No warmth, no comfortable feel, no leaves……November


I am not sure how long I can sustain a maritime theme but for I am increasingly convinced that UK assets are at or very near to the point when the ebb tide has run its course and turns into a flood tide. Now is the time to look beyond all the politicking, most of which is quite healthy, and get off the beach. The most important conclusion from developments over last few days is that a ‘no deal’ rupture next March is looking less likely than ever. This has implications, mostly favourable, for equities, gilts and the pound.

Chart 1 O brave new world that hath such people in it?
Source: Groupe Le Monde

Yet another month has passed and for the title to this edition I have plundered the poem ‘No’ published by Thomas Hood in 1844. It has not been a happy month with political division dominating the headlines and influencing, if not driving global markets…..until at the very end investors discovered a new Thanksgiving myth in Fed Chair Jerome Powell. This was followed over the week-end by the rather vague Sino-US truce on trade. With so many leaders rightly described as ‘beleaguered’ it is increasingly hard (and perhaps pointless) to blame them for instigating discord or merely reacting to it. A better way of categorizing them might be between those who emulate Louis XIV’s ‘L’etat c’est moi’ mentality and those who think about more than themselves. Once again, I hope readers will forgive me if here I concentrate on Mrs May and Brexit, while leaving Messrs Trump, Xi, Putin, Macron and Salvini to anther day.

Chart 2 Every one a loser!
Source: T/HM Treasury


Mayday, Mayday!

To be fair, Mrs May does not usually put herself first but even a cursory glance at Figure 2 points to the extraordinary situation of a democratically-elected government pursuing a policy that will damage the economy as a whole, public services and many of the less well-off voters. Readers will be pleased to know that I shall spare them detailed comments on the different Brexit scenarios except to point out that they are only scenarios and may be highly unlikely, as Governor Carney has pointed out. Moreover, it should be noted that, far from replaying his predecessor’s notorious ‘Project Fear’ in the referendum campaign, Chancellor Hammond has actually been trying to put a gloss on his forecasts, if not actually resorting to legerdemain. His base case is modeled on the failed ‘Chequers deal’ as well as the assumption that the UK would be able to negotiate favourable trade deals with just about everywhere  (including rolling over all existing EU deals with third countries) and he cheerfully talked down the forecast 3.9% reduction in GDP by 15 years hence.

In fact, Mrs May’s priority appears to be the Tory Party’s somehow coming together to stop a Marxist-led government’s taking over and this may well determine her strategy in the coming weeks. On a tactical level she seems to be trying to scare the leading Brexiters with the prospect of no Brexit and all Tory MPs with a general election that a disunited Party could well lose. This does not seem to be working and the first ‘Meaningful’ vote in the Commons on December 11th looks like being defeated heavily and possibly by over 300 votes, if all the Tory rebels follow through on their public declarations. The size of the vote may be affected by the Preliminary Judgement on December 4th of the European Court of Justice on the unilateral reversibility of Article 50 Notice (could go either way) and the reaction from EU leaders (either welcome it or volunteer to agree to a UK request for suspension). Events may move quickly after the 11th with Labour’s tabling a Vote of No Confidence, which the Government would lose even if all the Tory rebels fall back in  line and the DUP stops at abstaining. Accordingly, the various protagonists are preparing not very secret Plans Bs and Cs and here political instinct rather than logic will surely prevail.

After studying carefully Mrs May’s most recent words and deeds, I am going to venture my own controversial and definitely minority prediction: Mrs May will not resign after losing either the Meaningful Vote or Labour’s No Confidence Vote. She may well announce her intention to step down but only after, as the incumbent executive authority, withdrawing the Article 50 Notice and formally abandoning Brexit altogether. Labour, SNP, Lib Dems and Plaid would have no option but to support her or abstain when she asks for a new Confidence Vote while only irredentist Tory MPs and the DUP might vote against. This wiould avoid a highly divisive Second Referendum and from a narrower Tory Party point of view a fratricidal general election. Mrs May would be able to say that she has done all she could to deliver the least damaging Brexit but the practical, legal and economic challenges have proved too difficult to solve politically. She would have allowed her successor (surely a member of the current Cabinet) to escape most of the blame and get on with policies that might just be enough to see off Labour under Mr Corbyn in 2022.

I realise, of course, that my prediction may well proved to be wrong but in the spectrum of theoretical Brexit outcomes the pendulum has shifted to the extent that, even if a ‘no deal’ remains possible, a majority in the House of Commons will ensure that it does not happen. Mrs May’s deal looks doomed already and although ‘Norway plus’ or even ‘plus plus’ is doing the rounds it offers no benefits over full EU membership and plenty of disadvantages. This leaves a Second Referendum with the probability but not certainty of a Remain win. Nevertheless, logic appears to be on hold in Westminster. With so many seasoned political and financial market commentators clearly flummoxed, UK equities and, even more so, sterling will continue to twist in the wind for a few more weeks if not months. However, should Mrs May’s deal turns out to be the worst case Figure 3 shows that there are some considerable upsides.

