The dominant narrative tells of a global economy accelerating in 2017 and even stronger in 2018. It speaks of pro-growth reforms coming to America and, now that Macron has won, also to Europe. He cites inflation back to a perfect level, neither too high nor too low, as the best support for a calm bond market. And he cites the positive economic climate as the best justification for an orderly, strong and safe equity rally. He declares the anti-system phase that has swept public opinion in the West over the past two years, considers it a delayed effect of the initial difficulties in getting the economy back on track after 2008 and sees a new phase of globalization restoration on the horizon. albeit revised and corrected.
Like all successful interpretive paradigms, this narrative manages to convincingly explain much of what is happening. Like all paradigms, however, it tends to remove the awkward questions about anything that doesn't confirm it. We dedicate this week's note to some of these questions.
The first uncomfortable question concerns the major reforms that Trump and the Republicans in Congress have promised America in recent months. If these reforms drift further and further and appear more and more vague, why is Standard and Poor's quiet on all-time highs and the Nasdaq making new highs nearly every day?
The answer given by the market is that for 2017 we do not need the reforms because the improving profits are enough to justify the increase. The reforms will come in handy in 2018. In this attitude, the presence of pink lenses in front of the eyes is noticeable. Profits are indeed growing, but only in some sectors and not to such an extent as to fully justify the increase. As for reforms, it is increasingly clear that we will have a cut in corporate taxes but not a comprehensive and profound tax reform. On the extent of this cut we will have an initial number (not of rate, but of dollars to be allocated to the budget) from Trump by the end of the month, then it will be up to the lower house to indicate its own by the end of June and then everything will go to the senate. At least six months of discussions will follow on how to distribute the cuts and how to possibly compensate them with the abolition of deductions and deductions. Everything can only proceed if the health reform has been definitively approved first and for this we will have to wait until the end of September.
The political exchange on the FBI and the investigation into Russia will weigh on the quality of the reform, two issues that unite the Democrats and further divide the Republicans. In order to approve Comey's successor without prolonging the obstructionism beyond the autumn and lightening the Watergate atmosphere that reigns today in Washington, the Democrats will in fact ask for tax concessions.
The second uncomfortable question concerns the Fed. If 2017 growth will be the same 2 percent we've seen since 2011, why on earth should we willingly accept the four hikes the Fed has planned for this year (not to mention the another three-four in the pipeline for 2018) when in recent years the mere hypothesis of a single increase was seen as a serious risk for the economy and the stock exchange? Are we not already seeing the consequences of this new policy in the car and in the home, two sectors that are very sensitive to the level of interest rates?
For the moment, the market's response is the classic one of the first phase of a restrictive cycle. If the Fed raises rates, it is said, it means that the economy is doing well. For now it is a sensible response, but we must not forget that the Fed also raises rates to be able to lower them in the next recession. To do this, she too is forced to wear pink glasses and say that everything is fine. It is the opposite of what you said a year ago, when you always found a problem in being able to postpone the rate hike. Curiously, the growth was then the same as today.
The third uncomfortable question concerns raw materials. If the global recovery is as strong as they say, why is the commodity index today below the level of November 8, Trump's election day?
Here the response of the optimists appears convincing. It is not the demand that is lower than expected, but the supply that is much greater. In oil, for example, the return to production in America is greater than the cuts in OPEC and Russia. That said, the last two months' decline in commodities is amplified by the unwinding of speculative bullish positions built during the Trump rally. Now the market is clean and can slowly get back on its feet.
The fourth uncomfortable question concerns China. If emerging markets are doing as well as they say and with all the money we are bringing them, how come the index of the main emerging stock exchange, that of Shanghai, has lost all the rise in February and March and is today below the level of beginning of the year?
Here there are two answers, one economic and one technical. The first, and most important, tells us that China gave too much boost to its economy in the second half of 2016, enough to beat the plan targets. As always happens in these cases, some areas of its economy have run hot and have had to go from accelerator to brake in recent weeks. This has had an impact on the Shanghai stock exchange, but it must be said that the slowdown in progress will be short-lived, that the renminbi exchange rate is stable and under control and that the government will do everything possible and impossible to arrive at the congress in the autumn with a good level of growth and with calm financial markets.
As for flows, it should be remembered that the money arriving in this period from America and Europe does not end up with Chinese companies listed in Shanghai but with those (often the same ones) listed in Hong Kong, which in fact are rising in price. Despite the decline in Shanghai and the increase in Hong Kong, the latter share is still at a discount. This discount alone justifies further flows and further increases.
The fifth uncomfortable question concerns the new European political landscape, which arouses much hope in the markets. But why, one may ask, all this optimism about the ability of Macron and Merkel to succeed in reforming Europe, when Sarkozy-Merkel and Hollande-Merkel have not succeeded?
The answer is not certain, but there is no doubt that the Eurozone is currently in a more vigorous cyclical phase. This, combined with a greater German willingness to concede something (not much) may give Macron more room to cut public spending and liberalize the labor market. In any case, the biggest challenge for him will not be political but social. France is not accustomed to austerity.
Another question about Europe is why, with all this optimism, the euro has not been able to overcome the threshold of 1.10 against the dollar. Here the role of the ECB and its political will to maintain ultra-favourable monetary and exchange rate conditions until the end of the European electoral cycle is evident. Therefore, it will only be in 2018 that we will see a strengthening of the euro
