As much as we would prefer to discuss market fundamentals over the trials and tribulations of the current US Administration, it has been largely unavoidable in this first quarter of 2018.
The market narrative changed abruptly over the quarter, from observing the “melt up” in January with exceptionally low volatility, to a massive spike in volatility in early February with markets remaining on edge ever since. What happened?
Markets continue to come to terms with the return of higher volatility, triggered ostensibly by fears of inflation and the unwinding of highly leveraged short volatility positions at the beginning of last month. To this list we can now also add the spectre of increasing protectionism and outright Trade Wars.
In our 2018 outlook, we made the case for rising volatility as central banks across the developed world slowly remove the stimulus punch bowl, but few would have imagined volatility spiking with such a vengeance as it did in recent weeks.
Over the past few years, one of the main risks that concerned our team was the possibility that asset classes could become positively correlated. In 2017, we saw the positive correlation story start to play out in the best possible way, with strong positive returns across the board.
The Trump reflation trade may have lost some of its shine during the quarter, but any disappointment was more than overshadowed by strong global data as exports and production continued to gather pace. In fact, fading enthusiasm for Trump’s ability to execute has arguably served as a tailwind for Emerging Market (EM) assets in the form of a weaker dollar and moderating long term rates.
With President Trump announcing that he will be releasing his tax plans in the coming weeks, we have shifted to a more cautious position on US duration. The risk is that President Trump announces a sizeable stimulus package, with the backing of the broad Republican base. This would raise fears that the US Federal Reserve would need to act more quickly than expected, and with markets only pricing in two or three rate hikes in 2017, we believe that markets are under-pricing the risks of this announcement.
Donald Trump winning the US presidential election delivered a big surprise, defying poll predictions but ringing consistent with the wave of populism sweeping the developed world. First witnessed early last summer with the Brexit vote, the rise of populism remains a key risk in Europe, while the implications for the shift in US policy are more likely to be mixed.
2016 may best be remembered as the year in which Trump won and the world changed. The question becomes which reforms will take centre stage.
Emerging markets (EM) have endured strong adjustments in commodities and currencies that coupled with reforms makes a good case for better growth ahead. Still, it will take time for EM to navigate to more stable sources of growth, requiring relative stability through the delicate transition.
The UK's late June vote in favour of 'Brexit' was initially read as a deep negative, particularly given that markets were priced strongly in favour of a 'Remain' vote. However, after brief reflection, markets outside the region saw a rally, with risk asset performance more than making up for Brexit losses. Emerging markets have been a primary beneficiary...
2016 began in complete panic, with risk assets including emerging markets selling off deeply through the first few weeks of the year. This was then followed by the strongest rally since 2012.
In early 2016, hedge fund Nevsky Capital decided to call it quits after 15 years of successful asset management. One of the reasons for the closure is that since the global financial crisis, emerging markets are breaking away from the transparent 'Washington Concensus' model.