If the days in early autumn are cool and bright and the nights cold but not freezing, the level of anthocyanins in the foliage rises and, if the pH is at a certain level, the leaves do not turn yellow but turn fiery red, the color of Canadian maple forests in late September and early October. Before giving way to yellow and ash gray autumn can be more lush than spring and appear to be the best of times possible. Much more comfortable, shining and sumptuous than the stunted shoots that at the end of winter struggle their way between the frozen stones and the exhausted earth.
Green sprouts were discussed in February 2009, when here and there, with heroic optimism, it seemed to someone to see a slowing down of the fall. Yellow leaves are starting to be discussed today by some, when the majority seems instead to be experiencing a season of strength and acceleration of growth.
One of the most brilliant equity strategists, François Trahan of Cornerstone, argues that we are almost at the end of the first of three stages of the downward spiral leading to the bear market. In this first phase, inflation begins to decline first from its cycle high followed, after 2-4 months, by diffusion indices on production such as the ISM. At this point the second derivative of estimated earnings begins to decline. That is, profits continue to rise, but are starting to lose speed. Market signals deteriorate inconspicuously. Credit spreads stop narrowing and start widening, an increasing number of stocks move below their 200-day moving average, as defensive sectors displace growth stocks as the market leader.
The second phase, which is about to open, sees the debate shift to the possibility of a soft landing, which optimists see as a benign condition of constant moderate growth that can last a very long time and which pessimists instead see as a prelude to a real recession characteristic of the third phase. How true is this narrative? If we focus on America the warning signs fail
are missing and can be added to those already mentioned the cooling of the demand for cars and the stabilization of that of houses (cars and houses are the factors that most influence economic cycles).
We also note a fact that is beginning to appear structural, the growing frugality of the American consumer. Less petrol, fewer trips, fewer restaurants, fewer debts and, conversely, more time spent at home with much more television and even, almost incredible to hear, a recovery in reading paper newspapers. However, we would like to temper and, above all, contextualize these considerations. The ISM falls after being inflated in the first half of this year by Trump expectations. We had many months where the sentiment and spread indicators were much better than the real data and the overall data. Now the gap is narrowing, but this does not necessarily happen due to a deterioration of the real ones.
As for cars, the feeling is that demand in America has finished declining and could even rise again in the next few months, also due to the destruction wrought by Hurricane Harvey. The houses, for their part, are currently in a stabilization phase and it is too early for
talk about trend reversal. In Europe we are certainly seeing the peak of growth, but what will be lost from now on (if it is lost) will be the effect of a possible further revaluation of the euro, which will not remove growth in absolute terms, but will transfer it from Europe to America. It should also not be forgotten that while America becomes more frugal, Europe rediscovers consumerism, travels again, goes to restaurants and buys cars.
What Europe will lose on exports will therefore be largely recovered by domestic consumption. As for market indicators, internal factors (leadership, breadth) have undoubtedly deteriorated, but even here, rather than a worsening of the underlying situation, it is more appropriate to speak of a return to a down-to-earth positioning after the flights of fancy following the election of Trump.
The dollar's correction thus far extends the life of the global cycle and the red leaf season. The weaker dollar holds its own America in its ninth year of uninterrupted growth and forces the rest of the world to adopt even more prudent monetary normalization policies than previously thought. This was also confirmed by Draghi, who hinted at a very soft tapering (and even softer if the euro were to strengthen further).
Frankly, from what we've seen so far, it is difficult to draw particularly negative conclusions. Conspicuously missing, as classic ingredients of an impending recession, is a possible sudden contraction in credit levels (this time there was no bubble) and a possible drastic change in monetary policy, which the weak dollar makes even more unlikely.
If there are risks, they can come from another direction. Now that Fischer is gone too, Trump has a chance to radically change the face of the Fed between now and February. There is, at least theoretically, the possibility that a new, aggressively pro-growth road will be tested. There is also, just as theoretically, the possibility that an expansionary tax reform will not be challenged by a newly oriented Fed. If Trump decides to push the dollar even further, to choose as governor who will promise him the lowest rates and to seriously push (and obtain) a tax reform, the rate curve would steepen again and the American stock market could still go up.
However, it would be a road full of unknowns, first of all on inflation. Trump is and loves to be unpredictable. He knows he is incandescent and sometimes he shields himself by surrounding himself with people with opposite characteristics to him. Sometimes he chooses them and sometimes he gives the impression that he is forced to choose them because of political weakness and the strength of his opponents. The pressure from the establishment will be very strong on the Fed (banking deregulation and orthodox monetary policy) but there is no certainty about the outcome.
In conclusion, while a forecast for the rest of 2017 does not require particular courage (dollar in temporary stabilization, recovery of the European stock exchanges and relative calm of the American one) for 2018 the games are more open than commonly thought.
