Following through on a campaign commitment, President Trump announced that he is withdrawing the United States from the multilateral accord that halted Iran’s nuclear program development and opened it to international verification in exchange for the lifting of economic sanctions. We will leave the analysis and commentary on the reasoning as well as the implications for regional stability to others. Our specific concern is what the implications for global public markets might be.
The most obvious place market participants are looking for a signal is in the oil market. Our view is that there will be little direct impact on the global supply-demand equation since consumption patterns are unlikely to change and most of the world can still access Iran’s output.
Where we think there is underappreciated and largely unmeasured risk is in the asymmetrical application of a sanctions regime in global fixed income and equities. Continue reading
Made you look. No, this is not about that. This is also not about tariffs and trade wars. This is a reminder that there are more forces at work in the market, more fundamental forces, than just headline news.
The Technology and Consumer spaces have been having a bit of a Waterloo moment. A steady drumbeat of information breaches from tech firms, consumer credit firms, major merchants, health insurers and others has shown that our digital lives are the new currency of commerce, and thieves will gladly take and then sell this information to the highest bidder.
To date, the response has been largely profiteering. Play on the concerns of the citizenry that companies cannot be trusted to care for their personal identifiable information and sell them identity protection and credit protection services, in some cases crassly by the very same companies that fumbled the information into the open in the first place.
Here is something on which the Partners at WCM do not agree. We have a diversity of views as to the merits of punitive tariffs and the possibility of a trade conflict if not a full-on trade war. There is an extraordinary amount of complexity in the system, and as a consequence no clear, straight line of causality. Raising steel and aluminum tariffs could help to revitalize US industry and jobs, or it could raise input costs for infrastructure companies, auto and plane manufacturers, commercial builders, etc. Those tariffs could spark domestic activity, or it could kill jobs and mute the stimulative effects of the recently legislated tax cuts. Our disagreement is fine. That reflects the realities of the country and the economy, and therefore the markets in which we operate. Economists, analysts, academics, business leaders, pundits, policymakers, politicians, and the press all have hot takes on what this does and could mean, but nobody knows, including us.
We have been looking at the charts, very much the heart of our process, and are a bit puzzled by Europe. Many of the fundamentals that we have discussed in our blogs, monthly and portfolio updates have been pointing to favorable market conditions for equities and a lid on rates thanks to ECB policy. But the charts – oh the charts. If we take currency out of the equation the market’s performance has been, to be kind, lackluster. Our question – what is holding it back?
Stock markets around the world have been gyrating in response to higher interest rates – particularly in the United States. Long-term US Government bond yields have increased significantly over the course of the past year and a half. Yields on the 10 and 30 year US Treasuries have recently reached levels that some market participants believe may become headwinds for equities. While recent advances have been steep, interest rates are still well below what would be considered “normal levels” which would imply more volatility in corporate securities markets across the globe.
US stocks have regained their footing relative to US fixed income and have resumed their capital market leadership. Stock prices in the US have rebounded from their February 8th low while upward trending interest rates have been an obvious headwind for bonds. The higher interest rate environment, while widely anticipated by some for several years, may be a formidable challenge for equities both here and abroad. In our view, as long as interest rates rise at a moderate pace, equities should continue to advance and the global economic expansion should remain intact.
We would point out, however, that we are in the early stages of the recovery and the market may yet shake investors’ confidence in coming sessions.
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We decided to sit this one out. The way the market just whipped around over the last few weeks with little provocation, our concern was about informationless volatility, and we did not want to jump into the fray with comments much less action without any additional insight. In our view, there was very little if any new information that came into the market to trigger the bout of vol. A lot of observers and pundits were pointing to data about jobs (or was it wage growth, or perhaps it was GDP?) that signaled the potential for inflation, and with it the specter of a Fed getting the knives out to cut back the easy money. But, at least from our perch, these new data points were not only knowable, they were known, and they were not new. Perhaps rate watchers and equity market participants were hoping if they clenched their eyes very tightly the hallmarks of an expanding economy might go away on their own.
In terms of purchasing power, there has not been real wage growth for at least a couple decades for the cherished middle class, much less their undercompensated neighbors further down the economic ladder. Even at sub-5% unemployment, the quality of jobs may be poor in terms of wages and ability to exploit workers’ educations, skills and capabilities, and many of those workers would take more hours if only they were available. Compounding that, a significant and growing portion of the workforce is self-employed, and not by choice. Many jobs that used to be salaried and permanent, including knowledge economy jobs that were supposed to be the future of employment, have become temporary 1099 gigs if they have not been shipped overseas entirely. When looking at the fundamental reality on the ground, we could not find a rational explanation for why markets choked on encouraging but fairly benign data. An overheating economy appears still far off in the future and the Fed’s path to higher rates is inexorable, yes, but also slow and deliberate.
So what happened?
The last few trading sessions in stock markets around the globe have been painful. The sell-off on Friday February 2nd was the steepest in nearly two years, only to be followed by a deeper fall Monday. The prompt for the market rout appears to be a strong jobs report in the US that included signs of increasing wage inflation. Benchmark interest rates, in turn, rose with the yield on the 10-year U.S. treasury climbing to 2.84% on Friday only to fall to 2.7% on Monday evening. The perception that interest rates may rise faster than the market expects unnerved equity investors. In our view, the US stock market is consolidating strong gains posted over the past year and its longer term trends are still upward-sloping. With economic conditions showing continued improvement and corporate earnings accelerating, equities should resume their upward trajectory after this bout of selling pressure recedes. For now, we view the stock market as experiencing a healthy, albeit harrowing, correction.
On Dr. Martin Luther King, Jr. Day, it is a good time to listen rather than speak. Here are a few places to go to hear about both the legacy and the present day state of social and economic justice in the United States:
Equal Justice Initiative – https://eji.org
Southern Poverty Law Center – https://www.splcenter.org
The Innocence Project – https://www.innocenceproject.org
And, a compendium of discussions and excerpts from Dr. King’s sermons and speeches — https://www.npr.org/news/specials/march40th/speeches.html
And we’re back! Happy New Year to our friends, clients and partners.
US Personal Consumption Expenditure (PCE) Prices, depicted in this week’s chart, is an inflation indicator that we follow closely. It is still below the US Federal Reserve’s 2% target, but getting closer. This has historically been among the favorite inflation indicators monitored by the Fed and Fed watchers. Our concern is that, if inflationary pressures prompt the new Fed leadership to adopt a more rapid approach to raising the Fed funds target rate, the yield curve could flatten further or even invert. Complicating this picture is that comparable longer-term yields in Europe and Japan will likely stay lower for longer due to central bank intervention. The result could continue to tether comparable US treasury yields and lead to a yield curve inversion in the US, which in the past has been a reliable precursor to recession. However, such an inversion caused by central bank intervention rather than from the natural course of the business cycle could produce unpredictable consequences. This relationship bears watching.