a lot of smoke but no fire. In this scenario, the economy continues to grow - despite the politicians who remain securely grid-locked and therefore unable to inflict much damage.

However, remember the quote..."just because you don't take an interest in politics, doesn't mean that politics won't take an interest in you..." If it starts doing so, then markets might get much more exciting than many of us would like.

e-mail: steve.davies@javelinwealth.com
contact:  +65 65577186
Find us on Facebook: http://www.facebook.com/JavelinWealth
Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Sunday, June 18, 2017

Summertime blues...?

As we head into the second half of 2017, it's a valid question as to whether or not the market momentum that has been such a feature of the first half will be maintained into the second.

Does the classic "Sell In May" adage hold true?

Since 1926, annualized total returns for the S&P 500 during the “sell in May” weak phase of May-October at 6.8% are about half those of the seasonally strong November-April, which have historically returned 13.4%. The seasonal discrepancy is even greater when you look at the higher beta small caps.

This year there are probably more reasons for caution. Global equities are up 12% in USD terms since the start of the year, and valuations, especially in the US are at cyclical highs: there's a lot of good news baked into prices, which therefore make them vulnerable to any potential disappointments.

This is particularly the case in the US where legal challenges and politics look likely to restrain the Trump Administration's ability to deliver on some of its market negative campaign rhetoric (the Wall, trade and immigration restrictions). However, it's also affecting its ability to spend time on the crafting the detail needed to push through potentially more bi-partisan issues such as infrastructure spending and tax reform. Without the latter, the market's high valuations begin to get more difficult to justify.

Elsewhere, the UK's self-inflicted political have complicated an already complex Brexit process. The odds of an effective and mutually acceptable deal being agreed before the March 2019 deadline are lengthening, with the result that, according to the WSJ, the UK is fast becoming one of global investors least favourite places to invest money, and they've been pulling money out of the UK market for 8 weeks running. Rising inflation and slow wage growth for an economy that is heavily reliant on consumer spending are bad signs.

And yet...

Low interest rates seem likely to be with us for a while yet. This means that investors, when confronted by negative sentiment, rightly look for more attractive alternatives and come up short. Note for instance that "Alternative" assets such as many hedge fund strategies have badly lagged global markets in an era of consistently low volatility. Fixed income, has done well this year, but with yields once again back to historic lows, one has to question whether these are even more overvalued than equities.

There are also some markets that are looking more attractive. Europe (ex UK) is benefiting from the political winds of change blowing constructively in favour of reform and growth. They've tried everything else, and now France, hitherto a resistor to change may lead the way with its new political environment under Macron. Time will show whether he can translate popular support into structural change. If he can, then France may surprise by taking over more of the UK's pro-growth and pro-business mantle, just at the time when the UK seems keen to throw it off.

In Japan, too, inflation has lately begun to pick up, and with it a slow demonstration that the government and BOJ's liquidity driven growth policies are beginning to bear fruit.

On that basis, although we're trimming our equity exposures to the US and thereby locking in a few first half gains, we're adding allocations to Europe, Japan and Asia.

e-mail: steve.davies@javelinwealth.com
contact:  +65 65577186
Find us on Facebook: http://www.facebook.com/JavelinWealth
Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.