Among the ranks of asset classes, equities are usually the last to leave a market party. Now, as the music fades, US and global investors face a dilemma. Some might well buy the dip in stock prices, buoyed by a first-quarter rebound in revenue and profit growth for companies. Others will probably reconsider their faith in Trumpflation as political risk, with Brazil joining the fray yesterday, has taken centre stage when there are cracks in the global growth story.
The bottom line for investors is that the chaos engulfing the US administration significantly reduces the prospect of Donald Trump implementing sweeping tax cuts, deregulation and infrastructure spending that propel the economy into a much higher gear.
Disturbingly, this reset in US fiscal expectations comes when that other prime engine of global growth, China, has been clamping down on excess credit, triggering interbank lending stress. Sliding commodity prices signal expectations that China’s economy is easing after a six-month spurt through to the end of March.
Together, the loss of momentum from the US and China entails a potentially tougher macroeconomic environment for global equity, credit and emerging markets this summer. With investors in Brazil, one of this year’s popular EM destinations, suddenly being punished, the risk of a broader pullback in risk appetite beckons. In such an environment, investors tend to sell their winners to help cover losses from sinking leveraged carry trades.
In this light even Europe, a big beneficiary of investor flows and a region that has outperformed the US this year, looks vulnerable — and that’s before the pain of a stronger euro putting pressure on corporate earnings.
John Brady at futures brokerage RJ O’Brien says buyers of the dip will emerge, given the large amount of cash on the sidelines. “If equities go on sale for certain sectors like tech, investors will put money to work,” he says.
Beyond short-term political noise, the risk of global reflation ebbing means that the days of high-flying equity benchmarks and slumbering volatility look dated. After a rollicking ride since November, even those buying the dip will want to see robust macroeconomic data before they resume pushing equity valuations ever higher.