What did you truly expect?
(this is part one of our weekend blotter - we'll publish the latter part tomorrow)
I often write that investors have no control over, or no explanation for, the short-term gyrations in the prices of financial assets. Last week’s flagship report was dedicated to the topic of hedging our structural risk rather than attempting to fine tune performance when we really have no edge in doing so. While I have not done the analysis, my best guess is that I tend to focus on the unpredictability of daily price fluctuations when the VFTP thematic model portfolio is going through a period of losses. I am not saying that when things are going well that I take the credit for being on the right side of near-term movements, but it is human nature to think that your longer-term ideas are playing out when markets are moving your way and to claim randomness when they aren’t. If you have an investment time frame lasting months, overanalyzing each and every daily swing isn’t productive. You need to give your thesis time to play out and patience is always required.
If 2018 will be remembered for anything, it will be that politicians and policy makers stuck to their word and did what they said they were going to do. President Trump told us about Chinese tariffs and they eventuated. The Chinese threatened retaliation and they did. Federal Reserve Chairman Powell has implied, and projected, quarterly interest rate increases from the Fed and he is executing on this. The Italian budget to be announced this week will show that the populist coalition will propose a spending plan that will probably be at odds with EU budget caps, but this has been a platform they have promoted for ages. There is even a chance this week, a slight one, that the US and Canada cannot reach a deal on NAFTA and the US goes it alone with Mexico. Again, this is not out of the blue. Many investors just put all these down to negotiating tactics yet, time and time again this year, rhetoric, especially Trump rhetoric, has played out as stated. Why are we regularly surprised by all this?
Start hoarding cheese
British PM Theresa May has just returned from an EU leaders’ meeting in Salzburg with more, not less, doubt about the viability of the Checkers' Plan. Over the course of the last month, the pound has rallied appreciably, Gilt yields have risen, and expectations have grown of a more conciliatory approach by the EU. Press reports were that the two sides were getting closer to agreement about key issues like the Irish border, reports that appear to be far more about a positive rhetoric rather than a true closing of the divide between the parties. The result? More of the same. No deal. A speech back on British soil stating that the UK and the EU are at an impasse and that Mrs. May “will not overturn the results of the referendum and not break up (her) country”. The pound sold off and gilt yields fell. Truly, what are investors expecting from all this?
While Mrs. May could prove all the doubters wrong with some masterstroke of negotiation that appeases both the Europeans and the hardline Brexiteers in her party, the chances of this happening are incredibly slim. Yet, the pound by mid-September was back to levels not seen since July. I cannot explain the squeeze in the pound in recent weeks outside of strong inflation and retail sales data but big picture, nothing in the last month has changed. The gaping divide between all sides looks insurmountable and unless something alters dramatically, the approach by every speculative investor should be to sell the GBP against all major currencies into every 3%-5% rally because when it becomes clear the either a) the EU and UK can’t make a deal, or b) Boris Johnson and his merry band will vote down any proposal in the UK Parliament, then the GBP will fall 10% on a trade weighted basis and 10 year Gilt yields will fall to 100bps as recession is inevitable.
This week is light on data and big on events
The Fed will raise rates and all eyes will be on the dot plots and Chairman Powell’s response to questions about tariffs and deficits. The Italian budget is not about if the populist government won’t blow out the budget, but by how much. Degrees matter and will determine whether Italian spreads widen. An OPEC meeting this weekend is all about attempts to mitigate lost Iranian production. One observation. With the Aramco IPO off the agenda, how important are higher oil prices to the Saudis versus market share? The fiscal position implies they need the cash regardless. The Brett Kavanaugh confirmation hearings for the US Supreme Court will be a media circus but not market moving. Indian funding pressures, on the other hand, have been under reported but definitely worth watching for EM investors.
As mentioned, the US Federal Reserve meets this week, as does the RBNZ. Monday, Singaporean CPI. Tuesday, the US Consumer Confidence. Wednesday, Singaporean Industrial Production, and US Housing. Thursday, European M3, German CPI, and the US revises second quarter GDP. Friday, Japanese CPI and Industrial Production, Chinese PMIs, and UK GDP.