Horror Show

by | July 27, 2020

In horror movies, an incongruous, dissonant sound frequently alerts the audience that danger lurks. A rustling in the bushes or a tapping on the wall. Or the return of a musical score—an audio reminder of when things might go horribly wrong.

Yet directors must keep movie-watchers guessing. Sometimes, therefore, ominous tones betray comic relief. The audience is teased. Relief follows tension. But the grisly scenes have only been postponed, their terror magnified by the manipulation of human emotion.

Investing is not, statistically speaking, a horror show. Over time, diversified portfolios reward savers. But at discrete intervals, it can be useful to keep an ear out for dissonance –  important information can be discerned.

Oddities popped up last week. Equity markets dipped, despite much better-than-expected European economic survey data, an historic agreement on European debt mutualization and common fiscal stimulus, and mostly positive US Q2 earnings surprises. Puzzlingly, high beta, cyclical, small capitalization and value stocks outperformed despite the broader market decline. The dollar evidenced none of its traditional safe-haven attributes, dropping nearly 2% against the euro. Gold continued its powerful rally, topping $1,900 per ounce. Silver also rallied strongly. Meanwhile, large capitalization information technology stocks, momentum and growth strategies—the bulwarks of the bull market—underperformed.

To be sure, some of last week’s moves made sense. Risk premiums on Eurozone sovereign debt (e.g., Italian BTPs) collapsed on news of the fiscal deal. As noted, the euro extended its gains. A weak dollar keyed gold’s surge. Yet, dissonance also reverberated. Better-than-expected economic and policy news failed to lift equity markets. Rotation commenced in a falling market. High beta outperformed as the index declined.

Market peculiarities warrant close attention today because the fundamental backdrop remains precarious. Pandemic control is a genuine concern, above all in the US where public adherence to best practice is spotty. Renewed flare ups in areas that seemed under control, like Spain and even Germany, along with wildfire-like growth in Brazil, Mexico, India, Russia, parts of the African continent and numerous other countries are a reminder that Covid-19 remains a genuine threat to human health and economic welfare everywhere. From the narrower perspective of corporate profitability, better-than-expected results are, in many cases, not good results. To wit, the consensus of analyst’s expectations is for US Q2 profits to fall some 40% from year-ago levels.

The appearance of market dissonance against a still-fragile fundamental backdrop means that this week’s key policy and earnings developments assume even greater importance. Investors should focus carefully on three developments this coming week.

The first and most economically significant will be Congressional wrangling over the extension of fiscal relief measures. Republicans have dropped President Trump’s insistence on a payroll tax cut, appear willing to repeat direct transfers to qualifying Americans (i.e., checks of up to $1,200), and to pay for more pandemic preparedness and healthcare provision. But they are balking at extending the expanded unemployment benefits of the CARES Act. Their latest package, worth about $1 trillion, also falls well shy of the Democrats’ $3.5 trillion proposal. Investors are keenly interested in whether Washington can avoid a ‘cliff’ outcome, where drawn-out negotiations leave financially vulnerable Americans unable to meet short-term obligations, in particular for rents, mortgages and auto-financings.

The Fed’s policy announcement and Chairman Powell’s press conference on Wednesday will also be a highlight. In words and deeds, the Fed has already committed to doing its utmost. Investors will therefore scrutinize this week’s Fed statements for signs the central bank will use forward guidance to push down long-term interest rates. If so, the euro and gold will benefit. Investors are less interested in the confirmation process of Judy Shelton, provided that public opinion polls do not shift in favor of Trump’s re-election. For all the concerns about Shelton, there is little one Fed governor can do on her own.

Finally, Thursday will be ‘triple-A’ day: Alphabet, Amazon and Apple announce Q2 earnings. Expectations are running particularly high for Amazon, given the pandemic boost to online shopping in Q2. Concerns about business advertising revenues or deteriorating US-China relations could cast a pall over the outlooks for Alphabet and Apple, respectively. If mega-capitalization technology stocks can’t beat lofty market expectations, markets will face perhaps their most critical test. Will investors be willing to rotate to more economically sensitive small capitalization, cyclical and value stocks in the face of a still un-contained pandemic and before knowing how much US fiscal stimulus is forthcoming, or will markets have to give back some of their torrid gains since April?

Tap-tap, rustle-rustle, the stringed instruments take up the foreboding tune. McConnell, Pelosi, Powell and a cast of A-listers take their marks. The audience senses something’s afoot. Comedic relief or gruesome display? Who knows, but it might be a good time to hit the pause button and load up on popcorn.

Filed Under: Economics

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland. From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT. At both GAM Investments and UBS Investment Bank Larry was widely recognised for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others. Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides commentary and analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior business leader with two decades of experience growing and transforming businesses in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank. Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard. Friedman served as a White House Fellow in the Clinton administration and as an assistant to the Secretary of Defense. He is a member of the Council on Foreign Relations and the Chairman of the Advisory Board of Project Syndicate, the non-profit opinion page that provides world-class commentary to over 500 newspapers globally. In addition, he is a board member of the American Alpine Club and the Jackson Hole Community Housing Trust, and has served on the boards of the Gates-Cambridge Trust, the Seattle Art Museum, and a number of other non-profits. Friedman is a regular contributor to several newspapers and thought leadership groups and has published numerous opinion editorials on topics including economics, finance, philanthropy, and politics in Project Syndicate, Bloomberg, The Wall Street Journal, The Financial Times, The Guardian, CNBC, The South China Morning Post, The Chronicle of Philanthropy, and other news outlets. He is also the author of Babu’s Bindi, and The Big Thing, both children’s book. An avid mountaineer and rock climber for 30 years, Friedman has climbed some of the world’s highest mountains and led the first major climb to raise money for charity through an ascent of Mt. McKinley. He holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

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