Monday Digest
Posted 18 November 2024
Reading Trump’s tea leaves
Stocks were up and down last week. Investors bought into Donald Trump’s tax cut and deregulation agenda, then soured on Federal Reserve chair Jay Powell’s suggestion that interest rate cuts might be gradual. It was hoped that Trump would boost profit growth while the Fed would keep cutting, but Powell warned that the central bank isn’t “in a hurry” to slash rates. The data justifies this, but it was a bold statement ahead of what many expect to be a politically volatile Trump presidency, and sets up a fight over Fed independence. That pushed US bond yields to 4.5% and hurt stocks on Friday.
Tariffs and deportations are also on Trump’s docket, which markets traditionally dislike but are currently seen as worse for non-US regions – thereby reinforcing markets’ belief in US exceptionalism.
We have argued that Trump’s tax cuts will worsen US debt, as can be seen in the widening gap between US treasury yields and interbank swap rates. Interestingly, this measure of government debt risk has increased in Europe too. We suspect this is because markets think Trump tariffs will force European governments to spend more. UK bonds, meanwhile, have improved – especially after Rachel Reeves’ well received Mansion House speech. She suggested that pension funds could invest in private companies, which would support growth. Notably, the difference between US and UK bonds decreased last week.
We worry that parts of the Trump trade narrative don’t hang together. Markets expect growth, but comparatively little change to rate cuts; they think tariffs will hurt non-US regions, but that other governments won’t retaliate enough to hurt US growth. We think China will be more likely to respond with its own tariffs or by withholding key exports (China dominates global cobalt production) during Trump’s second term, for example. The pro-US story makes sense, but Trump’s effect on global markets is more uncertain than investors seem to realise. Company data releases – like Nvidia’s earnings report this coming week – will be crucial to watch.
Politics fogs European markets
Europe is in a tough spot. Germany and France look economically weak and politically unstable – after Macron’s electoral defeat in the summer and Germany’s governmental collapse last week. German Chancellor Scholz is likely to lose January’s election, and the (unlikely) risk is that the far-right AfD gains enough to enter a coalition. Germany’s export-led economy is squeezed on the one side by higher energy prices and on the other by a global manufacturing recession that was made in China. Trump’s likely tariffs on European goods will compound the problem, so his victory was seen as a hammer blow for European assets. Meanwhile, European governments seem too weak to address the growth problems.
The ECB is expected to cut interest rates more sharply in response, but investors see little upside from this steeper rate path. Stocks are valued much cheaper in Europe than the US, which, together with lower rates, should make European stocks more attractive. But for that to turn around European equities, investors need to see some positivity around growth, which they can’t right now.
We think there are signs of hope ahead. China is now stimulating its demand, which will likely benefit European exporters, and a cessation of Ukrainian hostilities (one way or the other) would loosen the energy squeeze. Europe isn’t just Germany and France either: combined, Greece, Italy, Portugal and Spain equal German GDP, and growth in that region has been much better than the north.
This a reversal of the classic pre-pandemic problem, when Germany powered ahead and the southern periphery faltered. Critics have long suggested that Germany’s fiscal prudence has been to the detriment of the Eurozone overall, but now Germany is likely to loosen fiscal policy while southern Europe is in a relatively stronger position. Europe’s economic problems are undeniable, but markets are arguably ignoring potential opportunities.
The crypto-president
Cryptocurrencies are surging after Donald Trump’s election win. Binance’s CEO thinks the president-elect will usher in a “golden era” for the sector, after four years of hostility from the Biden administration. Crypto enthusiast Elon Musk will head up a new “department of government efficiency” – nicknamed “DOGE” in a not-so-subtle signal to traders of Musk’s favourite memecoin dogecoin. ‘Meme-ification’ should make long-term investors wary of crypto. Dogecoin, for example, has a history of swinging up or down based on Musk’s actions, and it isn’t clear why naming a department after the currency should alter its fundamental value.
It’s not just speculators that are buying crypto, though. Institutional investors are more accepting of crypto because of expected regulatory tailwinds. Our argument against is more nuanced: it’s not that cryptocurrencies won’t go up, but that we have no way of judging their underlying value in a way that is consistent with other assets in a sustainable investment portfolio. Maybe we just need a new way of valuing them, but even if we could it would be hard to reconcile this with valuation metrics for traditional assets.
You could get exposure to an expected crypto boom through shares in exchanges or Bitcoin miners, but we worry that newer, unregulated industries are often playgrounds for bad actors who want to disguise their leverage (as we already saw with the fraudulent crypto exchange FTX). That being said, the underlying technologies can still benefit economies more broadly, and at the moment these technologies are being funded by crypto traders. Trump’s crypto push could therefore boost long-term productivity, but we worry it could also pose risks to the financial system that are hard to gauge. Crypto’s “golden era” will have far-reaching implications that all investors should consider, even if they are not directly invested in cryptocurrencies.