With summer over, the work begins
(this is part one of our weekend blotter. We will publish the latter part tomorrow)
I do feel like I have had a bit of a lazy summer and it is now time to put the foot down and get back into work mode. I get the sense that many of you have been feeling the same way but for vastly different reasons. US centric investors have done little because they simply haven’t had to. Month after month, quarter after quarter, US equities, led by technology have outperformed the balance of the globe. Asset allocation decision have not really changed that much because there was no need to. Investment grade credit has caused a few headaches but at the margin, there has been a distinct lack of volatility in a US biased portfolio.
For the rest of us, with our broader reach, the story is very different. Emerging markets remain problematic and the lack of activity for international investors has been more about being a deer in the headlights versus comfort in the construction of the portfolio. While I can make coherent arguments that we live in a world that is less susceptible to contagion and that US interest and dollar concerns are overblown, the constant barrage of negative headlines out of emerging markets says to me that only a crisis / capitulation by the likes of Turkey i.e. IMF involvement, will be enough to turn the tide. Traditional drivers of EM beta such as Chinese stimulus are not having an impact on the performance of broader emerging market assets and has driven me to the following conclusion:
Emerging market selling has less to do with the structural deficiency of emerging market economies and more with the strength of US growth and the buoyancy of corporate America. While I can make arguments about tax cut induced sugar highs, the reality is that with US growth and profits as strong as currently being witnessed, the risk adjusted returns in USD are just not compelling enough outside of the USA. It can be debated that it is the strength of the US economy that is forcing capital flight from emerging markets when their own growth outlook is not that bad. Twisted logic but I feel it is valid.
So, what should we expect from September?
Here, in bullet form, are the key factors to consider for the month of September:
- September is seasonally the worst month for US equities and this is a historic drag on global beta.
- Additional tariffs on $200bn worth of Chinese goods looks certain. A Chinese retaliation will follow. NAFTA (can we still call it that?) will become a larger headline as US / Canada trade talks failed to meet the September 1st deadline. End of November is new deadline. Tensions to rise, not fall near term.
- While the usual swag of monthly data will show the continuation of strong US growth and most likely a rebound in European and Chinese activity, we have an absence of earnings to reinforce the narrative of a buoyant corporate America.
- The Fed will raise rates and given the rhetoric from Chairman Powell at Jackson Hole, the path of quarterly rate increases between now and at least March looks certain. This implies that US interest rate volatility will remain depressed.
- You have offsetting forces in US fixed income. Tax changes on September 15th regarding the rate at which pension contributions can be deducted is being touted as a reason for bond buying / curve flattening in the face of a tightening Fed and robust economy. I’m skeptical as I believe more is at play here, but this is the narrative. The other side of this is the continued near historic short positions in US bond futures. Who wins? My bet is neither and the trading range is maintained.
- There is little on the horizon to believe that things won’t get worse in Turkey and Argentina. While the contagion effects on the rest of EM are debatable, it is tough to see EM bottoming without IMF involvement in Turkey.
- Politics will begin to play a larger role in the determination of price. Heightened focus on the US mid-terms and the prospect of a harsh rebuttal of President Trump. Brazil’s contentious election will garner more attention and bring potential BRL stresses to the top of the heap of EM concerns. Whether or not this eventuates remains to be seem, but we can say with confidence that Brazil is a much bigger risk to EM contagion and global beta than Turkey and Argentina.