“Unfortunately, these are risks that investors are bad at dealing with. Economic fluctuations can be modelled, but markets have always struggled to accurately price in the potential for political shocks. Most of the time, investors opt to ignore them until they become real, at which point it is too late, and the impact can be severe.”
Robin Wigglesworth, Financial Times, 10 May 2019
I was just asked by a client to produce a brief 'pitch' for my upcoming marketing trip to Asia and Europe. As this is, essentially, a summary update of my Outlook 2019 I decided it was worth reproducing here. And especially in the light of 'events' in the past week or so which have rattled markets somewhat — AND seen President Donald Trump's approval rating on the authoritative RCP Average creep above 45% for the first time in over two years, which strongly suggests we are in for more of the same over the next 18 months or so.
1. All about the election
- Contrary to what one might glean from the headlines most days, political and geopolitical risks do not revolve solely around President Donald Trump. But he is still — and will remain — a, if not the, major factor as, under mounting pressure domestically, he focuses increasingly on securing a second term.
- His campaign team appears to have concluded, for now at least, that his playing ‘hardball’ both at home and on the global stage is the key to shoring up his base.
2. Trade: Doubling down
- Mr Trump’s seemingly sudden decision to hike tariffs on imports from China last week sent a shudder through markets which had been expecting a deal. With negotiations still in play (and tariffs not due to take effect in practice for a couple of weeks or so) expect more uncertainty- and headline-driven volatility.
- There is also a risk that Mr Trump opens a ‘second front’ against the EU (and Japan and South Korea) on auto imports, with the additional prospect of EU/US tit-for-tat tariffs over large commercial aircraft.
- Furthermore, ratification of the USMCA remains very uncertain despite Mr Trump’s active threat to withdraw the US from Nafta.
3. Oil: Conflicting forces
- Escalating trade frictions pose a very real danger to global growth which, in turn, is currently acting as a damper on the price of oil.
- On the other hand, Washington’s economic assault on Iran has shown it can push up the price of crude, with a very real risk of more to come if (as is likely) tensions in the Gulf escalate further still.
4. Europe: The populist threat
- Against a backdrop of a weak economy, populist/nationalist parties are poised to do well across the EU in the 23-26 May European Parliament elections, greatly complicating decision-making downstream.
- The thus emboldened government of Italy will find itself in a major showdown with Brussels over its budget deficit towards the end of this year, further deepening the ‘north/south divide’.
- Meanwhile, Brexit rumbles on with no sense that investors are pricing in for the non-negligible probabilities of either a no-deal exit or an early election resulting in a Corbyn-led socialist government.
5. Emerging Markets: Accumulating concerns
- From an investor perspective, the two most sources of greatest EM-related concern remain Argentina and Turkey, both of which have important elections upcoming.
- But there are myriad other potential sources of turbulence out there including India/Pakistan, the Korean peninsula, Taiwan/China relations and Venezuela.
6. International Terrorism: IS is alive and well
- With the destruction of its caliphate, Islamic State is reverting to insurgency in Iraq/Syria and, seemingly, striking more widely wherever it can.
- Terrorism is unlikely to have a major impact on the global economy. But recent suicide bombings in Sri Lanka will underline in the coming months that it can dent individual economies’ performance.
“The playbook for the past decade has been one of easy policy signals from central banks boosting risky assets. That worked in the past, but after several rounds of stimulus that leaves us with an ageing economic cycle, the wash, rinse and repeat of interest-rate suppression may be on borrowed time.”
Michael Mackenzie, Financial Times, 8 March 2019
- Irrespective of political risk, there are legitimate concerns among economic experts (and the commentariat) over how much longer the “ageing economic cycle” can go on for.
- Furthermore, politically-driven volatility has long been flagged as a threat to market stability. And the return of ‘synthetic’ CDOs (based on corporate debt, rather than mortgages) is also causing warning flags to be raised.
- The bottom line? Caveat emptor!