Why it’s now a scarier environment for investors than ever before
A man is reflected on a glass panel as he walks past an electronic board displaying stock trading index at a brokerage house in Beijing, Wednesday, May 24. (Andy Wong/AP)
It is not one story, but so many stories, that is leading me to the conclusion that it’s as scary an environment for investors as it’s ever been. It is not a single item, or event, but the fact that we are being bombarded with supersized issues, whether it is at home or abroad. Investors are, in effect, under siege.
In the U.S., the push-back against President Donald Trump and his plans proceed unabated. Democrats, Republicans — it doesn’t matter. For one reason or another it’s like the entire establishment is barking, with great fervour, at our outsider President. I am paying special attention to all of this because I think it means that Mr. Trump’s agenda, on a wide variety of fronts, will take far longer to put into effect than the markets grasp.
Whether it is tax cuts, or some form of border tax, or his proposed cuts to Medicaid and food stamps, or less regulations, or changes to the tax code — you can just keep going. There is so much resistance, in every case, that whatever may get passed into legislation is unlikely to happen anytime soon. Consequently, the timeline should be noted as a negative for the markets as it will weigh upon them.
The equity markets will fluctuate, of course, but we have seen the vast majority of appreciation in this cycle. I said in November to buy equities and they have had a great run. The appreciation is beginning to stall and I suggest a more conservative course, relying on cash flows and the accumulation of intermediate bonds coupled with closed-end bond funds to produce a 7 per cent to 7.50 per cent total return. It is a far safer strategy when the political and economic currents are so frenzied that they may become unsafe.
Moody’s just downgraded China to A1 from Aa3. If you just looked at the headlines then you might shrug your shoulders and move on but the underlying reasons they gave for the downgrade might cause a different reaction. This was the first time since 1989 that China’s ratings have been cut by Moody’s and that, in itself, is a reason to pay attention.
Moody’s estimate that China’s general government budget deficit was around 3 per cent of gross domestic product last year, which is a number that I believe is far off from actuality, as I do not believe that the official growth numbers are accurate. I am not alone here, as Gary Schilling puts Chinese growth at 3.10 per cent. What is frightening is Moody’s estimates that by the end of 2018 China’s debt to GDP ratio will rise to 40 per cent, and closer to 45 per cent by the end of the decade. That would mean the leverage China is using currently, to maintain its global position, is quite likely understated.
S&P this week warned about Brazil, putting it on the negative watch list. “Near-term uncertainties around President Temer’s political viability and the potential for a prolonged or disruptive transition process have heightened downside risk to the rating,” S&P stated. The country is rated “BB” and the prospects do not look good as Michel Temer is slapped with corruption charges. The story may get far worse before it gets better. One more hot spot to avoid.
Then, of course, there was the terrible incident in Manchester, England. The U.K. has raised their terrorism alert to its highest level and the country has added, significantly, to their boots on the ground. Terrorism is not country specific and while the markets mostly ignore all of this there may come a point when they do not, either because of the amount of activities or some additional horrible incident. No one likes to talk about all of this, but it cannot be ignored either.
Next up is oil. Mr. Trump wants to sell off part of our strategic reserves, as OPEC appears to want to extend its production cuts, once again. The price of oil has been buoyed by OPEC’s rhetoric, normal stuff, but the price of oil is likely to head back down soon. Mr. Trump, at some point, is going to announce some form of taxation on importing oil and this may radically alter the price along with a slowdown in China. Here is one more verging market negative situation.
We are also facing a big unknown in the make-up of America’s central bank. Mr. Trump, at some point, is going to appoint at least four new members of the Federal Reserve — and maybe more — before all is said and done. It is quite likely that the appointees will be business people, which means that the highly academic Fed will be a thing of the past. I suspect that the Fed’s “return to normalcy” doctrine will also be a thing of the past, as the government pushes on them to keep interest rates “lower for longer and lingering.”
Dot-plots, current Fed speeches, continuing threats of higher rates, may all vanish in the Fed’s new reality, as Trump rearranges the chess board. When the appointments begin, in fact, we may all be surprised with a major move up in prices, down in yields, as the Fed gets reshaped in Mr. Trump’s image. No one is paying much attention to all of this right now, but I am.
I am also paying close attention to Europe.
I think the Italian banking system is bust, for all intents and purposes, and that it is just a matter of time before the rancor breaches the walls in Brussels. No one on the Continent is talking about it in public, and “radio silence” seems to be their strategy, but I do not think it will hold. Then, of course, there is Greece and its looming $7-billion bond payment in July and what is to be done about that. The Guardian states that, “A meeting of the Eurozone’s 19 finance ministers broke up late on Monday night, amid a row with the International Monetary Fund about Greece’s debt burden. The standoff came just hours after France and Germany pledged to deepen co-operation in the single currency and seize Brexit opportunities for their banking industries. After more than eight hours of talks in Brussels, Greece’s creditors – the Eurozone member states and the IMF – were unable to bridge their differences on Greece’s ability to repay its debts in the long run.”
Brexit is coming. Grexit may be coming. Both prospects loom large. You see, “stuff.” Just a whole lot of pending issues, and so many of them, that I am recommending a more conservative approach. If I am wrong, well, you didn’t make the last nickel but if I am right, you may sleep more soundly at night. I am good with that.
Mark Grant is a managing director and chief strategist at Hilltop Securities.