A correction is normally defined as a fall of between 10% and 20%, January's downturn just qualifies with the S&P falling by 10.1%. The adage that markets head higher on the escalator and come down in the elevator could scarcely be more apt. Note that the S&P 500 is leading the global rebound from February's lows and already the tech sector is breaking new ground.
This stumble took us back only to where we were in the autumn and it has done little more than blow off the market froth that had developed over recent weeks. If global markets begin to run again (as we suspect they might) this episode will quickly be forgotten. The catalyst for the fall was the US Treasury market where yields had surged 45 bps over the first six weeks of the year. They have since stabilised. One board member of the Federal Reserve described this episode as "small potatoes". We absolutely concur and fear that it is only a taster of might be to come.
The near term economic outlook remains favourable and a lack of growth is no longer an issue. The OECD indicates that the 45 largest economies are now all growing; this is something not seen in over a decade. Confidence abounds in consumers, businesses and investors. This makes markets vulnerable to swings in sentiment and the biggest risk to this lies with central banks. However, political risks are also on the rise.
Up to now, markets have benefited from Trump's unorthodox policies, but a tax cut of this magnitude has left a gaping hole in the public finances. The US deficit is forecast to approach 6% by 2020, this is nuts at this stage in the cycle. Merkel has forged a coalition with the SPD thanks to an additional spending agreement worth €46bn, or the equivalent 1.2% of GDP in an economy that is already running hot. German unemployment at 5.5% is the lowest level since unification, a number made more astonishing by the huge influx of migrants from within and outwith the EU.
The secular disinflation of the last 30 years has come about in part by the freeing up of goods and labour around the world. This trend was already coming to an end and could even go into reverse if an out-and-out trade war breaks out. The change in the secular trend could coincide with an inflection of the business cycle as spare capacity runs dry. We should also not forget that governments have spent ten years printing debt. OECD debt has gone from $25tr to $45tr since 2008 despite being in the supposed 'good bit' of the cycle. Bond markets reaction to this have been bizarrely muted given the diabolical risk to valuations.
We are through the dangerous part of the European election cycle, although the anti-euro undercurrent has not entirely gone away. Meanwhile, Macron is delivering reform, spare capacity is abundant and private debt levels are tolerable. Blemishes remain but the dynamics are clearly improving and we lift our equity guidance to the region by a notch.
Turning to the UK, everyone seems to have a Brexit proposal though sadly none of them work. This appears an intractable problem. Brexiteer's believe that the EU won't risk economic damage for political reasons. At the same stroke, they are more than happy for the UK to risk suffering far greater economic damage for their own political beliefs. Their lack of logic is breath taking and dangerous.
The EU has little choice in its stance, if it wavers it imperils the entire fabric of what they have achieved so far. May's vaunted red lines paint her into a narrow corridor. With May's party so fractured and her majority so thin, strong leadership is required. We have seen in recent days how tough she can be, as she expels 23 Russian diplomats and denies official representation at the World Cup following the attack in Salisbury. The Kremlin must be quaking.
History has taught us that investors flock towards perceived secure gains and become increasingly corralled into a smaller space at the tail end of a bull market. On this occasion, the US tech firms are the stocks escaping gravity. Perversely, these long duration stocks are arguably the ones most vulnerable to a rise in interest rates. We can see how this is going to end, the question remains when? Not now. Earnings, sentiment and confidence are all on a tear.
Much seems to have happened over the quarter but I'm coming around to the view that little has changed. Momentum in the headline indices seems to have been stalled but it remains alive. The MSCI World Momentum style index is up by 5.7% YTD, a staggering result when the MSCI World index has just undergone a material reversal and is unchanged for the year. Trump's cavalier attitude to trade has always been a worry and this is a threat that may grow as we approach the mid-term elections. Our most significant concern, however, remains the interest rate outlook and the potential hit that this could bring to demanding market valuations.
Currently rated by 5 people