Note March 14,2018 – Market Tryst With Ides of March: Much has occurred just in the first half of March 2018 in the complexities of mega mergers and market valuation, trade frets and major political developments that lie in not just in the United States. The same can be said about emergent observations by major central banks most tied to quantitative ease, hitherto seen as dominant in in this cycle. Political stress is indicated from change at the highest levels of the U.S. government and trade; from change in Europe absorbing both election results and trade stress including Brexit; from China cementing its political structure for the long term and likely, a more assertive post-election Russia. This nuanced environment is in contrast to that being assumed in capital markets especially in recent years of low volatility and broad risk on/risk off attributions onto equity and fixed income market behavior. We expect events leading up to the ides of March 2018 presage market tryst with higher volatility. Current market and fundamental aspects, as well as those previously ignored, are likely to add to risk premiums.
Political stress is substantial. It develops from change at the highest levels of the U.S. government and trade; from change in Europe that is absorbing both election results and trade stress including Brexit; from China that is cementing its political structure for the long term and likely from challenges emanating as Russia becomes even more assertive after its election. Trade wars (and for that matter shooting wars) often start with what seem to be at the time, limited actions. They often have had unforeseen consequences. Tit-for-tat retaliation and the need to save political face play a not insignificant role. These aspects often appear at work even among large mostly open economies like the G-7, for example in the mid-1980s. it currently appears in politics injected into traditional areas like intermediate goods and agriculture. It also appears in advanced technology such as in defense and communications. Amid industries and employment patterns undergoing global structural change, prolonged quantitative ease also may have affected the process of allowing weaker industries to make room for newer or more robust ones. Underemployment remains a flashpoint. To channel claims of unfair trade and to provide political cover domestically for advanced and emerging countries alike, it was for not without reason that trade organizations were developed and have been successful. Currently, the U.S. has claimed unfair action and national security as being the rationale in steel and aluminum tariffs, both intermediate goods. Its cost impact to higher value added U.S. products has yet to be delineated but in areas like aircraft, market assessments appear already. Meanwhile, neighbors like Mexico and Brazil are completing their elections ahead of any retaliatory action. The upper reaches of the U.S. government appear in extraordinary flux. The U.S. midterm elections are likely to be especially bitter, underscored by the Pennsylvania special election swing of March 13,2018. In Asia, emerging from its March 2018 National Peoples’ Congress is revision of strictures in China which strengthens incumbent power. It comes about at a time when China is focusing on reducing corruption but also on restructuring industry for the long term. In Europe after a number of national elections, most governments appear weakened with the arguable exception of that in France. These domestic developments of weaknesses within its body politic could reduce the flexibility of the European Union for example in Brexit talks with Britain to be completed by 2019. Furthermore and after its elections in March 18, 2018, Russian assertiveness can be expected to increase further. From developments in 2018 even just to mid-March, the probabilities for political friction appear being raised.
Within capital markets themselves, much has also been taking place in Q1/2018. One of the more intriguing developments appears in business related merger and acquisition (M&A) activity. In macro terms, M&A activity does tend to crest late in a cycle. As M&A gears up within a sector, not to be understated as having impact is corporate fear of being left behind. Whatever the management level rationale, the current scale of M&A developments underscores the present acuity of business competition. It is taking place despite global GDP growth being reported as close to 4% annually. In a wide range of businesses, afloat currently are M&A propositions that appear both substantial in global breadth and in the scale of the finance involved. In media overlapping both information technology and consumer discretionary, communications assets reportedly have attracted rival interests. Several chess like moves also appear over the ownership and distribution of music. In semiconductors and juxtaposed with the Barcelona Mobile World Congress of February 2018 emphasizing the next leap forward in information technology, the signals seem to be over leadership in 5G technologies and have taken place amid ever expanding interest in mega merger positioning for sharply greater mainstream industrial and consumer usage. As well as being over cyber security, there appear government signals over ownership limits coming from North America, Europe and Japan. In the European power utility industries, there have also appeared a complex but noteworthy potential amalgamation of interests or M&A in all but name that realigns mainstream power asset and green power assets. These potential mega mergers all involve media, information technology hardware and utility assets in distinct silos. It contrasts with conglomeration or with M&A fever engulfing primarily a single sector during a market cycle. Further in this cycle, low interest rates have appeared to have stimulated large scale financial engineering. Not just a response to better free cash flow, such engineering has included both share buyback and additional debt activity that in essence presume the continuation of easy monetary conditions. We see these corporate activities as underscoring a much more nuanced operating environment in many industries than may being generally assumed.
It makes particularly worth perusing the latest Bank for International Settlements March 2018 Review dated March 11,2018 on momentum,
volatility and leverage (https://www.bis.org/publ/qtrpdf/r_qt1803.htm). Separately, a series of central bank meetings have given rise to fresh subsequent observations, especially from the Federal Reserve, the European Central Bank, the Bank of England and the Bank of Japan. These central banks have been among the most tied to quantitative ease and have now sequentially laid the groundwork for its exit, albeit at differing speeds. We see the major (often intraday) swings back and forth of equity prices recently as indicating not blithe risk on/off but instead reflecting an ongoing assimilation of changed circumstances, worldwide. The same can be said about fixed income markets despite its behavior that seems more stuttered and odd in, for instance having more adjustment taking place in more liquid U.S. Treasury but less so in lower grade corporate or emerging country debt yields that could be most at risk from substantive change. Currency markets have had a habit of acquiring both a political and economic veneer with unforeseen effect. They deserve watching for reappraisal impact. In current markets, especially so in that of the Yen versus the U.S. dollar in its more liquid currency activity and of the Renminbi in those less so.
This nuanced environment is in contrast to that being assumed in capital markets especially in recent years of low volatility and broad risk on/risk off attributions onto equity and fixed income market behavior. We expect events leading up to the ides of March 2018 presage market tryst with higher volatility. Current market and fundamental aspects, as well as those previously ignored, are likely to add to risk premiums.
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. For disclosures, see www.subodhkumar.com .