Political volatility vs. market calm
The sigh of relief could be felt across all media channels last Sunday evening, when it became clear that the polls had been correct and France had chosen the moderate Emmanuel Macron over ultra-right, nationalist Marine Le Pen. However, short term investors who had bet their money on this outcome were disappointed as markets appeared to have had fully anticipated Macron’s victory and provided no further upside, not even the €-Euro.
The political calm only lasted until Wednesday when president Trump made his first major political mistake by suddenly firing the head of the FBI, James Comey. There were plenty of legitimate reasons to do so back in January, when he was inaugurated, if we think back to Comey’s dubious decision making in the Hillary Clinton email affair just before the election. However, now that the FBI is investigating Russian ties with Trump’s campaign, his decision to suddenly push him out was bound to rouse suspicions that this is attempted intimidation of FBI investigators. Given not even Nixon dared to sack the head of the FBI there was a widespread view that he had gone a step too far with his unorthodox methods of progressing his political aims.
Macron’s victory shifts Euro-bears’ focus to Italy
According to Dutch politician, Jesse Klaver, the Netherlands’ vote was the “quarter-final” of Europe’s electoral season, and the failure of the populists was a good sign for the semi-final (France) and the final (Germany). Actually, the ‘final’ is a much lower risk to markets. Angela Merkel’s CDU is on course for another win and, even if she fails, Martin Schulz’s social democrats of the SPD are hardly a threat to EU stability. As such, attention has turned to the next (supposed) political iceberg: Italy.
Italy’s banks have long been suffering under the weight of €260bn in non-performing loans (NPLs), a remnant of the Eurozone crisis that won’t go away. The NPLs have put considerable stress on the Italian financial system for years, making it the perennial weak link in the European economy. They have also locked the country in a vicious cycle. The bad debt has handicapped Italy’s banks, whose subsequent inability to fund business expansion has resulted in stagnant growth. This, in turn, means many Italian businesses and consumers can no longer service their debt – thus increasing the country’s NPL stockpile. What makes the Italian position more precarious than elsewhere is that a large chunk of the bank debt is held by private savers and pensioners in the form of bank bonds. This turns a bail-in of bond holders for a bank recapitalisation (as is now prescribed by post crisis EU rules) into a systemic risk for Italy’s banking sector.
GDP and income growth through higher productivity or more jobs?
Even though US output is ~11% higher than its pre-crisis peak and employment is now higher as well, the expansion is showing the slowest pace of GDP growth of any period of post-war recovery. The experience of the US is mirrored in several other developed economies. Both the US Fed and the Bank of England (BoE) seem to agree that productivity is a key cause of this dilemma. The BoE believes lack of personal income growth is one of the biggest current challenges, associated with a 16% shortfall of productivity in the UK since 2008. According to the US Fed, labour productivity has increased only 0.5% per year since 2010 – the smallest 5-yr rate of increase in the US since World War II and about 0.25% lower than the average post-war rate.
Long-term sustainable growth and productivity are unlikely to be achieved by just an artificial fiscal stimulus. As laid out above, this may inadvertently stoke inflation in the current environment, and, perversely, encourage the Fed to raise interest rates. This, in turn, would reduce business’ willingness to invest into their productive resources. To the extent that Western economies need further bolstering, politicians should give more consideration to encouraging business investment through increased planning certainty for business cases, as well as public funding of education, vocational training and continuous professional development for a more highly trained work force.
Solid company results (finally) drive up corporate confidence
With earnings and economic fundamentals improving globally, it becomes easier to justify the recent record highs in stock prices, possibly supporting the ongoing bull market. We believe the convergence of these factors is underpinning corporate confidence levels. The one concern to note is that many companies are relying much more on cheap debt at the moment then they have in the past, which makes them financially more vulnerable. Nevertheless, this confidence appears to be translating into increased M&A or investment activity.
We anticipate that this newfound confidence, a result of better earnings and improving economic fundamentals, may continue to provide support to equity markets at current levels. But, equally plausible is the idea that renewed M&A may provide a short-term boost to stock prices. However, the encouraging pick-up in CAPEX should generate longer-term positive benefits.
Bitcoin’s surge accelerates as Japan legalises Bitcoin payments
The market capitalisation of Bitcoin has risen from just over $7 billion last May to well over $38 billion today. This leaves Bitcoin as the best performing currency year-to-date after rising over 90%.
The turning point and trigger for the rally in Bitcoin appears to have come first from Japan and then Russia. The news that Japan legalised Bitcoin as a payment method (Russia is considering the same) led to an increase in popularity and demand from Japanese buyers.
Given the rule changes in Japan, the Nikkei reported that 10 local companies are launching virtual currency exchanges to tap the perceived growth in Japanese demand. Additionally, Japan’s consumption tax will no longer apply to digital currencies like Bitcoin.
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