After nine glorious years US equity markets may have fallen off the escalator. It may be temporary and is probably quite healthy but other stock markets have followed suit. The trouble started at the end of January just when it looked like more gains as usual. Most markets duly corrected but have not really been happy since and fell further in both February and March. It may seem facile but it is almost as if investors woke up from a coma to realise that Janet Yellen, stability personified, had followed Ben Bernanke, wealth effect personified, into the irrelevance of the celebrity speaker circuit. Dr Yellen was still in charge at the FOMC meeting on 30-31 January and the Statement contained all her usual balm but now Jerome Powell was in charge. Awkward questions presented themselves: who is Jerome Powell, is he a Trump stooge, why isn’t he an economist, how will he manage a more hawkish-sounding group of voting members, is he a hawk, over just how many rate hikes will he preside ? Clearly, the simple explanation was not good enough: that he was unlikely to abandon suddenly Dr Yellen’s carefully constructed forward guidance and embark on a rate-hiking spree. Two months on and Mr Powell has delivered his first testimony to Congress and chaired his first FOMC meeting and we now know that he is….er….a pragmatist. This could prove to be problematic down the road as pragmatists do change tack when they-and not financial markets-feel like it but Mr Trump himself came up with something else to worry about. It is still far from clear how far the President wants to go on tariffs but there is no doubt Trade Protectionism is not good for the global economy, the US economy and US corporations. His subsequent actions and yesterday’s first retaliatory response from China suggest a major Trade ‘War’ can still be avoided but one immediate consequence is that the recession genie is out of the bottle. As discussed above, the latest economic data indicates all is still well but it seems investors are sufficiently worried as to review their strategies and portfolios.
A number of investors have been particularly badly hit from their trades of doubling up going long on the S & P 500 index and/or its FAANG components while shorting the VIX volatility index. At just over 21 the VIX is currently trading above where it spiked in 2016 and at its highest level since the major flap in August 2015. The impact extends far beyond those wiped out by VIX shorts to investors in passive funds, momentum and growth strategies and to the merely complacent. Accordingly, faced with the double whammy of higher interest rates and higher volatility, investors are having to think for themselves. First casualties have been the erstwhile market drivers, the FAANGs, and doubts on valuation go beyond Facebook’s troubles, bad enough as they seem. Another major development has been the flattening of the US Treasury yield curve (Figure 9). The rise in 2-year yields is fully understandable at a time when the FOMC is hiking but less obvious is why 10-year yields actually fell in March, albeit after moving sharply higher in January and February. The answer appears to be long-term investors’ (insurance companies, pension funds) matching their liabilities in the expectation that inflation will remain subdued (thereby limiting the number FOMC rate hikes) while equities have become much riskier. Having said that, it is possible that shorter-term investors will take fright if the gap closes much more. There was a flight to the usual havens in February but only the yen remained in demand in Asia in March as investors elsewhere seem not to regard the outlook sufficiently grave to linger in the dollar and gold.
As a footnote, the Hang Seng was did end the quarter in the black while the star performer was Brazil’s IBOVESPA which somehow added in subsequent months to its surge in January to end 11.7% higher. It should also be noted that the more domestically-oriented FTSE 250 along with the FTSE 100 had a poor quarter as investors remain wary of both Brexit and Mr Corbyn.
US Treasury Yield Curve: flat landing?
Lest there is too much gloom in this latest edition of Doomwatch the indefatigable Jeroen Blokland has helpfully tweeted the chart below to greet the start of the best performing month over the last 15 years. He did not publish it in the morning on April 1st, in case anyone wonders. Perhaps more reassuring is that the companies in all S & P 500 sectors are forecasting higher top-line sales growth in Q1.