Uncertainty looms over Q3 2016 and beyond, but this isn’t necessarily a negative. If uncertainty is met by reforms and improvements, the present risk events could appear in hindsight as harbingers of positive change. Trading in Q3 will be about navigating the increased volatility, understanding how the social contract will create more political changes, and accepting that the world economy is renewing its flirtation with recession. The chances of a recession in the US are at least 60% as key leading indicators like the Conference Board Leading Indicators, and the Fed’s Labor Market Index continue to trend down. The asset allocation of choice has been overweight fixed income, but with the dramatic moves this quarter I’m going back to neutral weighting, and I’m slowly increasing my equity exposure from significant underweight towards neutral by the end of the year. View full article for my Essential Trades, including the main themes.
Looking into the balance of this year, it’s safe to say that uncertainty looms large. The Brexit vote, of course, makes sure we will take the fast track to facing the issues which in my opinion would have surfaced anyway
I think the analogy is similar to when you line up for the security check at the airport. There are two lines: ‘fast track’ and ‘coach’. The fast track line will get you to the gate faster, but remember – we ultimately all need to board the same plane and we will arrive at the same time.
That’s the global economy.
The main macro priority remains creating enough excess liquidity to service existing debt. It’s estimated that 75% of all quantitative easing is used to maintain and service the debt mountain created since the start of the financial crisis. Debt has grown by $60 trillion since 2007 and remains the biggest drag on our ability to create growth and productivity.
Personally, I am not too concerned about the Brexit as prior crises have taught me that these types of events often leads to real changes, and sometimes real reforms. Following the European Exchange Rate Mechanism crisis in 1992, UK growth and employment rose significantly. Among the UK’s economic issues, however, remains its twin deficit; the last time UK ran a current account surplus was in 1982.
That was the year when Italy won the World Cup in football with Paolo Rossi as the top score...ancient history.
The fact is that with or without the Brexit, the UK needed to change. So, in fact, do the EU, the US, China, and most emerging markets. The debt-driven cycle has reached its peak and the social contract is being remade through voters’ strong bias against the elitist political system.
The US election will soon become the main macro event when the post-Brexit political mess clears or stabilises. For the record, I think Donald Trump will do much better than polls presently indicate. This is not due to his policies but because he represents the anti-establishment faction.
I will wager that anyone – and I mean literally anyone – who is anti-establishment will be electable anywhere there is an election, as the voters have had enough of false promises of growth and better days ahead.
The economic policy of buying more time has simply failed and we are now reduced to dealing with a reality that no one likes or even understands. Least of all the politicians and central bankers who continue to hold on to their policies as if they were educated by Comical Ali, the former Iraqi information minister from 2003.
Trading the markets in Q3 will be about navigating the increased volatility, understanding how the social contract will create more political changes, and accepting that the world economy – including the US – is about to renew its flirtation with recession.
The chances of a recession in the US are at least 60% as key leading indicators like the Conference Board Leading Indicators and the Fed’s own Labor Market Index continue to trend down hard. This, of course, combines with external factors like the Brexit, a Europe where the leading indicator (Eurocoin) is making new recent lows, and a China that is desperately trying to keep growth from falling.
We will see Japan act one more time and I would not be surprised to see a fiscal expansion of 2% following the July Diet election combined with more monetary policy easing. I doubt any of that will move the needle on Japan’s medium- and long-term growth rates, but it could create new “hope”’.
To me, the asset allocation of choice has been overweight fixed income, but with the dramatic moves this quarter I am now going back to neutral weighting and I am slowly increasing my equity exposure from big underweight towards neutral by the end of the year.
The main themes will be Brexit, the US election, Japanese fiscal expansion, how the EU deals with UK leaving but also the ever-present immigration crisis, and a Fed that will soon be more likely to cut rates than raise them.
The uncertainty will increase the chances of macro intervention. The real need is for reforms – the mandate for “fast track” change I have constantly revisited over the past five years.
The good news is that the next six to 12 months will see a move towards this mandate for change. The bad news is that it will come with more volatility and more uncertainty.
When all is said and done, I think we will see the Brexit as a catalyst for positive change. We may all have to board the same plane and get there at the same time, but using the fast track does give you more flexibility to read, prepare and react.
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