Trade disputes are monopolising investor and media attention, with tough talk unlikely to abate before the US mid-term elections. But what if the more serious issues for financial markets were actually mounting inflationary pressures in the US and failing political unity in Europe?
European political waters were supposed to be calmer this year, after the many electoral hurdles of 2017. But investors’ nerves were tested again in late May with the ousting of the Spanish Prime Minister (leaving his successor at the helm of a very fragmented parliament) and complicated negotiations with respect to the formation of a populist government in Italy.
An important milestone was reached on April 24, when the US Treasury 10-year yield topped 3%, threatening to undermine the form of “equilibrium” that equity markets had settled into during the past few months.
Ten years have gone by since the Great Financial Crisis. The sequence of events that unfolded during this decade has profoundly transformed the world – not only for investors but for society at large. Democracy and free trade are under attack, technocrats have become very powerful, international institutions are unable to fulfil their historical role, and « peace for our time » is no longer assured.
As we step into 2018, there is little question as to the direction of the global economy – barring an unexpected external shock. For the first time since the Great Financial Crisis, the OECD in aggregate is operating above potential, thanks to years of easy monetary conditions and the ending of fiscal austerity. Momentum appears to be particularly strong in corporate investment spending, with the compromise on tax cuts signed last month by the US Senate and House of Representatives only to add fuel.
As 2017 wraps up, investors’ quest for return is becoming ever more desperate. The money flooding to private equity and venture capital funds is mind-boggling, as are the valuations at which some managers in these spaces are making transactions. Paying up to a hundred times sales for a recently-founded unprofitable company cannot in our view be called investing – rather it is a gamble. «But hey», even sophisticated investors are saying, forgetting prior discipline about double-digit portfolio internal return rates, «perhaps this one company will be the next Google?»
Complacency rules in this “Goldilocks” environment of improving global activity with no flare-up (so far) of inflationary pressures. The investor mantra is that markets are expensive but no severe correction is to be expected in the near future, thanks to never-failing central bank support.
We begin this letter on what might seem an incongruous note for a financial publication: the end of the ban on women driving in Saudi Arabia. We are even tempted to paraphrase Neil Armstrong, considering it “one small step for Saudi women, one giant leap for Saudi Arabia”. Yes, we view this development as momentous, in so far as it underlines the speed at which the Kingdom of Saudi Arabia (KSA) is evolving under the influence of the young Crown Prince. A more acceptable form of society to “developed world” eyes will allow the KSA greater support from Western countries. Ties with US have already grown noticeably stronger during the past year.
The month of August was certainly noisy, with Hurricane Harvey and escalating North Korean military provocations dominating the headlines. Such commotion should, however, not detract investors from what we consider to be the crucial longer-term development: the normalisation of monetary policy – assuming of course that a dire scenario will be avoided in North Korea.