Post sugar high, what is left for US assets?
Statements like “buying the rumor and sell the fact” are lazy ways to describe price action. However, most of us love a good catchphrase because we live in a world where attention spans are short, and analysts and pundits alike must find a way to capture the readers’ focus. But what actually is the idea of “buying the rumor and selling the fact”? My assessment is that it is a changing of the narrative or more specifically, it explains when an investment theme plays itself out. It could be an earnings report, some economic data or a geo-political event. Investors anticipate an outcome, establish a position to reflect this and when the event has run its course, they liquidate the exposure. This is why prices can often go in the opposite direction to where they should once the scenario ends as expected.
Take the US GDP print on Friday. The market had extremely high expectations for the strongest quarterly number in four years. You get this confirmation, yet stocks, yields and the USD fall. The thesis about Q2 growth has played out and we are on to the next idea. Korean equities fell post the Trump / Kim summit in Singapore. Amazon earnings had lofty expectations, expectations that were well and truly met and yet the stock saw a wave of selling over the course of the day as this narrative has played out and traders move onto the next shiny object. What have you done for me lately? What is the next catalyst for asset prices globally to reflect the tax cut induced sugar high for the US economy generated by President Trump’s loose fiscal stance? Without a new scenario to focus on, yields and the USD will stay range bound but head lower. If rates and the USD couldn’t break to a new paradigm with US GDP this strong, why now?
The problem for financial assets in the next ten weeks, before we get to mid-October and the seasonal bump that is the commencement of the Q4 ramp into the end of the year, is that we do not have a fresh, positive narrative to drive asset markets around the globe. What is the fresh impetus, that can relegate geo-political concerns regarding trade, Brexit, Italy, the Russian investigation / Donald Trump impropriety and idiosyncratic emerging market risks to the realm of nothing more than a scary story? Strong earnings can certainly help but with US earning season coming to an end, the strength of global profitability, one of the key reasons why I am so constructive on global assets over the next several years, ceases to be a driver of news flow. A resolution on US / China trade tensions would be a huge boost but much less likely as President Trump needs a foreign pariah to inspire the base going into the US mid-term elections in November. I just don’t see what else is on the cards to get investors to look past all the negative headlines and encourage them to pay an ever increasing multiple for risky assets around the world, especially in the United States. While I believe that a weaker USD and softer long dated yields will encourage rotation back into EM, capped US stocks put a lid on all global assets.
Two positive outcomes that could lead to a more upbeat scenario for global activity. I have been a broken record over my belief that the Chinese are in the process of undertaking a three-pronged stimulus involving fiscal, monetary and currency levers. We are finally seeing evidence that the market is buying into this thesis. While the Chinese appear to have learnt their lesson regarding recklessly throwing cash at the economy and hence, the impact on commodity markets should be muted, industrial metals will undoubtedly be supported. Domestic equities, especially financials, remain the clearest expression of any stabilization measures.
A stabilization / rebound in European activity, while less alluring for investors than China turning on the spigots, should encourage rotation back into European cyclicals and banks. Financials around the globe remain a huge disappointment as yield curve flattening has crushed the bullish narrative being espoused over the past 12 months. That said, there is little doubt that a H2 jump in European activity should see continental banks bounce between now and Q4 when Italian budget woes yet again hijack the narrative. European banks are a tactical trade higher for the next several months. The model portfolio has a small exposure to the SX7E Index.
All that said, a reacceleration in Chinese and European activity in H2 can encourage rotation but global beta will be driven out of the US that currently doesn’t have a powerful enough narrative to encourage investors to pay the prevailing multiple for equity and credit assets. Dips will be bought but first asset markets must recalibrate from lofty levels**. The thematic model portfolio is net long 20% equities with a heavy bias of long EM and short the US and upon the release of this report, we will take this down to 10% by shorting another 10% in US small caps.** The relative performance of the Russell versus the SPX is driven by the USD and with both the dollar and rates likely to head lower through August, small caps should underperform. This is the lowest net equity exposure for the year.
A slew of central bank meetings with nothing expected from the Fed, a close call decision likely from the Bank of England given the weakness in data the last week and the Bank of Japan where hype is growing that a change could be brewing. I am skeptical about the exuberance toward the BoJ because the data isn’t really supportive of an easing in stance. Bank of Turkey minutes will make excuses for their inaction despite rampant inflation, but the market is convinced about political interference, so I doubt they can change the extremely negative narrative. The RBI and Brazilian Central Bank also meet. Tuesday, Japanese Industrial Production, Chinese PMI (softer expected), and EU GDP. On Wednesday a slew of PMI’s, and South Korean CPI. On Thursday, the US releases Durable Goods Orders. On Friday, the monthly lottery that is US Payrolls.