Note May 1,2019: Markets Trysting the Night Away- In late 2018 and early 2019, there appeared only a brief pause to consider the long term impact of curbing quantitative ease. Now, markets appear again reverting to momentum whiletrysting the night away based on quantitative ease remaining massive led notably by the Federal Reserve and followed forthwith by other central banks.
From early April 2019 onward have been a corporate results torrent in addition to a series of political and central bank events. Salient remains the issue of appropriate sovereign yields versus deficit policies in public finance. Corporate results worldwide and across industries demonstrate that achieving consistent revenue growth remains difficult. Themarket momentum focus remains on applauding the beating of sharply reduced consensus. Recent covers lauding ostensibly unstoppable equity price increases and demise of inflation likely reflect consensus being fulsome.We believe that standards are overdue of equity valuation versus the deliverability of long term growth. Politicians and momentum traders may scoff at such longer run aspects of public and corporate policy but we assert them to be a crucial part of investment considerations.
We believe that central banks will also need to revert to balancing their long term versus a short term stance that has now stretched into a decade and more. Rarely as far apart as folklore suggests, we see politics and the exercise of central bank policies to be intersecting sooner than many believe. For example, the Federal Reserve likely only has six months or so of latitude and should raise rates 25 basis points in June and September followed by another pause. Volatility increase is likely as the May 1, 2019 FOMC was circumspect.
Numerous elections loom from Asia to Europe to North America. Tripolar geopolitics are evident from Russia asserting interests from Venezuela to eastern Europe to the Middle East to North Korea; in time honored major power fashion from China building out its blue water capabilities and a global infrastructure initiative while the United States appears more introspective. Meanwhile, conflagration remains expansive in the LeVant and into South Asia.
We believe that capital markets are likely underpricing risk by being momentum dominant partly from quantitative ease and partly as complacency occurs when cycles mature. Some fraying can be seen in post IPO 100 year bond and concept equities pricing. Quality and diversification appear key as do signals from the Financials sector.
Even setting aside deliberate efforts in many emerging and advanced economies and rarely as far apart as folklore suggests, we see politics and the exercise of central bank policies to be intersecting sooner than many believe. It seems so in Britain still tangled in Brexit. Ahead of a new appointment of Governor of the Bank of England, there appears a potential general election and/or referendum amid internecine strife in Parliament. In addition to populism in several member countries, European Union elections loom in late May with a new ECB President to be also appointed thereafter in 2019. Politics and central bank policies have been intersecting perennially in Japan. For many central banks in emerging countries, the issues of currency stability versus interest rates and external funding flows have re-appeared as policy factors, most recently in several countries in Latin America and Turkey. As well, in an already politically charged U.S. environment ahead of its 2020 elections, the Federal Reserve likely only has six months or so of latitude before tinges flare into issues of monetary policy versus imminent political races. As seen in prior election periods, the Federal Reserve may not directly respond but these same periods also demonstrate that as is already occurring now, the political decibels invariably rise. The Federal Reserve should raise rates 25 basis points in June and September followed by another pause. After having been clear in most of 2018 on reducing quantitative ease but then backing away in early 2019, volatility increase remains likely as the May 1, 2019 FOMC was circumspect.
In 2019/20, significant political events loom. Numerous elections are scheduled from Asia to Europe to North America. In May 2019 alone appear crucial decisions in India and Europe. The next sequence is due in Britain on relations with Europe amid political rift over an election and referendum. In Europe itself also in May and amid populism, appear struggles in both European Union Parliamentary elections and for a new President. U.S. electioneering for 2020 has already commenced by both parties. It is likely to be fierce, with populism, global positioning, and economic policy all at the forefront. Canada also has an election to come in late 2019. Tripolar geopolitics are evident. Russia seems asserting interests from Venezuela to eastern Europe to the Middle East to North Korea. In time honored major power fashion, China is building out its blue water capabilities and a global infrastructure initiative. The United States appears more introspective. Meanwhile in the LeVant, conflagration remains in expansive mode. From Algeria to Sudan there is regime change. From post-election Israel through to Saudi Arabia, the Gulf, Iran and Turkey, competition is intense for regional dominance. Meanwhile in South Asia, events in Afghanistan, Pakistan and now Sri Lanka demonstrate religious extremist terror as being fervent. We believe capital markets are likely underpricing political risk.
In early April 2019, the corporate results torrent started as have a series of political and central bank events. Beyond the initial phase now a decade ago, of this earnings cycle when earnings momentum was typically strong off the bottom in 2009, we see the sequential equity market reaction to have been one of initial expectations being cut back enough to allow actual earnings results to beat the most recent consensus at the time. Then, relief appeared demonstrated in equity indices moving upwards in momentum, abetted by massive quantitative ease. Subsequently, as S&P 500 earnings growth slowed from 2015, equity valuation expanded. Companies received a further boost in 2018 from U.S. tax cuts. Globally, equities have appeared taking leadership from the United States that was wrested away neither by lower relative valuation in Europe nor by higher relative growth in China. Momentum and quantitative ease suppressing rates appeared to be dominant until late 2018.
Towards the end of 2018 and only partially into 2019, there appeared that which now looks like only a brief period of assessing the impact of curbing quantitative ease. It did result in corrective activity in capital markets, including emerging country and low quality corporate through to sovereign fixed income as well as in equities. Momentum in equities appeared to play a lesser role. Following this has been reassertion led notably by the Federal Reserve of quantitative ease remaining massive and followed forthwith by other central banks. In turn, capital markets have followed suit by reverting to momentum tilts and away from stratifying risk for the long term.
Revenue challenges have been a consistent factor in this cycle for many industries and across geographies, leading to financial engineering including share buybacks instead of capital investment. This market momentum focus remains on applauding the beating of sharply reduced consensus but changes also appear. At the individual company level even for large well-known companies for instance, equities failing to achieve consensus have been greeted with sharp equity price drops. Some fraying can also be seen in the post IPO pricing of 100 year bonds and in concept equities that were all the rage not long ago. Corporate results worldwide and across industries demonstrate that achieving consistent revenue growth remains bifurcated. These developments do raise questions about market efficiency versus momentum fervor in present markets.
At salient points, fulsomeness tends to overflow in capital markets. Seen in retrospect, displays of consensus being fulsome were the assertions in the late 1970s/early 1980s about the demise of equities and again in the mid-2000s about encouraging credit extension merely reflecting dancing as long as music plays. Recent covers now lauding ostensibly unstoppable equity price increases and demise of inflation likely reflect consensus being fulsome again. We believe that standards are overdue of equity valuation versus the deliverability of long term growth. Salient remain the issues of appropriate sovereign yields versus deficit policies in public finance. Politicians and momentum traders may scoff at such longer run aspects of public and corporate policy but we assert them to be a crucial part of investment considerations.
We believe that capital markets are likely underpricing risk by being momentum dominant partly due to quantitative ease and partly as complacency occurs when cycles mature. Quality and diversification appear key as do signals from the Financials sector. StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e.