Political Risks Increase, Sentiment as a Theme, The Liquidity Dearth - DFX key themes
Add Political Risks to Our Long List of Market Concerns
It isn’t like we are lacking for fundamental motivation for the global financial markets. If anything, there is a surplus of critical themes that could – if properly induced – could single-handedly turn the universal tide. Nevertheless, it seems we will have to add another principal concern to our list alongside trade wars and the transition away from emergency monetary policy: political risk. This is not an unfamiliar market concern. Concern over governments’ and their influence on economy and financial health are fairly regular occurrence throughout the world and history. However, the tension seems to be rising quickly as of late. While there are still clear concerns over stability in the UK (constant discord between PM May, her Cabinet and Parliament), the Euro-area (Italy’s aggressive stance of budget and immigration) and Australian (having replaced its Prime Minister last week); the issues in the United States register more readily as a situation for global spillover.
We have seen headlines related to various investigations into certain Trump administration officials dating back to before the election, and last year’s more reserved headlines seemed to earn far more distinct response from price action – such as the drop back on August 17, 2017 when fears arose that cabinet members could part ways with the President following the lead of business leaders on his economic council. Over the past weeks, concerns have turned more directly onto the President himself with a jury finding his former campaign manager guilty on 8 charges, his personal lawyer pleading guilty to charges including campaign violations and the Trump Organization’s CFO being granted immunity for testifying in the Cohen trial. These may be for matters that do not implicate the President directly, but markets do not tend to act aloof to high impact potential risks.
Perhaps feeling the pressure, in an interview President Trump warned that if impeachment proceedings were started against him, he believed the market would crash and “everybody would be very poor”. That would not likely happen. For a financial market, who is President does not matter. Potential for returns and the course of the economy is primary. Markets didn’t immediately fall apart with the start of the Clinton or Nixon impeachments. However, when there are other concerns that the markets previously discount for favor of higher returns amid complacency, adding another source of uncertainty is a build-up of cumulative ‘risk’. Just as subprime housing tipped the scales in 2018, tech shares in 2000 and an emerging Asian markets in 1997; history shows the rolling over of markets owing to complex and deep fundamental issues often start with a single, smaller catalyst.
A Theme of Sentiment and a Market Prone to It
In the seasonal-dampened market conditions for the week ahead, we have a list of important, discrete event risk; but there is little that we could point to as systemically important and capable of single-handedly shifting direction or altering momentum for the entire market. That has more to do with a sense of complacency, appetite to hold to seasonal lulls and distraction from ‘themes’ that are not readily resolved with a single update (trade wars, political risks, Brexit, etc). However, the data should be registered nonetheless. It is the fundamental equivalent of keeping your eye on altitude in a hot air balloon as the risk of it popping grows. While the key listings ahead will touch on important topics – the US PCE for Fed tempo, an emergency Brexit meeting for the House of Lords – there is a particular theme that will offer greater weight due to its prevalence across the globe: sentiment.
There are a number of countries that will offer updates on confidence from consumers, businesses, on economies, etc all while the world deals with greater threats to passivity. The Eurozone and Italy will release current sentiment readings for various aspects of the group and individual country’s economies. With concern over the unity of the Economic and Monetary Unions growing, these will be critical reads for local and global investors. Clearly dealing with concern over an escalating probability of a ‘no deal’ Brexit, the UK’s business and consumer confidence reports Thursday evening will be crucial. Perhaps the most important reading on outlook will come from the US consumer via the Conference Board’s update Tuesday.
Not only are there the standard uncertainties for employment and financial security; but we have seen political stability and a U-turn on North Korea starting to position as external risks. Expectations are important as fear translates into reduced plans to buy goods, invest in factors, lend to entrepreneurs and other means to seed economy and markets – just as speculation of future events leads to speculators’ lifting or throttling a market before events truly come to pass.
T’was the Week Before a Seasonal Liquidity Shift
The week ahead is the final week of August. That is clear, but what is less obvious for the uninitiated trader, this also happens to reference a crucial period for transition for the financial markets. The ‘summer lull’ is a familiar axiom for speculators and it is sustained as much by self-fulfilling prophecy as it is by any tangible changes to the markets themselves. Historically, August represents the ‘quietest’ calendar month of the year – qualified by the S&P 500’s volume going back to 1980. Yet, this is a probability, not a certainty. There are always exceptions in open markets where the winds of economic and financial crisis don’t necessarily abide the same assumptions. For instance, global risk assets were sliding sharply in August in both 2015 and 2011. And, we have more than enough unresolved fundamental uncertainty in the wings of our markets to spur a speculative avalanche for expensive markets.
However, the period encompassing the UK Bank Holiday and US Labor Day Holiday represents a period that historically carries a statistically high probability of quiet. That said, just as remarkable As August and this week is for restraint, the month of September is renowned for its volatility (VIX peaking in September and October) and a sense of risk aversion (historically the only month for the S&P 500 that averages a loss). We may find market participants are less restrained when making decisions with their portfolio amid economic uncertainty in a few weeks’ time, but that doesn’t mean we should simply check out in the meantime.
If markets are to offer up a surprise level of activity in the week ahead, what would it likely follow: a sudden sense of unexpected enthusiasm or fear amid an unseen crisis? Fear typically arises from the blue and prompts action more readily than greed. This is not a high probability occurrence, but it would lead to a remarkable amount of financial pain (probability vs potential). Hedges are still very cheap as evidenced by implied volatility. It is also the case that there is no risk when we are out of the markets, only the self-flagellation some suffer when they feel they are ‘missing out’. But if markets are genuinely quiet as assumed, there should be little to miss out on by closing now and reopening when liquidity tops off again...
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