Checks and balances
Guy Stephens, technical investment director at Rowan Dartington, reflects on recent geopolitical events – and non-events – and their impact on markets.
Stock market pundits use the term ‘silly season’ to describe those times when markets appear to be focusing on the frivolous and the irrelevant. Usually it takes place over the summer or around Christmas, when investors appear to be punch-drunk with recent market intensity and almost suffer from crisis fatigue. But I believe we may be encountering this market mindset right now.
The business press plays an important role at these times. Its sensationalist headlines attract readers, but they can also suck in investors, who then lurch from event to event without focusing on what really underpins the value of the assets they hold. A few weeks ago, the headlines were all about the Chinese president’s visit to Mar-a-Lago, Donald Trump’s Florida resort, yet it proved to be a non-event. Importantly though, what it did tell us was that Trump’s antagonistic pre-election anti-China rhetoric had clearly softened. Next up was the escalating confrontation with North Korea; until it transpired that the US battleship supposedly travelling to North Korea had in fact been sailing in the opposite direction. Talk about Chinese whispers. That said, the likelihood is that further US-North Korea antagonism will again grab the headlines.
It may be that the US president is at last learning that less is more when it comes to public statements. He has been tweeting a lot less in recent weeks and US policy appears to be increasingly decided in the Oval Office and in private – as it should be.
Back to base
This brings us to the markets and to the reality of what we invest in, namely companies, with their balance sheets, profits and dividends. Markets have certainly performed strongly since February 2016, when Chinese economic growth was the crisis of the time, but it is very easy to get sucked into the argument that markets are expensive just because they have rallied to new highs.
As both individual economies and the global economy continue to grow, markets should set new highs. Similarly, if valuations get ahead of economic reality, because investors are expecting positive developments which never in fact materialise, then markets should correct.
This may in fact be where we are now. Equity markets have driven ahead in expectation of the Trump reflation trade, which dragged up global indices. However, to date, Trump has delivered very little and so he will be all the more focused on achieving a positive congressional outcome. Conversely, political concerns regarding Brexit and European electoral turmoil have started to settle down.
A Trump upset and a European electoral firestorm were the biggest recent worries for investors, but both are looking like distractions as they play out. Of greater importance is the US reporting season, which offers a far better gauge of the state of the US economy and of whether valuations have got ahead of themselves. At best, we believe that results will be consistent with current valuations but not lead to upgrades, supporting our modestly underweight stance. However, in the case of Europe and emerging markets, the fear factor has already been priced in, mostly over euro sustainability and Donald Trump’s protectionist rhetoric.
Both these issues seem to be subsiding in importance. Market participants have started to realise that, regardless of Trump’s best intentions and tweets, Congress provides the requisite checks and balances to neutralise any policies that make little sense. Of course, if Trump is going to fail to deliver very much, then we could well have seen much of the positive upside from US equities this year.
As for those areas which have been discounted and are undervalued, we are positioned accordingly. To follow the argument through, however, this means that US interest rates will not rise as much as forecast, since the economy will not be strong enough to cope with the unwinding of QE. Both these factors will be supportive of our holdings.
Thus, while the most optimistic forecasts may not be realised, nor will the most pessimistic. That suggests that any short-term volatility provides a buying opportunity. It also means this ageing bull market has further to run, albeit at a slower clip.
As for the UK election, it appears market-friendly and looks annoyingly predictable, as well as deflecting attention from Brexit negotiations until MPs return from their summer recess. They then begin conference season, which ends in early October – by which time, we will know the outcome of the German election. Should Theresa May have a far larger majority, she would then be freer to reveal her true colours. In her case, fewer checks and balances would in fact be more beneficial.
A broad, well-diversified investment strategy would be well-advised, with perhaps some caution over whether US reflation will disappoint, and whether UK inflation will force higher prices onto consumers. Neither of these factors is earth-shattering, but they may serve to dampen excitement, and could lead to a dull period for markets.
Rowan Dartington is the stockbroking and discretionary fund management arm of St. James’s Place. Guy Stephens is technical investment director at Rowan Dartington. All views are his own and should not be taken as investment advice.