The Single Biggest Risk in the Market Right Now (it's not Trump)
How about that? Portfolio managers think the disintegration of the European Union is a bigger risk to stockmarkets than the bond bubble or Donald Trump! That was from a survey by Bank of America Merrill Lynch that showed portfolio cash balances are at their highest percentage since 9/11. Maybe those managers surveyed have seen Tim Price's new presentation on what ails the European banking system!
A Trump victory is more likely than some people in the media bubble would like to admit, I've argued in this week's cover story for MoneyWeek magazine. But even if the Donald goes down in flames to Hillary Clinton, his attacks on central bankers will cross the Atlantic to have an impact in French and German elections next year. Trump's parting shot may hit the European Union dead centre.
Speaking of which, prime minister Theresa May will make her first appearance at the European Council when she travels to Brussels for a meeting today. Brexit is not officially on the agenda. But you can bet it will be on everyone's hearts and minds. The negotiations to leave, which haven't officially begun, are poised at an interesting point.
The EU has so far presented a united front. But how long will that last? The longer Brexit looks like it hasn't done any damage to the UK economy, the more appealing leaving may look to other countries. Pressure will be build. And with elections in France next spring and Germany next autumn, the driving force between EU integration may be a lot weaker this time next year.
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Meanwhile, back in Westminster, it's clear that some parliamentary forces have decided that the referendum is a suggestion and that Brexit requires official action by Parliament. Will this resistance to the Brexit result become more overt? Will it provoke a legal challenge? A constitutional crisis?
These are all political questions. As such, they're beyond the reckoning of markets and prices. That's a point Tim Price made yesterday when he conducted the quarterly strategy conference call for subscribers to The Price Report. You can use bond yields and exchange rates for proxies on what markets have to "say" about political events.
But a vote is not a price. Political decisions are driven by a host of emotional variables that markets simply can't measure. The result is that markets can get stuck in limbo until the political situation clarifies. And the longer the political situation remains uncertain - with Brexit it could be years - the harder it is for markets to move with conviction (in either direction).
In a fascinating twist, British oddsmakers have now moved Donald Trump's chances for victory from 11-2 to 4-1. And here's the really interesting bit: the betting patterns on the US presidential election are looking awfully familiar. The "smart money" is on Clinton. But the "weight of money" is on Trump. What do I mean?
Bookie William Hill reports that 71% of the total value of bets is on Clinton. But 65% of the total number of bets are on Trump. Are a few big players in the betting markets trying to create the impression of an inevitable Clinton win? Maybe. But probably not.
I suspect what's going on is exactly what happened with Brexit. The "insiders" - those in the media, politics, and your basic big city elites - have convinced themselves that no right-thinking person could vote for Trump. And given how deplorably Trump is reported to have behaved with women in the past, it seems like a pretty comfortable conclusion to reach.
But remember, pollsters, the media and political elites have been consistently out of touch with the social mood in the last three years. I blame quantitative easing (QE) for this. As asset markets have powered higher on low interest rates, the world looks and feels different for those who benefit from financial repression.
On the outside of the bubble - where ordinary people have to deal with the consequences of open borders, free trade, bureaucratic overreach and low growth - QE has created a cauldron of discontent. Trump has tapped into the victims of financial repression. And if he were anybody but himself, he might find himself with a commanding lead just a few weeks before the election.
Here's the flip side: a Clinton win and signs of inflation in the US and UK could trigger a big rally in stocks and commodities in November. All that cash on the sidelines could storm out of short-term bonds and into growth stocks. Or, dare I say it, commodities!
"We have seen early signs of markets rebalancing," says BHP CEO Andrew Mackenzie. Iron ore prices are up 35% year-to-date, he reports. And metallurgical coal (used in steelmaking) has tripled. Could the long nightmare of oversupply and tepid demand be over? Have a look at the chart below.
The current line being peddled by central banks is that they need to run inflation "hot" in order to combat the forces of deflation. Those forces are well known: excessive debt (which makes growth hard); demographics (declining consumption in the West); and automation, technology and globalisation (all putting pressure on wages and prices). Higher-than-expected inflation is just fine with Janet Yellen and Mark Carney because they believe it will take some doing to overcome the natural desire of the planet to deflate.
Keep your eye on commodities, then. The Reuters/Jefferies CRB got the year off to a dismal start. Then it rallied from early February to early June. Once Brexit looked possible, and once politics overwhelmed markets, the index slid. Now, it's in a rising trend and looking to make a new high by the end of the year.
My prediction: this kind of inflation will be welcome at first and look encouraging. Traders in commodities could make some nice profits. But be afraid. Be very afraid. Inflation is like fire. It gives heat and light. But get too close and it burns.
Central banks never manage to engineer "just a little" inflation. They are convinced that QE can be wound down without leading to a collapse in bond prices or unleashing inflation in the real economy. But this entire monetary era is experimental. It's your money, your retirement and your portfolio they're experimenting with. And central planners have a poor track record when it comes to defeating market forces.
All this will be in the mix next week in Australia. I'm travelling there on Friday to speak at a conference next week on "The Great Repression". I'll be joined by old friends and colleagues from Melbourne. And some of the keynote speakers - Jim Rogers, Jim Rickards and Satyajit Das - will no doubt have a lot to say about Trump, the dollar, commodities and the battle between central banks and markets.
Please note: This article was first published in Capital & Conflict on October 20, 2016
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