What Matters More to Risk: Healthy Growth or More Stimulus?
This seems like it would be a simple question to answer from a textbook perspective; but if you’ve been active in your investment these past years, reality has clearly deviated from the theoretical. We have seen economic activity the world over progressively struggle for traction. This is not a question of interpretation or the reliability of the signals being triggered. There have been far too many realized indications of strain (global GDP, PMI activity reports and investment figures among many others) while warnings over the future course have come from wide-ranging and reliable sources (such as the IMF, WTO and numerous central banks). Yet, despite this obvious strain, capital markets have held their bid.
Not all benchmarks – equities or otherwise – have performed as well as the key US indices, but their strength has generously surpassed more rudimentary measures of value nonetheless. While we can attribute this to some measure of complacency – pursuing return while remaining numb to growing risk – there is something that fosters that speculative abandon. In the moment, it can be difficult to recognize the unusual foundations of sentiment; but past years have clearly shown an assurance in monetary policy.
While the early waves of unorthodox monetary policy, such as quantitative easing, were necessary to stabilize confidence in capital availability and financial stability, the subsequent rounds beyond 2013/2014 seemed to be more devoted to accelerating growth to some unclear goal of hitting a pace that could somehow be more self-sustaining to ‘buy out’ the major policy groups. Though economic activity has slowed, improvements in employment pacing have diminished and inflation targets have never been met consistently; the central banks pushed on. It may not seem this way yet, but such dependency is placing enormous pressure on the world’s monetary policy and setting it up for inevitable trouble. The debate that these groups have reached the end of their effective range is a common one, so it stands to reason that it is eventually applied to capital market inflation as readily as standard price growth. Any fits of desperation – even coordinated ones at this point – will highlight the strain. And, if fear is indeed triggered by questions over the efficacy of this backstop, there is no greater power to swoop in to save us.
Top Fundamental Theme Updates for the Week Ahead
These past months, I have been keep tabs on three principal fundamental themes that have drawn more consistent responsibility for global sentiment than anything else. Rather than arranging these considerations for their ultimate potential impact, I’d rank them thusly for their recent outsized influence: trade wars; recession fears and monetary policy. Each of matters has key event risk that can rise to the scale of universally market moving so long as there is an attentive and liquid environment and the events themselves issue some fundamentally-meaningful surprise.
For trade wars, the US-China trade war concern will eschew monthly trade war figures for impromptu headlines referring to the two parties’ moods. The underappreciated risk remains other fronts of this external economic throttling. The Trump Administration still hasn’t given official word on the section 232 auto tariffs and is reportedly still mulling a section 301 investigation, but neither is certainly to offer update this week. One point of known contention next week is the US Trade Representative office’s findings on France’s controversial decision to apply digital tax on large tech companies – many that are domiciled in the US. Another, more nebulous risk is the NATO summit through the final 48 hours of the week. There will be many high-level topics, many of which revolve around economic competition and/or conflict fostered by the US.
Health of the global economy – more specifically, fear of recession – is the next most omnipresent matter. As mentioned above, it is far more important than the market is accounting for which is why its influence should not be underestimated. There are more explicit growth measures on the horizon such as official 3Q GDP updates (Australian, Brazil, South Africa), timely PMIs (China, Italy and ‘Final’ readings for so many others) and sector-targeted readings for key economy economies (such as Germany’s industrial production update). The indicator I will be watching the most closely, however, will be the US service sector activity report from the ISM. The US economy – the world’s largest – has been running at a premium to most of its major counterparts; and the services sector is the largest source of GDP for the country. This is as much a risk of destabilizing as it is source of potential assurance.
As for monetary policy, most would put the onus on the US employment report through the end of the week. I believe it will due more to distract with unfulfilled anticipation than it will provide actual market influence. The Fed is presently held hostage by the market’s demands more than anything as mundane as a dual mandate. There is greater potential at genuinely moving the needle on the surprise scale from either the Reserve Bank of Australia or Bank of Canada rate decisions. Yet, even if they do offer up surprises relative to forecast; they will struggle to catch the full attention of the global cadre. Given the dependency on monetary policy and line of doubt running through the system, I would watch ECB President Lagarde’s testimony to Parliament, looking for any unexpected changes to one of the most extreme efforts at accommodation across the world.
What Type of Trading Should We Expect in December?
One of the most overlooked questions by nearly ever trader is: ‘what kind of market am I facing?’ This isn’t a one-off existential analysis but rather an evaluation that should be raised at regular interval – if not before every trade. Though fundamentals and technicals matter for filtering out opportunities where they may arise, they are secondary to understanding the general shape of the environment. Asking whether there is enough liquidity in the system is important for establishing whether we could fuel consistent trends or foster enough volatility to afford significant moves. This and certain other factors are also important to determining whether we are more likely to encounter range, trend or breakout setups over our investing horizon, because why would you pursue trends when most assets in the market are offering ranges.
For general current patterns, we have seen limited liquidity over these past few months – the period from which we usually see a revival from summer doldrums. We haven’t exactly faced any significant strains to test the availability of a market owing to the quiet climb in risk assets, but that may also starve any attempt at more systemic drives of enthusiasm – or what seems enthusiasm. In the event that we take a more troubling turn for the global financial system, the lack of market depth will lead to more erratic market conditions and could hasten the elevator ride down. Volatility is also exceptionally low – a serious function of liquidity. It is far too quiet, but history has shown that the final month of the year normally enjoys a positive drift for capital markets. That will represent a strong draw for keeping the status quo, but don’t overlook the possibility that ‘this time can be different’.
Given the liquidity situation and the uneven conviction in global risk appetite, I see trends as particularly difficult to fuel. As such, I would need the greatest level of conviction to pursue any serious trends – which is over a week at this stage. Breakouts are more appealing, but the tenaciously deflated VIX (and most other assets’ volatility measures) means that a serious catalyst is of upmost importance to get the ball rolling. A further complication is that there are few truly inspiring ranges to count. If you look for too large a congestion pattern to resolve over a longer period of time, the time frame for follow through is likely to run up against liquidity issues. Those two types accounted for, ranges will likely be the most plentiful. That said, you still need volatility and technical milestones of merit to make such technical patterns worthy of pursuit.