Views From the Floor

Does impeachment matter to markets?; strange divergence in the credit markets; and the fraying US/China relationship.

In this week’s edition (11 Dec 2018) – the bamboo curtain; assessing Chinese growth: more ‘L’ than ‘V’; and the Fed in context.
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Does Impeachment Even Matter?

America’s House of Representatives have voted to press ahead with formal impeachment proceedings against Donald Trump. This means that the hearing – which have, up to now, been held behind closed doors, will now all be made public. Past private testimonies may also be published.

So far, the impeachment proceedings have had little to no impact on the financial markets. We have frequently heard the mutterings of: “if it had mattered, it would have already had an impact”, while others point to how the market thrived after the impeachment of Bill Clinton.

We don’t believe impeaching a president is a non-event: as televised hearings unfold over the balance of 2019 and early 2020, uncertainty around the impeachment leading into an election with significant differences between the two parties may impact corporate investment activity, the evolution of the trade war and, ultimately, fiscal policy going forward.

Additionally, we don’t believe that we can compare history to today. While the S&P 500 Index rallied about 29% between the day Clinton’s impeachment process started and his eventual acquittal, we would also note that Clinton was impeached right when the Federal Reserve started cutting rates post the Asia crisis. We also believe that comparison to Watergate, which undid President Richard Nixon, is meaningless as the US was in the middle of a major inflation shock.

Time to Invest in Emerging Markets? The Lows of Earnings Revisions

There has been a lot of discussion recently about whether the trend of downward revisions in earnings has reversed. So, what happens when there is an upward revision in earnings forecasts?

To answer that question, we looked at 12-month forward returns1 when the earnings revisions index (‘ERI’) is less than zero, but rising. We found that:

  • On a global basis, 12-month forward returns were positive 84% of the time when the ERI is rising; with an average return of 9.4%. This compared with 12-month forward returns being positive 64% of the time over the whole sample period; with an average return of 4.1%;
  • In Europe ex UK, 12-month forward returns were positive 81% of the time when the ERI is rising; with an average return of 6.3%. This compared with 12-month forward returns being positive 61% of the time over the whole sample period; with an average return of 2.1%;
  • In emerging markets, 12-month forward returns were positive 71% of the time when the ERI is rising; with an average return of 11.6%. This compared with 12-month forward returns being positive 60% of the time over the whole sample period; with an average return of 8.2%;
  • In Japan, 12-month forward returns were positive 65% of the time when the ERI is rising; with an average return of 9.8%. This compared with 12-month forward returns being positive 52% of the time over the whole sample period; with an average return of 2.6%.

The conclusion?

For Europe ex UK, the probability and scale of success increases substantially when the ERI starts to turn upwards. As Figure 2 shows, the ERI for EM has just started to turn upwards, implying that this would be the best time to invest in EM. For Japan, the scale of 12-month forward returns is worth writing home about once the ERI turns upwards.

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Source: Bloomberg, Man Group; between 31 December 1999 and 18 October 2019.

This Time It’s Different: Credit’s Haves and Have-Nots

There is a material divergence in the performance of higher and lower quality credits in high yield. Lower-quality bonds – such as those rated CCC – typically outperform when markets are up and vice versa. However, this year, it has been different: CCCs have underperformed other high-yield bonds by roughly 6 percentage points on a total return basis (Figure 2).

We’ve also observed:

  1. Little fear from BB buyers about rates risk, which usually constrains the bid for BB (as it is more rate-sensitive);
  2. Number of defaults are low; however, there is an increasing number of names trading at distressed prices;
  3. The tightest names are rallying;
  4. Off-the-run CCC names are drifting lower, with very few buyers. This is causing rapid price adjustments – without many buyers, each sale is resetting prices with no opposing price action;
  5. Names that disappoint are being punished.

All these factors suggest a high yield market that fears the end of the cycle, but is still willing to reach for yield in higher-quality names.

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Indexes are Bank of America Merrill Lynch Indexes
Source: Bloomberg; as of 1 November 2019.

The Power of QE

What have secular stagnation, the US/China trade war, the near collapse of the euro in 2012, the election of Donald Trump and Brexit all got in common?

The answer, in our opinion, is that they have all been powerless in the face of financial quantitative easing.

On 30 October, the MSCI World Net Total Return index crossed the level of 5,000, a colossal 300% rally from the 6 March, 2009 low. By the same token, the S&P 500 Index crossed 3,000 on 21 October, representing an almost 350% rally from the 5 March, 2009 low.

In the face of QE, then, none of these potentially disruptive fundamentals have been sufficient to upset the relentless rise of financial asset prices. And much as they might deny that it’s QE, the Fed has re-started its balance sheet expansion just as fiscal budgets have started to expand.

Many will be wary of standing in the way of financial markets with this policy backdrop, until and unless inflation starts to accelerate meaningfully.

Doubling Down: The US/China Relationship

Twelve months ago, US Vice President Mike Pence gave a speech the Hudson Institute, in which he detailed how the US administration would “continue to act decisively to protect American interests, American jobs, and American security. As we rebuild our military, we will continue to assert American interests across the Indo-Pacific.” At the time, we highlighted the Hudson Institute speech as a key reason to remain sceptical of the then-thawing US/China relations.

It seems our scepticism has been justified. A year on, Pence delivered an even more hawkish speech, on 24 October. Figure 3 shows the four main thrusts of Pence’s speech, and his corresponding quotes.

Figure 3. Statements Made By Pence on 24 October
Topic Quote
Depicting the rise of China as a zero-sum game for the US “…as each factory closed in the heartland of America, as each new skyscraper went up in Beijing, American workers grew only more disheartened, and China grew only more emboldened.”
Offering support for Hong Kong and Taiwan “Hong Kong is a living example of what can happen when China embraces liberty. And yet, for the last few years, Beijing has increased its interventions in Hong Kong and engaged in actions to curtail the rights and liberties of its people — rights and liberties that were guaranteed through a binding international agreement of ‘one country, two systems’… And we’ve stood by Taiwan in defence of her hard-won freedoms. Under this administration, we’ve authorised additional military sales and recognised Taiwan’s place as one of the world’s great trading economies and beacons of Chinese culture and democracy.”
Explicitly condemning Chinese human rights abuses “We’ve held Beijing accountable for its treatment of Muslim minorities in Xinjiang when, just last month, President Trump imposed visas restrictions on Chinese Communist Party officials, as well as sanctions on 20 Chinese public security bureaus and eight Chinese companies for their complicity in the persecution of Uighurs and other Chinese Muslims.”
Criticising corporate cultures in the US “By exploiting corporate greed, Beijing is attempting to influence American public opinion, coercing corporate America … A progressive corporate culture that wilfully ignores the abuse of human rights is not progressive; it is repressive.”


In addition, the overall tone was even more aggressive than the 2018 Hudson speech. Figure 4 shows a comparison between the two speeches in terms of word mentions. Words which we believe have critical or aggressiveness connotations were tracked. In all categories but one, this year’s speech was more or equally aggressive than in 2018.

So, where does this leave us going forward? In our view, Pence has clearly signalled that ongoing confrontation between China and the US is here to stay, despite a lull in the trade war. Indeed, Pence’s consistency may make him the person to watch within the White House when it comes to assessing US/China relations. Whilst the trade war may thaw, the charges Pence is levelling suggest a more combative relationship in the longer-term.

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