Radiografía de los mercados

Mark Tinker, AXA IM - Jueves, 16 de Febrero

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The current consensus concern is on US isolationism, high tariffs and negative trade policies, but the shift to bi-lateral deals by the US looks less damaging and more about the art of the deal. As we look into Q2 the concern will shift once again to European politics. Meanwhile as the Trump cabinet fills out, focus will shift to policies on tax – particularly corporate tax and border tax. These will have stock and sector implications and much will be in the details such as treatment of interest charges etc. Meanwhile we should pay attention to the Fed winding down its balance sheet.

·       Here in Asia we continue to watch the impact of capital flows from China, less for the supposed worry about the currency and more for the impact it appears to be having on markets.

This week is half term holidays across much of Europe and the markets are focussing on President Trump, much as this time last year the world was panicking about China collapsing. Markets subsequently moved to worrying about politics with the EU referendum in the UK in the summer term before metaphorically taking the summer off. They then returned in the autumn/winter term to worry about the US election and now they are worrying about the result. Next term they will start to worry about European politics, with the Dutch vote in March and the French in April/May. Then they can take the summer off and worry about the Germans and possibly the Italians in the autumn.

In fact, as our friends at Gavekal pointed out in a seminar this week, the big surprises for markets (as opposed to pundits) were economic rather than political and principally around the misreading of China. The commodity complex, beaten down by concerns over China, actually bottomed around this time a year ago, while the US bond market peaked in July, effectively highlighting that the so called Trump reflation rally started long before he took office. To the extent that most of this reflected capacity reductions and limitations to output by China rather than expectations of stronger demand from the US raises questions as to the durability of the reflation trade.

It is worth remembering that it’s not even been a month since the inauguration, even if the pace of the announcements coming from the White House has left many people feeling exhausted. Some will see a switch back to old school policy forecasting, in this case that of monetary policy, as a welcome relief to something akin to a rules based system and Janet Yellen’s biannual testimony this week will be examined for hints as to whether rates will be tightened as early as March and noise traders, particularly in the dollar are waiting to react. The statement about reducing the size of the Federal Reserve’s (Fed) balance sheet may be rather more significant than the comments on interest rates since it undoubtedly shifts the supply demand imbalance for fixed income. In terms of funding costs of course, real world interest rates are already up 40bps over the last year, if we look at Libor rather than Fed funds, (a technical factor to do with money market funds that also began before the election) and so any move in Fed funds would be catching up rather than leading. Nevertheless the broader tightening of offshore dollars remains a concern, particularly given the growth in leveraged products in recent years.

As discussed before, behavioural finance theory tells us that, while ultimately they are rational, markets are susceptible to short term emotional moves and politics can be part of that. In that sense the rational aspect of markets is busy trying to discount cash flows with the appropriate discount rate whilethe more emotional and narrative driven aspect of markets can not only be moving discount rates (too high or too low) as happened immediately after the US election but also be creating expectations of cash flows that may not turn out to be correct. If for example, we consider the narrative of isolationism and tariff barriers that is currently impacting emerging market exporters as strategists and analysts try and pull out economic consequences from the potential policies of the new administration. Rather like similar statements around UK and Brexit, it is easy for the assertions to become accepted without any real evidence and to the extent that they become embedded in prices it represents a free call option to go the other way. It is always interesting to speak to an analyst at the end of a long marketing tour as the ‘reverse broking’ is often evident and they tend to open the meeting with the statements that have generated the most favourable attention in recent weeks. Thus speaking to a sell side economist this week, their assertion discussed was that President Trump would declare China a currency manipulator because it would be ‘an easy win’, a view that was part of a wider view about a weaker renminbi (RMB) and I am guessing something of a consensus among clients in Asia on account of it being produced as the upfront statement in one presentation. I am not so sure. Personally, I can’t see why that would be a ‘win’ for President Trump, not least since he would have to change the definition of currency manipulation currently in use in order to do so, opening him up to widespread criticism on a number of fronts to little advantage. The definition is to meet all three of 1) a trade surplus with the US greater than US$20billion, 2) a current account surplus greater than 3% of GDP and 3) a country that repeatedly devalues its currency by buying foreign assets greater than 2% of GDP over the year. China hits the first of course and misses the second and it is difficult to argue the third when China has been intervening to support its currency. While declaring China a manipulator under these circumstances would allow tariffs to be imposed, it would not only provoke an unnecessary row with China and almost certainly a reference to the World Trade Organisation (WTO), but also re-inforce the ‘alternative facts’ narrative to no real purpose.So not an easy win, but more of an ‘unforced error’ in my view. If anything, Korea and Taiwan have acted much more as currency manipulators, while thanks to multinational accounting Ireland has the fifth largest trade deficit with the US, more than three times that of Canada.

