Earlier today, we brought you “Epic Struggle Emerges At Citi As Stock Bulls Battle Matt King’s Bearish Credit Juggernaut,” in which we lightheartedly presented excerpts from Citi’s latest Global Asset Allocation piece.
As it happens, Citi’s equities team doesn’t agree with Citi’s credit team. The equity folks are bullish and the credit folks are bearish and well, you know what they say about who’s usually right when equity and credit disagree.
The bullish equities thesis rests on this notion of a global economic renaissance. “The cornerstone of the equity argument presented by Robert Buckland and team revolves around the idea that we are seeing ‘synchronized growth,'” Citi writes, summarizing the house view on stocks.
Part and parcel of this view however is the idea that growth is just strong enough to justify optimism and inflation is just subdued enough to keep central banks from getting too aggressive on the long road to normalizing policy. This is, to quote many an equity bull, a “Goldilocks” scenario.
Of course there’s some irony in that, because the people who make that argument are very often the same people who dismiss the notion that a weaker central bank liquidity impulse will ultimately pull the rug from beneath risk assets.
Those folks can’t have it both ways. That is, you can’t base part of your bullish outlook on the idea that because inflation is low and central banks are thereby hesitant to roll back accommodation, risk will remain supported, and then turn around and say that central banks tapping the brakes won’t undercut those same risk assets. If you try to do that, you’re effectively arguing with yourself. Either central banks staying in the game is important or it’s not.
Further, there’s a myth floating around out there that volatility is low because the macro backdrop is more benign than it’s been in some time.
That seems patently absurd to me. And I’m hardly alone.
Indeed there’s a (strong) argument to be made that it would be difficult to dream up a more tenuous geopolitical and policy environment if you tried.
Imagine going back in time a decade and describing the current situation to someone. Here’s what you’d have to say: Donald Trump is the President of the United States, he’s being investigated for obstructing an investigation into whether his administration colluded with the Russians to rig the election, Syria is mired in a horrific six-year-old civil war that’s created a massive refugee crisis, European capitals are the targets of regular terrorist attacks, North Korea is launching a ballistic missile every three or so weeks, the UK is exiting the European Union, France damn near elected a Le Pen as President, Saudi Arabia has essentially destroyed Yemen and is now engaged in a push to ostracize Qatar, Erdogan has for all intents and purposes declared himself Sultan in Turkey, Greece is basically a vassal state, China is trying to unwind a shadow banking system that no one understands, and Brazil is mired in yet another corruption scandal less than two years after the country nearly fell completely apart amid a related corruption scandal that brought down the President.
So “no,” I would not say that qualifies as a particularly “benign” macro environment.
But Barclays doesn’t agree. Specifically, the bank imagines that “global political risks are much lower, for the first time in more than a year.”
Read below from the intro to the bank’s latest Global Outlook piece and draw your own conclusions (and yes, “Hakuna Matata” is actually the title they chose)…
Measures of both implied and realized volatility are very low across a range of financial markets. In our opinion, this is not dangerous market complacency but a reflection of an abnormally tranquil macro environment, with a benign economic outlook, very supportive financial conditions, and lower political risks.
The synchronized global recovery remains on track, but core inflation in economies such as the US and Japan has been weak. This is risk positive for now, because it allows central banks to remove accommodation even more slowly. And with jobless rates still falling in many economies, renewed deflation fears are unlikely.
Global political risks are much lower, for the first time in more than a year. The French elections produced a strong mandate for a pro-euro and reform-minded president, there is a lower risk of snap elections in Italy, and US trade policy has been stable.
Equities have had a strong run, and the contrarian view would be to fade this move. We believe this would be a mistake. Equity valuations are elevated, but so are global bond yields. Given the earnings resurgence, tight spreads in advanced economy credit, and the possibility of US tax cuts, stocks have the least unattractive risk-reward.
We remain overweight equities over fixed income globally. Eurozone equities remain our top pick and we have turned more positive on Japanese stocks. We are underweight short rates in the US and longer yields in most other developed economies.
We believe the USD super-cycle of the past five years is over: the cyclical divergence that helped the dollar in these years has likely peaked, not only because of the European recovery, but also because the US business cycle is more advanced than in Europe. Valuations also suggest downside risks over the medium term, though for the immediate future, we expect the USD to move sideways against major currencies.
Steady global growth and the lack of USD strength bode well for carry trades in EM local debt and parts of EM equities. However, EM is no longer as uniformly attractive as it was a few quarters ago: growth momentum has peaked, commodities have weakened, domestic politics have introduced idiosyncratic risks, and positioning has become heavier.