Blotter: The Noise Coefficient is at eleven
The Noise Coefficient is the way I define the impact of broadly irrelevant information on asset prices. For those of you with a short time horizon, news flow, generally negative, can have an outsized effect on markets and can easily upend a two-to-four-week theme. For example, the bumper earning season that we have witnessed over the last few weeks has not resulted in the returns many speculators would have hoped for due to headwinds such as US / China trade relations, a hawkish Fed and inflation concerns leading to USD strength. Russia, Syria, and Iranian headlines all had an impact in dampening the euphoria over record corporate profits for the SPX. Many of these headlines will prove to be inconsequential to global growth, profits and default rates and as such will quickly be dismissed. Time and time again, noise proves to be nothing more than a buying opportunity for quality companies and cheap markets. The strength of US equities after a disappointing payroll report looks like one of those occasions.
However, if there is enough noise, it can force investors to challenge their underlying framework. Is European weakness a weather-related blip or a threat to the synchronized global growth thesis? Is USD strength temporary or a sign that EM outperformance has structurally plateaued? There are just so many crosscurrents that many investors, even with a longer duration, are starting to second guess themselves on whether the buy on dips mentality that worked so well in 2017, will come back to haunt them. What about the Mueller investigation? Tech regulation? China weaponizing the reclaimed islands in the South China Sea? The conversations are less about the economic cycle and more about an ever-increasing list of peripheral factors that are distracting from the core drivers of asset returns: Growth, profits, interest rate cycles, inflation and corporate default rates. I get the sense that these are taking a back seat to headlines.
Now you may disagree with my long-term narrative that inflation isn’t going to be a problem; that long dated yields are capped and that we are in the early stages of a multi-year re-rating of emerging market assets. What I am saying is that noise creates opportunities and it always will. If you are bearish on EM because you think the USD has bottomed, do not dump EM equity on the back of bad China / Taiwan headlines (these are coming!). Don’t hit bids if Syrian tensions get worse. Will Argentina lead to EM contagion? Be smart. Appreciate that noise is not narrative and history tells you that selling pressures (or buying pressures for that matter) quickly reverse when the dust settles and the headlines fade. Stick to your fundamental thinking and don’t be fooled into believing that noise is the start of something bigger.
My narrative remains that rates are capped and eventually, the USD will be also. While many emerging markets look technically shaky, valuation support should ensure weakness will be short lived. I believe that Argentina’s woes are noise for the rest of the emerging world. The thematic model portfolio will be adding to China risk down 2% and will be looking to sell USDJPY at 109.80. Tough for me to see USDJPY much through 110 with a 4% of GDP Current Account Surplus. We are looking at adding aggressively to EM carry currencies and this week will be introducing our TPP-11 basket, which will be currency and equity index exposures across those countries benefiting from the Trans Pacific Partnership.
The BOE and RBNZ meet this week. On Monday, German Factory Orders, and Indonesian GDP. Tuesday, German Industrial production. The US report on PPI on Wednesday. On Thursday, Chinese CPI and PPI, and the US CPI. On Friday, Hong Kong GDP, Indian Industrial Production, and University of Michigan Sentiment.
Founder, View from the Peak
IND-X Advisors Limited