Note Précis May 15,2018: Real & Trade, Proxy and Proximity Wars – Arguably after many decades, political economy brinkmanship seems alive. Contrary to strategic doctrine to not initiate two front confrontations, the U.S. appears willing to engage simultaneously on trade and geopolitics with friends and rivals alike. Real and trade policy trade tensions have been building up. Real Estate may be replete with brinkmanship but it is also replete with bankruptcy from New York and Canary Wharf in the last century to Argentina and the Suez Canal further back with countless others in history. The beneficiaries come later from picking up the restructuring pieces. Capital markets need to consider tensions in real and trade, proxy and proximity wars that appear all too real, quantitative ease notwithstanding. It means that risk premiums are all the more necessary. In fact, in fixed income and despite stronger growth than global GDP averages, emerging market debt especially in dollar denominated areas show wear and tear. After large interest increases not calming its currency, Argentina has had to approach the IMF. The reaction gap remains glaring between low grade CCC corporate bond yields being sticky versus other portions of fixed income including 10 year U.S. Treasury Note yields as benchmark. In FICCs, energy prices appear slightly above our benchmark range.
We believe that equity market assessments have been shifting from earnings momentum and towards balance sheet strength and revenue competition. Quantitative ease from central banks is likely to be diminishing in providing sustenance for momentum equity markets. Despite market chatter about death crosses averted for the S&P 500 between 50 and 200 day moving averages, we see no reason to lower our guard about enhanced volatility nor about the need for higher risk premiums than equity valuations or credit spreads indicate. Rather than geographic rotation, we expect industry sector rotation to likely dominate, with the unparalleled sector diversity of the U.S. market being critical for leadership. In our favor for quality of delivery and financial strength as likely to be crucial than momentum for more selective markets, we do not see a contradiction between being overweight in both Information Technology and Energy.
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