Is a financial crisis on the cards?
• Markets have shrugged off the Trump presidency, but some analysts fear a crash is looming
Last year, Jim Rogers, who founded the Quantum Fund with George Soros, warned that “A $68trillion ‘biblical’ collapse is poised to wipe out millions of Americans”.
Mark Faber told CNBC “investors are on the Titanic” and stocks are about to “endure a gut-wrenching drop that would rival the greatest crashes in stock market history”.
Andrew Smithers warned “US stocks are now about 80% overvalued … the only time in history they were this risky was 1929 and 1999”. Even the Royal Bank of Scotland told their clients to “sell everything” because “in a crowded hall, the exit doors are small”.
So far, these dire predictions have proven to be wrong — spectacularly wrong. After President Donald Trump’s speech to Congress last week, the Dow broke through 21,000. It cleared 20,000 three weeks ago, making this the fastest rise between 1,000 milestones since 1999. The Trump presidency, it seems, can do no wrong on Wall Street. Travel ban troubles? Who cares? Russian revelations? Nah. Staffing woes? So what? Stocks continue to shrug it all off and rocket to new highs on the promise of big tax cuts, infrastructure spending and mass deregulation.
That said, some analysts are worried the Trumphoria is turning sour. “Ever so slowly, Wall Street is being shaken from the trance of Trump’s promises of deregulation and tax reform,” says Lynette Lopez at Business Insider. “As this happens, an industry known for sharing notes and trading tips is starting to worry that it may be working off of the wrong playbook.”
The things that are rattling Masters of the Universe are varied. Baupost’s Seth Klarman is worried about Trump’s tax cuts and spending plan. He’s also, along with Bridgewater’s Ray Dalio, scared of populism and trade wars. Greenlight Capital’s David Einhorn is worried about inflation and Elliott Management’s Paul Singer worries that the market has become complacent. “The market is completely wrong,” says Douglas Kass of Seabreeze Partners. “The fiscal path and regulatory reforms coming out of Washington and the new administration are likely to provide a lesser and later contribution to economic and profit growth than the consensus expects.”
Analysts at Credit Suisse agree. “On current 2018 expectations, US stocks still look highly overvalued,” they say.
The real problem though, as Credit Suisse and Business Insider see it, is that the US markets appear to be simply trading on Trump’s performance right now. “It seems as if Wall Street has given up the difficult work of picking stocks and making models, of calling experts and building theories,” says Lopez.
“Instead, it is allowing the market to try to figure out whether the president can handle his job. As a result, 10-year Treasury yields, the dollar, crude oil and [most] stocks are correlated to Trump’s favourability.
“This is a delicate state, to say the least. The people in the US don’t like it when their president is rattled and we know it doesn’t take much to rattle Trump – a skit on Saturday Night Live, poor sales at his daughter’s company, it could be just about anything. And you don’t want to be in a stock market that can move on just about anything,” Lopez says.
“The effect Trump is having on capital markets is the first thing clients want to talk about. For many, it is the only thing,” Nicholas Colas, chief market strategist at Convergex, told MarketWatch. So, why is the CBOE Volatility index (VIX), Wall Street’s fear gauge, hovering around historic lows? The VIX measures the implied volatility of S&P 500 index options over a 30-day period in the future.
In other words, as MarketWatch says, “it isn’t about current levels of fear but about the market’s wager on how far the S&P 500 could move over the next month. Low levels in the fear gauge usually coincide with rising equities, which is currently the case.”
Since share prices often fall faster than they rise, a low VIX implies that more investors are expecting prices to extend gains, which means an unexpected shift in sentiment spurred by a market surprise could catch investors off guard.
However, Colas thinks 1968 offers a good proxy for the current situation. “Despite wideranging political tumult at the height of the Vietnam War,” he says, “the S&P 500 generated a return of roughly 11%. Back then, the biggest drivers of the market were corporate earnings and interest rates. Which is all the market really ever cares about.”
Still, fears that the VIX could suddenly spike can’t be ruled out. Colas believes the current level of the VIX is anchored to everything we knew before the election and about the fourthquarter corporate results. “[Therefore] a new event could scare up implied volatility.”
INVESTMENT GAINS
Warren Buffett released his closely watched annual letter last Saturday, in which he told investors that Berkshire Hathaway’s investment gains would continue to be “substantial” in the coming years and the US economy would continue its “miraculous” boom. The conglomerate’s net earnings rose to $6.29bn in the fourth quarter of 2016, up from $5.48bn in the prior comparable period.
Investors parse the document for Buffett’s insights into specific sectors, in addition to his thoughts on the economy.
“Our expectation is that investment gains will continue to be substantial — though totally random as to timing — and that these will supply significant funds for business purchases,” says Buffett. “American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle. Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism.
“Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media.
“Meg McConnell of the New York Fed aptly described the reality of panics, ‘We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.’ During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively financed American businesses will almost certainly do well.”
THE EFFECT TRUMP IS HAVING ON CAPITAL MARKETS IS THE FIRST THING CLIENTS WANT TO TALK ABOUT. FOR MANY, IT IS THE ONLY THING