Uncertain uncertainty in markets
This awkward-sounding phrase (which may not even be original) is my attempt to look beyond the term ‘uncertainty’ (as in markets do not like it), which is being devalued by excessive repetition and becoming rather meaningless in the same way as ‘we live in times of great change’ is now a tedious cliché. It seems it is no longer enough in financial markets just to decide that not being able to judge current developments is a bad thing. It is also important to second guess how others will react to such ‘primary’ uncertainty.
Information from the ‘real world’ of consumers and businesses via official data is by definition ‘after the event’ and variable in its reliability but trends can usually help as can confidence surveys. However, that is all rather too slow for many investors, especially those who rely on algorithmic programmes for immediate responses to, and even anticipation of, the latest news. The challenge is intensified by the failure of many government and central policies and, indeed, their growing unpredictability. There now appears to a ‘secondary’ level of uncertainty that is much more unsettling and is resulting in volatility that can only be described in undignified terms as stampedes by investor herds. It ain’t easy in this uncertain uncertainty where traders and algorithmic programmers cannot themselves think of everything let alone fret over what everyone is thinking! Here I am not just alluding mischievously allusion to the warmongering Donal Rumsfeld and his ‘unknown unknowns’ but also respectfully to George Soros and his theory of reflexivity.
So, what should those involved in financial markets do about it all? Firstly, they should look more closely at the ‘real world’ where consumers and businesses make choices about enduring in difficult times, splashing out in good times and remaining on the qui vive for bargains and other opportunities. After that, they might be able to view more calmly the latest efforts of policy makers to catch up with events and also the latest gambits of other market participants.
Chart 1 US Personal Income and Spending 2006-16: consumers saving as well as shopping
Plenty of things to be uncertain about
US recession: this story is starting to fade as Employment, Average Earnings and (parts of) the Property sector continue to advance while consumers do their bit. However, Manufacturing and Oil are clearly part of a global recession in those sectors. GDP quarterly numbers are remarkably erratic but US growth still seems to be running at above 2%, albeit not by much. This week’s data is unlikely to settle many arguments as the Labor market in February will have been solid enough while various business surveys continued soft.
It seems unlikely, therefore, that the economy (stupid or otherwise!) will determine the Presidential Election as most non-white have-nots are always going to vote Democrat and most white have-nots Republican, irrespective of the candidates. Accordingly, it may well come down to whether enough voters in a few swing states will prefer any man from the fissiparous GOP over the experienced but nevertheless female Mrs Clinton. Perhaps surprisingly for some, a Clinton vs. Trump (no Neocon he!) is likely to keep World War III off the agenda while Wall Street can expect no new favours.
China collapse: Party control comes ahead of any economic considerations but even then officials are still struggling to keep announcing data in line with official targets. GDP growth seems easy enough to fix while the Caixin/Markit Services PMI is proving independently supportive but both imports and exports are showing signs of stress. A rigged stock market does not help dilute widespread cynicism and concern but for all that China is probably still growing much faster than any developed economy. The most recent moves by the PBoC confirm that the priority of Party control is to restrict capital outflows rather than a major currency devaluation or tightening of monetary policy, even if this inhibits inward foreign investment.
European disunion: significant economic recovery since 2009 has yet to materialise beyond Spain and Poland despite the extravagant claims of Mario Draghi. Italy seems to going backwards while Germany is losing momentum and. unlike in the US and UK, EZ consumers are not making up for the global slowdown in trade. Inflation is falling back again (flat in Germany year on year in February) as the latest falls in oil prices feed through. Then there is a scary list of political problems, including funding for Greece and for ailing banks, Russian trade sanctions and, above all, the refugee crisis.
Brexit: the whole debate is riddled with ironies of which the greatest perhaps is that any damage is likely to be self-inflicted. Meanwhile, GDP growth is being held back by the global recession in Manufacturing and slowdown in trade but the Services sector is still going well. In preparing yet another major statement Chancellor Osborne is on the receiving end of Schadenfreude as tax receipts threaten his self-imposed and unnecessarily tight fiscal targets. Any proposed tax increases will enrage even further Europhobic Tory MPs whose willingness ‘to put country before party’ seems baffling when so many of their arguments have (yes!) uncertain consequences.
Chart 2 Central bankers: mad, bad and dangerous to know
Central Banks’ next moves: it is hard not to see BoJ Governor Kuroda as either desperate or dogmatic or both and it may be that Japan’s economy is in such a poor state (GDP growth negative again in Q4, Household Spending down as Inflation fizzles out) that he cannot make matters worse. Mr Draghi seems just as dogmatic but more overtly political as he schemes for further loosening of monetary policy at the ECB Governing Council’s next meeting on March 10th when Bundesbank President Weidmann by rotation does not vote. What is not clear is how far he feels he dare go with negative rates and or expanded QE purchases. By comparison the Bank of England’s MPC seem positively sane in their apparent acceptance of its inability to do much and specifically to eschew negative interest rates. Meanwhile, the FOMC also seem wary of negative rates, especially as it has to justify any sudden switch from its recent expectations of raising rates throughout 2016. A new QE programme in the US is, however, a possibility albeit not on a grand ‘Bernanke-scale’.
Chart 3 Global Investors: net preferences show future opportunities
Source: BAML Global Fund Manager survey
Where uncertainty is hurting
The mood has changed dramatically in equity markets during February. The major sell-off in 2016 (which actually began in December when the Santa rally never materialised) stopped mid-month and the stampeding herd then changed direction. By the end of last week even the stampeding had become less thunderous. It is still not clear why this happened but the main reason was a sense that some stocks had been oversold, especially in the US, UK, (some) Emerging Markets and in the Mining and Industrial Sectors. This looks like continuing into this week and March is historically a month for buying. There is also a feeling that a majority on the FOMC recognises that the US economy and, almost for first time, the global economy is simply not strong enough to withstand a serious of dollar interest rate hikes. Less healthy may a continuing correlation between equities generally and oil prices and it seems that investors remain convinced that cheaper oil is good for economic growth. The real hope has to be the signs of some differentiation between different stock markets and, whisper it soft, individual stocks. Nevertheless, earnings rightly remain the chief restraint on any rally soon.
In the bond markets, investors had already discounted a change of pace by the FOMC and, of course, no hikes are expected from the MPC. European and Japanese sovereign yields have, however, kept falling, many far into negative territory, in anticipation of further unconventional measures from the ECB and BoJ. It is, however, not clear whether this driven by fear or opportunism to catch ‘greater fools’ as the currency markets are clearly less impressed. The yen has surged in February and the euro only recently has started to slip lower. This apparently illogical resilience seems due to hot money flows: nervous investors still unwinding carry trades and also a reaction to diminishing prospects for US interest rate hikes. Talking of fear, Gold is being talked up in many quarters but it remains hazardous for those hoping to make money trading futures as opposed to buying bullion as insurance for tough times ahead.
No surprise that the current favourite sitting duck is the pound, always a favourite for selling whatever the justification. As it happens, Brexit is as good a reason as any for a long time to give sterling a kicking and more can be expected. Until recently, however, the slide has had a variety of causes, which explains why the pound has been so weak against the euro. The more prominently Brexit features from now on the more likely it will also pull down the euro, which appeared to happen when Boris Johnson announced his ‘momentous’ decision a week ago. Hence, my suggestion in Signals that the ECB should sign up the Great Man to keep talking down EUR/USD as well.
Chart 4 GBP/USD since 1975: ‘Speaking for England’?
Source: BNY Mellon/Bloomberg