Markets are rarely static for long and the market focus shifts over time. Whether these shifts in focus trigger investors to look for opportunities or put out fires often says as much about an investor’s long term psyche, or their short term performance, as it does about the nature of the event. Either way, there have been some important changes in the key drivers of financial assets over more recent times.
For an extended period of time, the focus for markets had been entirely dominated by QE and, therefore, central bank actions or statements. This is much less the case now (though the tomes written on the ECB’s June statement proves it’s not entirely dead and buried, unfortunately).
The speed at which central banks will give up the use of these extra powers is unclear but what is clear is that the drivers of markets, or at the very least sentiment, have moved away from central banks towards ‘policy makers’ in a broader sense.
For example, the headlines are currently dominated by Trump and his trade tweets, a weakened May trying to deliver a seemingly impossible Brexit and the high and volatile oil price, driven broadly by geopolitically-induced supply risk. What links all of these, and contrasts sharply with the QE era, is that they are often driven by unstructured and unpredictable processes or, in risk terms, they exhibit very low visibility. Where there is low visibility and high impact there might be cause for concern.
So, how are markets reacting? Taking each of these in turn, markets worry that escalating trade tensions present a risk to global demand (and, further out, pose an inflation risk). So, for example, auto makers have suffered, as have industrial metals such as copper. At the same time, US smaller companies have been one of the better performers this year, in part as they are considered to have limited global trade exposure as well as higher exposure to a strong US domestic economy.
Turning to Brexit, and May’s White Paper. The lack of any real leadership challenge, despite a couple of high level resignations, seems to be less of an assessment of May and her administration’s progress, and more a reflection of limited volunteers stepping forward. Probably the more relevant question is how Brussels will respond to the White Paper, including any amendments.
The most likely scenario is that in a few weeks’ time reality will bite and we’ll feel no closer to achieving Brexit: the more clarity we get from the UK government, the more impossible it all seems. Unfortunately, it feels like a crisis is needed to force this issue up the political list of priorities in Brussels and, less necessary perhaps, the UK. The impact this is having on markets, beyond short term moves in sterling, is fairly limited, though the impact on sentiment and investment planning is more relevant.
In stark contrast to the drip-drip impact of Brexit, a tighter oil supply environment has driven the oil price higher for most of this year, at a time when many other commodities have been hit by concerns over weaker global demand and a stronger US dollar. Whether it’s OPEC, or pronouncements from Russia or the US, it seems a world away from the tightly controlled world of central banks, where text and tone were agonised over and coordinated globally.
In short, central bankers have passed the baton to politicians, or at least the emphasis is shifting from monetary policy risk to geopolitical risk, though these are of course inter-related. For example, a fully-fledged trade war would likely lead to looser than expected monetary policy.
So, where is the action in financial markets? It is being reflected mostly in a change in equity sector leadership, with less cyclical sectors performing better, and weaker commodity prices, rather than bond markets, with the US Treasury 10 year yield moving broadly sideways since February and credit spreads edging only slightly wider.
For our part, we try to look past the noise, remaining focused on the data. Globally, the macro environment remains sound, though the current corporate earnings season will help fill in some of the blanks, not least the degree to which companies are being impacted by the evolving trade war.
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Source for information: Miton as at 18/07/2018 unless otherwise stated.
The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment advice.
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