There are two ways of looking at 2018 and of dealing with it on the markets. The first is the Excelsior Ball, the smug narration of the magnificent and progressive fortunes of a world that has started to grow strongly again and without inflation. Despite this triumphant deployment of the productive forces, governments and central banks, which by textbook should already have started to bring back the alcoholic beverages that were used to heat the atmosphere to the kitchen and cellar, can continue (precisely because there is no inflation ) to distribute expansive fiscal cocktails and euphoric monetary champagne with impunity.
From here the feeling of a 2018 destined to replicate 2017, with stable bonds, further compressing credit spreads, growing profits, equity multiples still expanding and stock exchanges confidently climbing to new and higher levels than ever before.
The second way to look at 2018 is the ascent of the river in the forest, the Congo of Conrad, the Mekong of Coppola, the Orinoco of the Aguirre of Herzog. Nature is luxuriant and obscenely rich, it is enough to reach out to have everything you want, but it is also full of pitfalls, rustles, whispers as disturbing as sudden silences. And in the hearts of seafarers the memory of the safe world behind them slowly fades away and anxiety, fear of the unknown, a sense of loneliness and the awareness of an end to the journey which, however distant, will inevitably be dramatic.
We had an example of the prevalence of the first narrative in the first days of this new year, when a sense of euphoria, for the first time in more than ten years, took hold of the markets and also infected minds that we have come to know as sober and balanced. And so, between one positive macro surprise and another, we've heard from solidly observant value managers like Buffett or Tepper assert that the market is not as overvalued as it appears and which, calculating the expected profits still growing and the tax cut, is no more expensive, in terms of value, than it was a year ago at this time.
The second narration instead influenced the last few sessions, when the markets stopped using their eyes to look at real facts and started tending their ears towards the rustlings and whispers coming from the forest. It seems that China wants to reduce its purchases of Treasuries. It seems that Trump is about to unilaterally withdraw from NAFTA. He also seems to be crazy. An impeachment request based on the XNUMXth Amendment (physical or mental incapacity) is apparently in preparation. It seems that Grand Inquisitor Mueller has enough material in hand to precipitate things and is preparing to interrogate Trump.
It seems that Merkel, one hundred days after the vote, is encountering more serious obstacles than previously thought in forming a government with the SPD. It seems that the ECB wants to harden the guidance on rates already in the coming months.
And if China buys fewer Treasuries, rates go up. And if rates rise, stock multiples contract and stock markets fall. And if NAFTA dissolves Canada and Mexico go into recession, the extremist Obrador becomes president in Mexico, the multinationals flee north of the Rio Grande, where production costs are much higher, so inflation rises and profits fall. And if Trump is put in check and Washington becomes ungovernable, the trust created by tax reform dissolves in an instant.
And if Merkel doesn't make it and we return to the polls, we risk skipping Macron's plan for Europe, which has a tight schedule and must be implemented before the 2019 European elections. China denies its intention to buy fewer Treasuries (it's fine to send warnings to Trump, but why hurt yourself and make the two trillion Chinese reserves invested in US government go down in value?). And if Trump were to announce the American withdrawal from NAFTA, he would then have to get it approved by Congress (difficult) and still wait six months to make it executive.
Six months during which the negotiations would continue until a very likely revision of the treaty, which is Trump's real goal. As for Europe, the theater of German politics will still take a few more weeks, but in the end, almost certainly, we will have a government that will get off to a flying start. And as far as the ECB is concerned, some linguistic acrobatics will be performed, such as in Sintra last July, to say that growth is strong and better than expected, but the program established on QE will not be changed (at most it will be indicated as less likely the tail end of the last quarter hypothesized by Draghi).
The point is one and only one, inflation. Until it rises, normalization will be slow and will not consist of a return to positive real rates. At most, real rates will be allowed to rise towards zero. In the last period there has been much talk of creepingly rising inflation and here and there we have even seen something. Honestly though, it's still too little.
We also note, in all the surveys of companies in America, Germany and Japan, a growing difficulty in finding personnel. At the same time, however, we note that companies do not chase candidates by offering them higher salaries and try to make do with the staff they have available or, possibly, with automation and increased productivity. We agree, the water is always hotter, but the boiling point, full-blown inflation, is still not being reached. And on the other hand, prevention, by raising rates ahead of what has already been announced, risks bringing down the level of financial assets and cooling down the climate of confidence too soon.
In short, 2018 is looming with a double narrative. On the one hand, the real data, very good until proven otherwise, on the other, anxious listening to any noise that might even remotely resemble proof to the contrary. The result is a gradual increase in volatility (the passage from one narrative to another and vice versa), a possible slow increase in real rates, expected long-term inflation and the term premium in bonds and a possible halt (and hint of reversal trend) in the process of expanding equity multiples. All combined with a modest further depreciation of the dollar. On the other hand, this does not lead to any generalized, significant or lasting decline in financial assets, at least for this year or until inflation actually occurs