The argument is the same with unilateral tariffs on China, another commonly held view based on a reading of campaign rhetoric. However, if, as he has repeatedly stated and shown by his actions, President Trump’s real priority is to bring jobs back to America, raising tariffs that make imports more expensive I think is a very crude way of doing it. Tariffs on Chinese goods would only lead to switching to Vietnam or other Asia as a supplier, often from the same manufacturer who currently re-imports to China before exporting. Equally, raising input prices across the board for basic consumer goods without US domestic competition would simply alienate his voter base who would face price rises at Walmart and higher inflation. And contrary to some conventional wisdom, higher inflation is not seen as a ‘good thing’ by low wage consumers, even if it remains an obsession of some central bankers. Thus a policy that potentially hits his core voters, alienates not just China but the whole of Asia and could trigger reprisals against big US corporations (Boeing suddenly gets orders cancelled, health inspections on US agricultural exports, etc.) seems to me very far from an ‘easy win’. Together with the shift on the issue of the One China strategy, this would represent an extreme position being moderated as part of a wider ‘deal’.

More likely, in my view, will be continued pressure via bi-lateral discussions with multinationals, use of the tax code (including the repatriation of the overseas cash) which will likely collapse that deficit with Ireland and, rising in probability, some variation on the Paul Ryan proposals for a border tax. This latter notion is something previously described by Trump himself as “too complicated”, but it does have its merits and appears to be gaining more traction recently – although it is by no means a certainty. Importantly the notion of a border tax is tied up with wider corporate tax reform, not least because the US system does not allow for export rebates in the way that VAT based systems do. The US has said they would make the rule changes compatible with WTO rules, but here again there are issues and, according to the media, the EU is gearing up for a WTO challenge to any border tax proposal. Indeed, it may be that while a border tax looks like a more probable route than straight tariffs, we may end up with neither. We might find for example a move to a VAT based system by the US instead – it would address the imbalance the US claims harms US companies without involving the WTO – or a border tax proposal may simply not pass through Congress. In very simple terms, the US taxes are set by production location and the rest of the world by consumption location. In that sense US companies are double taxed, a key reason why President Trump describes it as ‘unfair’. As such, moving to the system everyone else uses actually is an ‘easy win’. In any event, any potential impact on revenues and consumption is an exercise in pricing power and competition and will vary between countries and products depending on details suggesting that there is little point trying to second guess at this stage. We will hopefully get some clarity in the coming days.

Meanwhile, another interesting challenge to the isolationist narrative was this last weekend’s meeting with Shinzo Abe in Florida. The response to the, not entirely unexpected, provocation from North Korea was extremely supportive and, dare I say, statesman like. No tweets, just solidarity and a commitment to defend and support Japan and other allies in Asia. Indeed, it looks like the US sees Japan as a key ally in dealing with China. We know that Japan has been extremely competitive with China regarding Foreign Direct Investment across Asia - something the UBS strategy team refer to as Patronomics – and it looks like the ‘deal’ may be that the US continues its military support for Japan and Japan ensures that Japan’s economic actions in the region are in the US as well as Japan’s national interest. One wonders if Mr Abe has been tapped up to pick up some of those fixed income products that the Fed no longer wants. Here again, the reality is that far from withdrawing from its role as the ‘world’s policeman’, it looks like Trump is actually re-engaging. The difference is that now he wants to be compensated for it, both by Japan and Europe paying more towards the North Atlantic Treaty Organisation (NATO) and its structures and also by the countries it ‘defends’ being seen as having America’s interests at heart in their economic actions. The notion of bi-lateral trade deals instead of multilateral ones also fits in here and makes the withdrawal from deals such as the Trans-Pacific Partnership (TPP) look more rational. Instead of long drawn out negotiations trying to please the different multilateral aims of multiple countries (remember after almost eight years the Canada EU trade deal came close to foundering over dairy farmers in Walloon), it looks like the Trump administration are using bi-lateral trade deals as part of broader economic policy aims.

