Time to Deliver

So rhetoric turns into reality.

2017 has so far been characterized by repeated rallies in risky assets – despite a background of political and policy uncertainty. These rallies have been ascribed to the “Trump trade”, with markets thought to be excited about the possibility for fiscal reform and infrastructure spending in the US. Most recently, the first round of the French presidential election has also helped. But this can only be part of the story. Markets are aware that fiscal spending could take time to ramp up and that US tax reform could be highly regressive.


Markets are also, I think, responding to a bigger belief that, nearly a decade into the financial crisis, the economic landscape is finally brightening. Some of the hard evidence for this is already there – in the form of Fed rate hikes and improving labor markets. Survey-based (soft) data on corporate and consumer intentions suggests that more upside is possible.


There is also a subtle change of psychology away from the “bad must be good” market responses that have often characterized the quantitative easing (QE) era. (The upside-down logic being that "bad" data is in fact “good” for markets as it increases the likelihood of further monetary policy intervention.) Markets are no longer completely in thrall to monetary policy: they are also looking for genuine opportunities.


This change is not without risks. Even after Fed rate hikes, developed market interest rates will remain low, leaving investors chasing yields. And, as we know, markets cannot themselves predict the future: they are opportunistic and will respond to trends both up and down. There is a sort of rational irrationality in play here, but it makes sense only over a short-term time horizon. Long-term sustainability is not central to the markets’ calculations. (A study of behavioral finance yields some useful insights here.)


It is also clear that government policy initiatives may not be honored. President Trump may find it difficult to pass infrastructure and tax reform proposals through Congress. Brexit-related discussions may prove unsettling. There remains a risk – although it is not our base case scenario – that European political developments could still derail European policy direction. And while we expect strong Chinese growth to continue, the country’s policymakers still have some very difficult tasks to handle.

What is important is that the appearance of forward motion is maintained for the next few months – and that evidence of economic improvement becomes more and more visible in corporate performance. The way this should happen is through a further improvement in earnings. But this will be a gradual process while policy reversals and disappointments could be more immediate and sudden.


This suggests that markets could still be choppy in the months to come, and that we are likely to be reminded that we still operate in an unstable policy environment. Many of the problems that have characterized the last decade are unresolved. Despite the Fed’s moves to raise rates, we still live in a very abnormal monetary policy environment, fiscal deficits remain a problem and social stresses remain: the concept of “inclusive growth” remains an elusive goal for most economies and governments. Market gains will not fix these problems on their own.


How should an individual investor operate in such an environment? I think that if markets are often characterized by rational irrationality, then an individual investor should aim to be an optimistic pessimist. They should be pessimistic about the likely end-point of market booms – never believing that “this time it’s different”, to borrow the famous Reinhart-Rogoff title. But they should be optimistic about possible wins along the way – and not just in terms of temporary market gains, but also longer-term opportunities, for example from technological change.


To do this will require a highly active and enquiring approach – able, for example, to identify differences between short-term market reversals and larger-scale, longer-term events and act accordingly. As the examples of Brexit and the Trump presidency make clear, anti-consensus views will need to be evaluated on the basis of their likely impact, not on whether or not you agree with them. You should not assume that the low volatility world will continue forever: in fact, volatility has already picked up in fixed income and FX markets. And you may need to force yourself into some rational irrationality on the future too: nearly a decade into the financial crisis, there is a danger that we are too accustomed to assessing things in terms of danger, not potential opportunity. There will be plenty of investment opportunities out there – ensure you take them.


Christian Nolting
Global Chief Investment Officer
Deutsche Bank Wealth Management

Source: CIO Insights, Q2 2017

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