The Rearview Mirror – January 2017


Christian Zorico (160)



rearview mirrorCould the post-election rally be considered as a snow flurry? And what about the US long-term yield upswing? Was it a positioning for a further reprising? We can keep on by attempting to answer whether the greenback will continue to strengthen against the other currencies. And so on, if we knew in advance the pattern of all asset classes, it would be an easy task, for portfolio managers and for investors, to make money.

On top of it, the upcoming year will be characterized by a series of political events: overall the Presidential Election in France, expected in April, and the Federal Election in Germany late in September are contributing to make any market prediction less valuable.

In fact, as for the 2016, it will be crucial to focus not only to the outcome rather than evaluating the spectrum of consequences in terms of growth, fiscal measures and social sustainability. Indeed being a political expert will be more efficacious than owing a crystal ball, if any.

In less than two weeks we are going to face with the first unknown: the US Presidential inauguration due to the 20th of January will unveil the plan of action of Mr Trump.  A reasonable assumption is to have no idea where asset prices are headed so that no asset allocation will be provided in this article, but some factors to take into account once we are called to allocate our limited resources.

A way to analyze what happened is to highlight the word “panic”. A possible reading behind the recent rally is the powerful buying fire of some hedge funds and activists that have missed to track the equity performance so far and decided to participate for the Christmas rally. Still we are not talking about panic, but a large number of investors could react in a bullish way by panicking of missing the opportunity to jump into this exuberant rally, i.e. the Dow Jones Industrial Average has gained almost 9 percent and the S&P 500, tapping record highs, is up around 6%.

This behaviour can provide support to the current price action even if we are already in overbought territory.trump casa bianca

Another way to read the word panic is to focus on nominal yields. Since Mr. Trump’s election, 10-year Treasury have sold off 80bp by reaching a high of 2.65% and reinforcing the reflationary momentum. Such steepening of the yield curve is perfectly in line with a new environment where an expanding fiscal policy will push the inflation higher and force the FED to overreact adequately.

Clearly a real risk is a possible shock due to a panic reaction. In fact the proliferation of  VaR sensitive investors, increased the risk of stop losses triggers when a volatility shock arrives. Investors will be forced to reduce their duration; the process is self-reinforcing at least until the new yields level will induce market participants that are not exposed to VaR model to enter into the trade. We already experienced such a movement in May 2015 within the Bund sell-off or in June 2013 with the “Taper Tantrum”.

Certainly the announcement of a fiscal expansion by the Trump administration will help dissolve some doubts. Although part of its plan is largely expected by the market, investors could continue to support last trend because a pro-business approach by the new administration will be offset by a tighter monetary policy.

Still I believe that in the absence of a full visibility of fiscal policy, we should avoid any strong convincing trade idea; for investors that already have speculate into Trump my best advice is to sell the inauguration. In both scenario of disappointing or even supportive message, I consider that time a good opportunity of getting out.

Moreover as we pointed out several times, the hunting for yield has pushed everything higher. It seems to be the same trade. Hence, we have seen a reprising into yields so far but not the same for the high yield world and for the equity as well. Keep in mind that a panic reaction is always possible also for the equity, moreover for the fact that volatility is trading at its historical minimum. Stay cash for a larger than usual part of your portfolio. A gradual repair of the global economy is still supportive, thus in this environment any market corrections could offer some real opportunities.

Back to the beginning of the article to answer the last question. What about the Dollar? I believe that Mr Trump will not like a strong dollar. In this case the currency will act against its fiscal purposes. But again timing is everything.



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