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The Days Ahead:
Jobs report. Amazon will close Whole Foods on Monday.
It was a slow week for markets. No big economic news, reporting season over and no Fed speak. Most eyes were on the Jackson Hole speeches from Chairs Yellen and Draghi. Would they discuss monetary policy? They didn't. But they did move markets more by omitting any major policy changes. The Euro rallied hard and 10-Year Treasuries closed at their lowest level in over a month.
Yellen’s speech was interesting on another front. She compared the financial regulatory framework from pre-crisis to now. It's better and should make the system more secure. But the Fed still lacks many macroprudential tools that other financial regulators across the world use. These allow central banks to adjust things like loan-to-value, leverage and debt-to-income ratios on the fly and depending on the cycle. Meanwhile, there are moves afoot to pull back on many parts of the Dodd-Frank regulations. Call us worriers. But the mix of not enough tools and a deregulating financial services sector does not fill us with confidence.
1. Spanish Dancer:
We've talked a lot about the recovery in Europe. For years, investors had every reason to avoid the place. Europe suffered terribly in the economic crisis but, 10 years later, austerity policies and slow reforms are showing up in the numbers. Eurozone growth is now ahead of the U.S. German GDP is on track for around 2.3% growth this year. QE has certainly helped and the Euro’s strength has not yet hurt the German export machine.
Earlier in the week, we saw Q2 Spanish GDP. It looks like this:
Spain, along with Greece and the other painfully named PIIGS economies, lived through a disastrous real estate bubble compounded by a failure to address bank failures and bad loans. The shaded area shows the almost six-year recession where GDP fell over 10% and unemployment peaked at 27%. In the U.S., we had four quarters of decline and the worst year was a -2.8% decline in 2009. The latest numbers saw domestic consumption rise 2.2%. For us, this is a key number as ultimately it shows confidence returning. Spanish stocks are up 11% this year and up 25% for an unhedged U.S. investor. It’s a small market. You could buy the entire market for one Apple and a Facebook. It’s also heavily weighted to banks. But it's moving in the right direction and carries a yield of 3.7%. Patience should work.
In the U.K. meanwhile, the Brexit fallout is growing some teeth. Last week saw lower household spending, several profit warnings and higher import prices from weak sterling.
2. Debt Ceiling:
It’s a week closer and while we had some assuring words from Senate Majority Leader Mitch McConnell, other government branches seemed positively gleeful at the prospect of a shutdown. So far, the T-bill market has not reacted. But it’s worth recalling what happened in 2013, when there was a shutdown over Obamacare and 800,000 government employees furloughed. Here's how stocks and bonds reacted.
In the weeks up to the shutdown, the S&P 500 was down 4% and then recovered 9% in four weeks. Bonds both reacted and recovered earlier. In both cases, it was “risk on” once the impasse was over.
But that was then. This time, we’d argue that markets are taking one day at time. The news of tax cuts weighed more than the debt ceiling and Treasuries rallied on Friday after Janet Yellen’s speech. At this point, it seems nigh impossible to reconcile the House proposal to cut $200bn from Medicare with the Senate’s desire not to see any change in the deficit. Congress has only 12 working days to pass something when they return on September 5th. After that, the House and Senate swap weeks before they reconvene together on October 23rd. Expect a few weeks of wide swings in risk markets.
3. Emerging Markets check in:
It's been a few weeks since we discussed Emerging Markets equities. They have been this year’s clear winner, up 25% compared to S&P 500 of 9.3%.
Nothing big has happened in the last week. The Emerging Markets (EM) story is underpinned by steady growth in Japan (Asia weighs heavily in the index and exports to Japan), a slow rate increase in the U.S., which means EM central banks can keep rates low, and robust export growth. The wrinkle, of course, is trade negotiations - particularly NAFTA and Mexico. But on balance, we think EMs will stay well bid.
Stock and bond markets remain range bound. The 10-Year Treasury is only 6bps away from its 50-day moving average. In January it was more like 25bps. It all makes sense. There is little to go on and the market judges most of the politics a sideshow.
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All charts from Factset unless otherwise noted.