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Why Markets Are Rising Despite a Trade War, Brexit and Impeachment Threats

Posted by hkarner - 20. Oktober 2019

Date: 19-10-2019
Source: The Wall Street Journal

Many investors are watching the Fed while not trading geopolitical events

Some investors say they aren’t trading geopolitical events such as Brexit and the impeachment inquiry in the U.S.

The world seems more tumultuous than it has in years. Congress is weighing impeachment, the U.K. is on the verge of a momentous vote regarding its role in Europe, and the U.S. and China are still mired in a trade war.

Yet the S&P 500 is within about 2% of its all-time high. What’s going on with Wall Street?

For many money managers, the answer has a lot to do with the Federal Reserve. The central bank has already lowered interest rates twice this year and is widely expected to do so at least once more in 2019 to help support a slowing economy.

Bets that the Fed will step in if markets become too volatile or economic data continues to decline are helping many investors shrug off what they say are increasingly dire signals. Their rationale: If interest rates are lower, borrowing costs for businesses and consumers will drop, potentially giving the economic expansion more room to run even if trade policy and foreign affairs seem murky.

Many investors are also choosing not to try to trade geopolitical events that don’t have immediately obvious policy implications because they say it’s hard to quantify how events from the Hong Kong protests to the rise of nationalism in Europe will affect asset prices.

“We may have gotten to a point where investors ignore fundamentals because central banks will always step in with more stimulus and easy money when credit spreads widen or stocks fall,” said Torsten Slok, chief economist at Deutsche Bank Securities.

That has made for relatively muted moves in markets.

The S&P 500 closed down just 0.5% on Sept. 27 after a report that the White House was weighing limiting investment in China. It was down 0.8% on Sept. 24 when calls for President Trump’s impeachment gained momentum. Oil prices shot higher after an attack on a Saudi Arabian oil facility last month but returned to their previous levels in two weeks.

Markets also barely budged Wednesday when U.S. retail sales data for September came in much weaker than expected—though investor expectations of a rate cut rose by nearly 15 percentage points on the Chicago Mercantile Exchange that day.

Overall, the S&P 500 has moved an average of 0.8% each day going back to its July high, according to Dow Jones Market Data. The index is up 19% for 2019 but less than 5% from January 2018.

Sandy Villere, portfolio manager at the $2 billion Villere Balanced Fund, says expectations that more rate cuts are on the way have made it easier for him to stay invested in stocks. Mr. Villere said he believes the Fed’s support will limit the stock market’s declines to around 10%, and he’s keeping more cash than usual to bargain-hunt during market dips.

“When you see those chinks in the armor, you feel the Fed will be there even longer,” he said.

Part of the market’s resilience may stem from the fact that investors have already priced in many geopolitical risks, said Chris Verrone, a partner and head of technical & macro research at Strategas. For instance, last fall’s selloff sent the S&P 500 down nearly 20% in less than three months. That has made the market’s double-digit percentage gains in 2019 look more like a game of catch-up, rather than an unfounded rally.

“The market, I think, is saying all this bad news is already priced in,” Mr. Verrone said.

Market volatility may also be limited by the fact that many long-term asset managers say they aren’t trying to make swift bets on geopolitical events. Many have evolved so quickly that it’s best to stick to investing based on factors like long-term growth expectations and valuations, they say.

Back when the Brexit referendum and U.S. presidential election loomed in 2016, GAM Investments traded options in an attempt to benefit from rising market volatility. But it didn’t have much luck: “To be brutally honest, it didn’t work,” said Larry Hatheway, head of investment solutions at the Swiss asset manager. Now, the firm only owns stocks that it thinks will perform well regardless of how and when the U.K. leaves the European Union, Mr. Hatheway said.

Similarly, Ed Al-Hussainy, senior interest-rate and currency analyst at Columbia Threadneedle, said he has recently debated whether to buy the British pound, which has surged as a possible Brexit deal came into view. But he has left that trade on hold for now.

“The risk has always been that we walk into the wall and there’s a no-deal Brexit,” he said. “Why bother with these risks?”

Still, some firms have kept trying to find opportunities to profit from gyrations in geopolitical risk. In June, M·CAM International rolled out its Innovation Alpha Trade War exchange-traded fund, which includes large companies like Micron Technology Inc. and Nintendo Co. that it believes would have better-than-average protection from intellectual property disputes if the trade war worsened.

Hedge funds and other speculative investors have also tried playing geopolitics. This month, they’ve taken out bets on soybean futures rising as reports have suggested the U.S. and China were making progress on trade talks, according to data from the Commodity Futures Trading Commission.

And while wagering on a presidential election months before primary season can be treacherous, more money managers are adjusting their portfolios as the Democratic field takes shape and Elizabeth Warren emerges as a presidential front-runner.

If Sen. Warren wins the presidency, “we believe legislative focus would likely fall on money center banks and nonbank consumer lenders,” says Neal J. Wilson, co-chief executive of $7.6 billion hedge fund EJF Capital LLC in Arlington, Va.

That’s partly why Mr. Wilson’s firm continues to hold shares and debt of smaller community banks. He said he believes smaller banks will fare better than larger institutions if Ms. Warren or another Democratic candidate wins the election.

Still, those with longer time horizons caution that trying to make short-term bets off hypothetical scenarios is risky.

“Investors are trading on a hope for some sort of lasting trade peace, which after 18 months, appears to be elusive,” said Alexis Crow, who leads PricewaterhouseCoopers’s geopolitical investing practice.

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