Revisiting the Macro Narratives That Prevailed In Early 2018

As I approached Angels Stadium a few weeks ago, I couldn’t help but notice something oddly out of place—a gigantic Christmas tree towering over fans at the entrance. Soon I learned it was “Christmas in June,” an annual team tradition marking the halfway point to the holiday. That’s right, 2018 is halfway over, which got me thinking about how we started the year, where we are now and where we will end up.

Entering 2018, three macro narratives were widespread across the investing landscape. Let’s revisit them.

The crypto craze

Narrative at the start of the year:

Bitcoin, crypto currencies and blockchain are huge investment opportunities.

Update:

Bitcoin opened the year trading at $14,310. As I write this, bitcoin trades at $6,615—putting it down 54% for the year and 65% off its all-time high from last December.

Bitcoin isn’t the only crypto taking it on the chin. A cold chill has spread throughout the digital currency world. According to website Coinopsy, more than 1,000 initial coin offerings (ICOs) have bit the dust. Fraudulent deals, regulatory crackdowns, security breaches, and miserable price action have all contributed to a negative feedback loop, resulting in a broad bear market.

Outlook:

For those awaiting a new bitcoin bull market, my advice is: don’t hold your breath.

It often takes a long time for a sustainable bull market to form after a euphoric top and subsequent bear market. Investors need time to recover from the psychological slingshot.

If a category survives, extended periods of sideways consolidation are common. That’s because a lot of weak hands get sucked in near the top. If they don’t get washed out right away, there are usually sellers-in-waiting once rebounds occur.

The crypto outlook is also clouded by the lack of a value anchor. There aren’t cash flows or yields to lure potential investors.

Many Bitcoin supporters call it a currency, but why would anyone want to own such a currency? At the most fundamental level, currencies exist to be a store of value. Orderly commerce cannot take place in a currency that appreciates over 1,000 percent one year, then loses over half its value the following year. Sorry, it just doesn’t work.

If the bull argument rests on the notion bitcoin is a “world-changing technology”—the most common response in a recent survey on why people invest in bitcoin—then the person making that argument may want to review how 2,000 auto companies went bankrupt in the last century. Diagnosing technology breakthroughs is one thing, picking successful investments in order to capitalize on those breakthroughs is another.

Global synchronized recovery

Narrative at the start of the year:

The world economy is in a ‘Goldilocks’ period which offers a friendly backdrop for risk assets.

Update:

If you’re long U.S. stocks via the S&P 500, you’re up about 2% so far in 2018. Not exactly a raging bull market. If you’re long any region outside the U.S., chances are you have a negative return.

Across the globe, performance divergences are widening. In hindsight, that’s not surprising, because the world’s economies have differed in their respective growth and inflation trends.

U.S. real GDP rose 2.8% in Q1 and has now accelerated seven quarters in a row—tying a record. In Europe and the emerging world, growth rates are still positive, but decelerating. Since the dollar bottomed in April, cross-asset volatility has picked up considerably.

Outlook:

A lot of financial pundits started using the phrase “globally synchronized” to describe the macro setup early this year. Ironically, just as it really caught on as a consensus narrative, the data stopped supporting it.

Citi’s economic surprise index for Europe and EM has been declining for months and now resides in negative territory. The U.S. index remains positive, albeit modestly.

There seems to be a whiff of 2015 in the air. That year saw a global equity correction led by weakness in emerging markets.

This year, the iShares JP Morgan Emerging Markets Bond ETF (EMB) is off to its worst start ever. The iShares MSCI Emerging Markets ETF (EEM) is down about 8% for the year, and over 17% from its January high.

Other similarities to 2015—commodities are falling, and the yuan has depreciated sharply in recent weeks.
Some speculate Chinese officials may be depreciating the currency to defend against the potential impact of trade tariffs. Whether true or not, this overhang makes capital flight and market dislocations more potent risks to monitor in the second half of the year. Meanwhile, the U.S. will likely be the beneficiary of safe-haven asset flows.

Longer-term, I believe there is going to be an excellent opportunity to go overweight foreign markets. But timing matters with such a rotation—being a few quarters too early could prove costly. Since the U.S. tends to be low-beta relative to the rest of the world, my instinct is to wait to get long EM/foreign until after the next global equity market washout, whenever that occurs.

Tax stimulus

Narrative at the start of the year:

Tax stimulus is going to light a fire in the economy and boost corporate earnings.

Update:

U.S. fiscal stimulus is benefiting the economy. To what extent is debatable.

There’s no denying, however, that the Q1 earnings season was a blockbuster success. S&P 500 earnings rose 27% in Q1, the best performance since 2010. Operating profit margins expanded to 11.4%, which is a new high for the cycle. Overall earnings results trounced expectations. Even though tax relief was clearly a positive, stronger than expected top line growth also served as a pleasant surprise.

Outlook:

It’s rare and unorthodox to see major fiscal stimulus this late in a business cycle.

In 2017, U.S. stocks appear to have priced in much of the positive earnings news relating to tax relief. As we get closer to the November midterm elections, there may be heightened focus on a potential second round of tax reform, which could potentially buoy the market.

In between now and then, trade tensions appear to be the primary source of uncertainty for markets. Despite supportive underlying fundamentals, investors appear reluctant to embrace a full risk-on posture while trade skirmishes hover in the background.