Figure 3 Broad sunlit uplands….er…..sort of?
Source: Bloomberg Economics

Economics: Central Banks’ new clothes increasingly exposed

There is much irony surrounding the enthusiastic concentration on a single sentence in Mr Powell’s speech last week: “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy that is, neither speeding up nor slowing down growth.” . True enough, it contrasted with his previous remarks on where interest rates were relative to a neutral level and it could mean that he is more concerned about the stock market than he has previously disclosed. More significant, however, is his reference to the late Hyman Minsky’s analysis of how excessive lending by banks can turn stability into financial and economic instability. He is not the first Central Banker to cite Minsky (the PBoC’s urbane Zhou Xiaochuan did so just before he retired) but it is nonetheless a portentious departure from the orthodoxy of equilibrium models, which typically ignore credit creation. In recent years the Fed, ECB and Bank of England, having been put ‘in charge’ by the politicians in their jurisdiction have too often talked as if they were in control of economic developments thereby creating a rod for their own backs. Mr Powell appears to breaking ranks by suggesting he is neither in control nor in charge.

Every month, I monitor around 150 indicators in most but not all G20 economies and those released in November, including those referring to earlier months, continue to point to a global slowdown. Tthe finger is pointing increasingly to too much debt, as Mr Powell is hinting at. It is true that Q3 GDP figures (except the EA and Japan) are holding up quite well but leading indicators (PMI and Confidence surveys) are faltering just about everywhere, albeit less so in the US. Each of the classic components of GDP  (Consumption, Business Investment, Trade and Government Expenditure) is now showing signs of slowing in most economies. In the US and UK, average earnings have perked up a bit but there is increasing evidence that this is skewed in favour of the better off. Borrowing conditions may be very different between economies and sectors but collectively we may be at the point that if banks keep on being willing to lend and borrowers willing to take on more debt, then there could well be a ‘Minsky Moment’ of widespread defaults and insolvencies. On the other hand, if banks and their corporate and consumer customers pull in their horns, growth will surely stall.

While the trade ‘truce’ agreed at the G20 meeting by the US and China brings some relief it is tempered by the rather different spins each side has put on it. Trade disputes will not be settled easily with so many macho ‘nationalist’ leaders in so many countries. Exporters and importers around the world have over the last decade relied on China’s growth but Mr Xi’s preference for Party control is leading to a reversal of the ‘opening up’ economic policies of his predecessors. At this stage we are looking at a slowdown rather than a slump but companies are going to have to fend much more for themselves rather than rely on a rising global economic tide.

Chart 4 As global debt keeps growing is a Minsky Moment due?
Source: IIF, BIS, IMF, WSJ

Global Markets: having to think for themselves

Investors who believe that Mr Powell is offering them a new ‘put’ just like his predecessors at the Fed may soon be disappointed but after his speech US equities rallied by around a heady 5%, which was enough to push  both November and YTD performances back into positive territory. Once again, retail investors were ‘buying the dip’. However, small caps fared much less well, rotation continues into value stocks and the fortunes of the FAANGs are diverging. Institutional investors are likely to take opportunities to book profits ahead of the year end and may not be in a hurry to pile back in again either indiscriminately or soon.

A rate hike in December is still more likely than not even if the FOMC takes a break from quarterly increases of ¼% in 2019 in order to ease some pressure in the credit market (Minsky again!). Any impact on US Treasuries looks like being very limited as there are plenty of buyers of 10-year paper at 3%. The prospect of US Fed Funds peaking at or below 3% should further tame the dollar and thereby help EM currencies and equities. As always, a rally on Wall Street ripples outwards but trade worries have been holding back Shanghai, Sydney and, less obviously, Frankfurt. European equities are still stuck in the doldrums but more conciliatory talk from Mr Salvini  has certainly helped Italian bank shares and the sovereign bonds of Italy and other lower rated issuers. As discussed above, UK equities remain deep in the shadow of Brexit.

Oil got hammered again as financial investors’ profit-taking as rival rumours rather than facts circulated on production cut-backs and surpluses. Wall Street, the third force in oil prices will soon be back at this rate. Gold is still languishing as investors appear to be insufficiently worried about anything, perhaps unwisely.

Figure 5 is a good summary for November but is missing US equities, which squeaked in to close with a gain of around 1.5% in the month. On the first trading day in December equities everywhere rallied on hopes for the Sino-US trade dispute to be settled.

Chart 5 No warmth, no comfort, November
Source: FT


By Alastair Winer

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