Peaking, plateauing or dimming - and how about that war?
13 April 2018Considering the sheer volume of geopolitical war talk, it might seem surprising that stock markets ended the week up, not down. The reason for this is most likely that the probabilities for an actual trade war between the US and China are seen as reducing, while the probabilities of retaliatory US military strikes against Syria's Assad regime (inadvertently) getting out of control are potentially underestimated.
A speech by China's president Xi on his country's plans for trade and economic rebalancing sounded so constructive and measured that investors became more inclined to believe that negotiations rather than tit for tat tariffs would be the further course of this trade dispute. Together with Trump's conciliatory tweet. one could be forgiven to think it has all just been blustering and a storm in a teacup. The prospect of renewed hostilities involving the US in Syria seemingly unnerved market only briefly.
When Trump's tweets were not followed by the intimated immediate rocket strikes, the assumption became that it had once again been more bluster and volatile tweeting, than an actual step up in retaliation measures compared to what has been experienced in the past. Indeed, the Trump administration's actions have proven to be far more measured than the president's language of tweets would have first suggested.
While we would like to agree with this interpretation, we know that capital markets are not particularly good at assessing political risks and therefore we will only breathe easier once the deed is done and the civilised world has delivered its message to the Assad regime that anybody resorting to chemical warfare will always pay a price that is higher than any possible tactical gain. In the meantime, we have to assume that things could inadvertently escalate, even if this is not our central case and expectation. More on this topic in our '˜US and Russia conflict over Syria' article this week.
Beyond this noise, investors are beginning to come to terms with the post equity market correction environment. Having rapidly switched from Goldilocks and stock market '˜meltup' joys at the beginning of the year, to panicking over inflation and economic overheating in February, to expecting global trade wars and economic slowdown in March, 2018 has already provided quite a few contrary perspectives of where we may go from here.
In this regard, it is increasingly apparent from the economic data flow that the acceleration in growth last year is giving way to a more moderate pace of activity. Whether this is called rolling-over, peaking, plateauing or dimming of growth, it most probably sounds more worrisome than it actually is. With the growth dynamics of last year it is little wonder that business sentiment in Europe and the US got ahead of itself. This is now reverting back to more realistic levels, which makes it look like a significant drop, when in actual fact the previous expectation highs may have been just as overblown.
The two areas we will continue to pay closest attention to are changes to economic activity levels in China and the Q1/18 corporate earnings announcements. The latter kicked off in earnest over the week, with a number of US banks managing to beat the already elevated growth expectation (see earnings article last week) of company analysts and delivering 23% year-on-year earnings growth. If other sectors of the US economy can follow suit, then this would breathe new upside into what was deemed an overly optimistically priced stock market. If replicated in Europe and Japan - minus the tax cut windfall - then it would provide some evidence for the assertion that the economic data direction change is merely a consequence of previous overshooting, but not a first sign of lasting decline.
Data from China on the other hand is telling us that compared to 2016 and 2017 we should probably not expect incremental growth contributions from the still fastest growing -big- economy in the world. Just as elsewhere, the rate of growth has stabilised and the government does not seem inclined to change that in the near term.
Altogether this leaves us almost where we started the year. February and March have cancelled out January and after the roller-coaster of fast changing sets of expectation, somewhat more balanced expectations may return. However, let us not make the mistake and expect the 2017 low volatility goldilocks trading environment to return. Now that volatility has made a return it is here to stay and we can expect markets to remain jittery. At least until macro-economic data flow proves stabilisation of growth, corporate earnings evidence continued business growth and the benign interpretations of the latest geopolitical frictions prove justified.
Quite a few '˜if's' and '˜but's' which make us for the time being comfortable to remain underweight equity risk in portfolios, even if we can see that position not to become a permanent fixture over the remainder of 2018 - just like the negative absolute returns that the year has so far brought investors at large.
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