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EDINBURGH — Developments in the US have created a potentially deadly cocktail for global financial markets. This is underscored by Nigel Dunn, a seasoned and highly respected stockbroking analyst in South Africa. Dunn has pulled together key facts and trends that have raised risk levels for international investors, including anti-migrant sentiment in Europe. He also highlights recent moves by US President Donald Trump that have increased the likelihood that the world could be plunged into a crisis. Dunn reminds us that it was a US policy on tariffs that helped to spark the Great Depression in the 1930. He says he doesn’t want to cause panic; however investors should pay close attention to statistics that show that markets have avoided a notable dip for a decade. – Jackie Cameron
By Nigel Dunn*
Are we headed for a perfect storm? I have not written this to alarm people; merely to highlight a number of things coming together concurrently that are concerning and merit consideration by anyone exposed to markets. In no order of importance:
- Merkel and her coalition appear to be in trouble, after Interior Minister Seehofer from the CSU party proposed Germany reject migrants who have already registered in another country. The Chancellor is opposed to any restrictions being placed on her open door policy to migrants. Either she moderates her stance or runs the risk of the coalition or herself becoming a casualty, as the CSU party appear to be in no mood to compromise.
- Recent Italian actions pertaining to migrants are divorcing them from the Eurozone; in the words of Salvini, Italy’s new Interior Minister, “the party is over for migrants.” His rhetoric appears to be resonating with Italians, as recent polls show the right wing anti migrant League gaining 5 percentage points in a matter of weeks; they are now ahead of the Five Star movement.
- The trade war is becoming increasingly real, with Trump requesting the US Treasury identify an additional $200bn worth of Chinese goods for tariffs, this after the Chinese retaliated to Trump’s initial 25% tariff on $50bn of Chinese goods, by slapping the US with a 25% tariff on $34bn of their goods.
- The US yield curve is 35bps from inverting; the global yield curve has inverted. In plain language: investors generally expect a lower return on short term monies than longer term. When the yield curve inverts; long term debt instruments have a lower yield than short term instruments, market sentiment suggesting the long term economic outlook is poor and yields will continue to fall. Inverted yield curves are not to be dismissed lightly; they have predicted the last seven recessions in the US.
- US Dollar strength allied to US rate hikes is tightening liquidity conditions globally; that at a time when debt has never been higher. Emerging markets are most vulnerable, as many have borrowed in USD, some heavily. There are already casualties in that space; Argentina, Brazil and Turkey for starters. The USD has two major tailwinds behind it; rising political concerns in Europe and a very favourable interest rate differential with the developed world; there are others; a better capitalised banking system for one.
- Despite rising inflation in Europe; Draghi indicated last week he has no intention of normalising rates whilst still in office; his term ends next year. By contrast, Powell has every intention of pushing through further hikes; both this year and next; thus widening the differential.
- Exacerbating the problem; the Fed has started to wind in its balance sheet; the numbers are not meaningful as yet, but already markets have felt the draught, particularly emerging markets, as liquidity is drained.
- Concentration risk is building; the top five tech companies today comprise a greater percentage of the index than the top five did ahead of dot.com, elevating the risk is that some are trading on triple digit price earnings multiples. This has been fuelled in part by investors switching from active to passive index tracking ETF’s, and part by fund managers believing exponential growth is an infinite phenomenon.
- An aside: ETFs only gained traction post the financial crisis of 2008; as a product, they are yet to be tested by a severe market downturn.
- Genuine liquidity levels are lower than many believe; high frequency traders (HFT), scalping accounts for 30% – 70% of the market, depending on which stats you believe. Given a full blown financial crisis, many of these HFT traders might curtail their activities; forced selling via ETFs and other leveraged traders into a vacuum, is going to lead to some interesting results.
- Compounding the liquidity issue is the growing number of assets many central banks are taking onto their balance sheets; BOJ being the most active.
- I am not going to elaborate on the geo-political situation, other than to say anyone not concerned cannot be meaningfully engaged.
Those with a perspective of economic history will remember it was the Smoot-Hawley Tariff Act signed into power in 1930 that precipitated the depression, as trade slowed up. I hope history does not repeat, and those believing Trump’s recent actions are merely “the art of the deal” are correct; sanity will prevail, and a potential crisis averted. If not, slower global trade allied to tightening liquidity conditions portents a possible debt crisis, both sovereign and corporate.
In conclusion, the more deeply ingrained something is, the greater the catalyst required to disturb the equilibrium. Markets have gone a decade without any notable correction; one could safely say buy the dip is ingrained deeply in the minds of most market participants.
Merkel has been the glue that has held Europe together through various crises; should her position weaken, worse still be forced from office, the fault lines running through Europe may well widen. A strengthening USD allied to US rate hikes is tightening global liquidity; a real European political crisis will result in an even stronger USD; debt has never been higher, some of it denominated in USD. The last thing the world needs is an escalating trade war with concomitantly slower economic growth.
Should these events come together simultaneously; I posit it will be the catalyst of sufficient magnitude to disturb the current state of play; the “Lehman” moment of 2018. I leave you to watch; draw your own conclusions and act accordingly should the storm come together and break.
- After graduating with a B Com Honours, Nigel Dunn moved into stockbroking close on three decades ago. He has been a registered member of the South African Institute of Stockbrokers since 1994. He started his career in 1987 advising individuals, moved to research, company specific and of a strategic nature, before settling in fund management, both for private clients and pension funds. He was a partner of Anderson Wilson, subsequently acquired by Standard Bank, where he became a director of Standard Equities. Thereafter he moved to Investec Securities where he managed funds for private clients, family trusts and helped on the corporate broking desk. Most recently he has been managing discretionary funds for clients, proprietary trading in addition to generating his own corporate research. Of late he has started to write articles of a market related nature intended to stimulate thought and debate.
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