Disconcerted complacency

07 Aug 2017

  • While the catalyst for a sustained change in sentiment can be difficult to predict, several risk factors may disrupt markets during the remainder of this year.
  • The global economy appears to have entered a synchronized expansion
  • Despite rising exogenous risks, markets appear to be prodding along on a steady upward trajectory

Doldrums have arrived as we enter the final weeks of summer. However, those that followed the old seasonal adage of “sell in May and go away…” may have missed an atypical seasonal rally in risky assets. Have we become too complacent? Are we missing something? What challenges are looming around the corner? While the catalyst for a sustained change in sentiment can be difficult to predict, several risk factors may disrupt markets during the remainder of this year. These risks can be broadly categorized in three groups: politics, geopolitics and economic.

Chaos in Trump administration continues to drive headlines and this week was no exception. The reshuffling of cabinet positions has led to another dismissal in the oval office. White House communications director Anthony Scaramucci was fired after just ten days in the role in response to inappropriate comments made which exceeded the boundaries of social decorum. Distractions within the administration continue to severely limit the potential for legislative success. With congress departing for August recess, healthcare reform has been put on hold for the foreseeable future. The next item on the triage list is an increase in the debt ceiling which will dominate the agenda in September. With just a few weeks before the mid-term elections, political gerrymandering will be prominently displayed in the media. Admittedly, the risk of a government shutdown should be taken seriously, but as in previous iterations, a “save the day” agreement is likely to be made at the eleventh hour.

New developments in the geopolitical environment are far more concerning. The diplomatic discourse with North Korea was taken to a new level this week as the US military proudly displayed their intercontinental ballistic missile capabilities with a test launch across the Pacific Ocean. Not to be left out, Congress passed a new sanctions bill on Russia largely in response to suspected election meddling which was subsequently signed into law by President Trump later in the week. The bill, which included additional sanctions on both Iran and North Korea, related to the nuclear ambitions of both countries, served to disrupt any hope of improving US-Russian relations, another strike to the Trump platform. The deterioration of international relations has been a troubling theme for the last year and may pose increased risk to markets in the coming year.

In contrast to politics, economic conditions are less dire with low perceived risk of a near term US recession. The global economy appears to have entered a synchronized expansion with several economies in the mid to late cycle stages. We are comforted by the fact that weak growth generally leads to long cycles and that, with inflation remaining below target, monetary policy makers are unlikely to remove stimulus very quickly. Current economic conditions continue to support corporate profit growth lifting both revenues and earnings across the globe. The US consumer has benefitted from a steadily improving labor market which has the potential to drive spending patterns in the coming year. Nonetheless, the combination of a maturing economic cycle and a shift to tighter monetary policy may introduce more volatility in markets going forward.

Despite rising exogenous risks, markets appear to be prodding along on a steady upward trajectory. The Dow Jones Industrials breached 22,000 on Friday, after the Bureau of Labor Statistics reported an increase of 200,000+ jobs and a corresponding decrease in the US unemployment rate to 4.3%. The modest increase in wages should support improvements in consumer spending patterns though are unlikely to drive inflation appreciably higher in the near term. While current conditions should restrain monetary policy makers, the source of market risk may lie elsewhere.

Download to read more