The era of benevolence and loving care towards the financial markets, already considered the decisive weapon to support the recovery of the world from the depths of the recession, is over. “Note the behavior of central bankers. Until a year ago, after each downward correction, hardly a few days went by without a Fed member intervening to calm the markets. Now that's not the case anymore." Talk like this Alessandro Fugnoli, the Kairos strategist who has been guiding us for years with "Red and Black" into the secrets of the great global game. Gone are the days of the Bernanke put and the loving care of “dove” Janet Yellen, ready to seize any opportunity to postpone the rate hike. At the time, a $500 billion drop in leading Nasdaq stocks would have triggered an earthquake. On the contrary, the news that the Fangs (Facebook, Amazon, Alphabet and Netflix) have left 500 billion dollars of capitalization on the ground this week since August has practically gone unnoticed.
In short, is the Nasdaq party over?
“Certainly the best is behind us. But the market, as always, will realize it late, insisting on the usual themes for a while longer. Let's say that we are on the eve of a change of themes: I don't rule out 18-24 months of weakness. The relationship between the growth of the economy and that of financial assets has been inverted. In the past, the former has grown little, the others a lot. Now it's a question of recalculating the multiples in the light of the new situation”.
The consequences?
“I wouldn't worry too much about the Internet giants, at least as long as earnings remain solid. By a strange analogy in Europe, luxury stocks and many medium caps are facing a similar situation. In the eyes of the market, the European Nasdaq is represented by the list of luxury stocks. Going back to Wall Street, I think the market needs to get used to a much less brilliant future trend. Even if the situation is complicated. The rate hike is already having negative consequences on the home and car markets. I do not exclude that the Fed, in this scenario, will be forced to suspend the rate hike cycle sooner than it would like to keep inflation under control”.
And to avoid widening the conflict with Donald Trump. How to interpret the duel between the White House and the central bank?
“There is a lawyer at the Fed today, Jerome Powell. Yes, Trump wanted it, but the president does not have the authority that people like Volcker or Greenspan had in his time, who dominated the board. And so he finds it difficult to impose himself on the others, chosen by Barack Obama or, even worse, by George W. Bush, a Republican who hates Trump. It will be interesting to understand the weight that Richard Clarida, the new Fed deputy chairman, will have, a man whose charisma and preparation has the qualities to play the role that Stanley Fischer, the thinking voice of the central bank has had in recent years".
Clarida, in her first official speech, sided against Trump arguing that "if the incoming data is as I expect, I believe that a further gradual adjustment in the federal funds rate will be appropriate".
"Let's wait. I well remember a very incisive speech of his in 2014, when he explained that, after such a serious crisis, it would take at least five years before talking about raising interest rates. And only and I emphasize, after the return of inflation, not first as a medicine to be proffered as a preventive measure to the market in the face of the increase in employment or other phenomena that in the past preceded the increase in prices. It is by no means certain that this time we have to follow that script. The strength of growth or the falling number of unemployed will not necessarily weigh on the number of increases. On the contrary, the Fed will limit itself to looking at actual inflation: if this is stable, rates won't be raised that much”.
Much will depend on the upcoming midterm elections. Or not?
“They will certainly be a key step even if, even in the event of a democratic triumph, it would still take a long time to dismantle Trump's tax reform as evidenced by the fact that, despite his efforts, he has failed to undermine Trump's health reform Obama. The second part of the presidential mandate will in any case be more complicated because the president will not be able to limit himself to acting on the supply side, something will also have to be done on the demand side. But the road seems marked: The effects of the fiscal path (the United States will have a deficit of 6 percent next year) are there for all to see: doubled growth, tripled productivity, inflation above two percent but not check. In perspective, if we continue on this path, we will also have a faster growth of wages than profits and therefore, in this way, a reduction of inequalities.
What will be the consequences for the financial markets?
“As far as the USA is concerned, we realize that we are only now entering normality, with a tense but not yet too unbalanced job market, solid structural inflation that is not yet too high, a strong fiscal impulse that generates accelerating growth and productivity . For this reason, a season is looming in which monetary policy will act as a handmaid to fiscal policy and will be talked about much less. Even the Stock Exchanges will probably have to resign themselves to a less central role”.
This explains the lesser push from Wall Street…
“There are two causes of the less lively market: the compression of multiples and the gradual decrease in liquidity due to the reduction of the Fed's balance sheet. The compression of multiples is the other side of rate hikes. The withdrawal of excess liquidity on the Fed's balance sheet amplifies the effects of rate hikes. Central bankers are obsessed with the fear of not being able to cope with a future recession so much that they run the risk of causing one. But, looking at past experiences, one of the main risks is that, sooner or later, bankers make mistakes ”.
This applies to US markets. What is the state of health of other economies?
“The situation on other markets is not brilliant. The confrontation on tariffs, even in the event of an improvement after the US elections, promises to be very tough. Meanwhile, China, which has cut off all contact with Washington for at least two months, has reacted to US tariffs with devaluation. Olivier Blanchard has demonstrated that the current level of the yuan is sufficient to offset the effect of tariffs. I don't think, at this point, the Democrats would be softer on Beijing. Perhaps on duties but not on the technology front. An electronic iron curtain is now emerging between the two superpowers. Meanwhile, China is changing its power profile based mainly on exports. And it's not good news for Europe: a China less based on trade will also reduce purchases in the Old Continent, with repercussions on consumption in other economies”.
Another tile for Europe, the other economic area based on exports.
“And for this reason it is also the area that risks paying the highest price in the current state of uncertainty. The euro, if we look at the trade balance data, is greatly undervalued. It would be necessary to invest the proceeds of the surplus, but Germany opposes it. After all, after twenty years of the single currency it would make sense to review the mechanisms of the euro, but the situation is blocked. And so the imbalances within the Eurozone, now condemned to a policy of low rates, in the Japanese style, worsen. One wonders to what extent Washington will allow it”.
In short, Europe risks being the weak link.
“Surely the European architecture needs a major upgrade. For example, it would be enough to re-read Keynes' lesson which recommended punishing countries with an out-of-control trade deficit but also those with an excessive surplus to the same extent: the European Union, despite having provided for sanctions on the matter, has never passed from words to deeds".
In this context, the Stock Exchanges are short of breath. Is it time for bonds?
“A rebound is not excluded, albeit limited in size and over time: in October the negative seasonality exacerbates the trends, but the phenomenon will be reabsorbed by the positive seasonality at the end of the year. The rising trend of real yields will be good news for those who start investing today, but not for those who have the old paper destined to fall”.
What to do then?
“Better to favor the liquid component. The most logical solution seems to me indexed bonds to hedge against inflation. But only on tight deadlines. It may be time to reconsider some gold bets. But the market is now difficult to interpret, conditioned as it is by the behavior of three major players: China, India and Russia. Difficult to venture a prediction at this time”.