As far as domestic policies go, the tax code changes obviously have to progress through the full US system (no executive orders here) and could be very positive for small and medium size companies, especially if it also means deregulation – not just at the federal but also at the state level. It is also interesting to note that while the subject of financial deregulation has got Wall Street very fired up – well at least about the prospects for Wall Street - both Treasury Secretary Mnuchin and Steve Schwarzman, head of Blackstone and also Donald Trump’s economic advisory council, regard de-regulation of mortgage lending as a bigger priority. They make the (valid) point that cheap money is not the same as money actually being made available and that while the notion of de-regulating mortgage markets may sound like repeating past mistakes, the issue is that things may have tightened too much. This would obviously have implications for residential investment and related businesses, but also on business formation generally. Although much of the modern service sector business does not need much capital, being able to borrow against your home is a classic way of funding start-ups of all kinds. Business formation data is very weak in the US since 2008 and it is my opinion that lack of access to capital for new businesses due to much tighter lending criteria is part of that. This  could be another ‘easy win’.

As happened last year, European politics is creeping back into view, with the European Council starting to worry about the Ides of March as the Dutch go to the electorate on March 15^th 2017. As is often the case in Europe, the political equation in Holland is one of potential coalitions and who, if anybody might go into coalition with Geert Wilders. Meanwhile in France, the prospects are starting to upset markets, while, as previously discussed, a loose coalition between the Northern League and the 5 star movement in Italy could yet produce a referendum on the euro. The lessons from last year appear to be, take no position until the results are out and as such Europe remains off the investment radar for many international investors until the ‘summer term’ at least, although it seems to me that small and mid-cap equities – perhaps currency hedged look the best place to be long Europe if you have to be.

Returning from Chinese New Year break, Hong Kong remains wary about US policy, but has seen some intriguing flows through the Southbound Stock Connect, pushing turnover sharply higher, such that last week daily turnover, at around US$50bn, was up almost 50% on a week earlier. One theory is that a number of companies who were previously cleared for outbound capital flows for M&A reasons are now finding that those deals have not gone through and have permission to ‘park’ the cash in Hong Kong ‘H shares’. They seem to be following a form of ‘Dogs of the Dow’ strategy and are chasing previous underperformers, like Hong Kong property shares and Chinese banks. Just as we highlighted last week that the Chinese regulated fund management industry now tops US$7.5trn in AUM, so we are increasingly likely to find that movements here in Asia reflect the market mechanics of our neighbours to the north more than the more traditional investor.

To conclude. The two strongest narratives at the moment appear to be that inflation is back and that the US is becoming inward looking and isolationist. Both deserve to be challenged. On the first it looks like the strength of commodities prices since this time a year ago is a combination of a rebound from a hugely pessimistic viewpoint on Chinese demand and some meaningful limitations to supply and output from China. This has now left markets as long this year as they were short in 2016 and one can’t help feeling that the mean reversion trade could be just as painful. The classic speculative indicators are appearing in China in areas like copper for example and while China never collapsed, the supply demand imbalance still appears in favour of weaker, rather than higher, prices. On the second, narrative, it looks like, far from dis-engaging and becoming isolationist, the Trump White House is actually re-engaging with the rest of the world, but is changing the terms of engagement. This means blanket reactions need to be more nuanced. The US, it appears to me, ready to resume its role as the ‘world’s policeman’, but wants a return on its investment. I think it wants other countries to not only provide monetary support but also, I suspect, to ensure that their economic policies tilt in ways that favour (or at least do not hinder) the US. Meanwhile, the process of putting America first also points to ambitious moves for domestic policy, notably on tax, which allowing for the checks and balances of the US political system have the potential to shift the earnings landscape meaningfully for various stocks and sectors. As with waiting for election outcomes, there is little upside in trying to second guess policies until they are announced, but it does suggest some likely volatility at the stock and sector coming up shortly.

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