Astromacronic rally!

Stock markets around the globe roared on Monday in apparent response to Monsieur Macon’s victory in the first round. If that was the reason, it felt a major over reaction. Headlines that Donald Trump is looking to cut US corporation tax to 15% may also have had an equal, if not greater, influence. We did also point out last week that the many uncertainties investors are currently dealing with have taken sentiment, at least according to Morgan Stanley, back to levels seen around the time of the Brexit vote, so any good news was likely to get a positive reaction.

The Vix, or fear and greed index, which had also been showing modest signs of fear fell from above 14, to close back below 11, an area that many would consider greed territory. The FTSE 100 also recovered many of last week’s losses, partly as a result of the Great British Pound giving back some of last week’s strong gains. Equity sentiment will probably ebb and flow once again alongside expectations as to how effective Donald Trump will be at implementing his tax reforms.

Of the many risks to the equity market, the question that continues to vex investors is which one is the most likely to derail the equity market rally? In our view it is unlikely to be the election of another popularist President, or the breakup of the euro, or some Geopolitical event further afield. Although one obviously can’t rule these possibilities out completely!

So, what will? US treasuries in particular, but all government debt is ultimately what every other asset class is valued from. That is why Central Banks at times of crisis look to lower the returns on these assets to encourage investment in other areas. Any change in the “risk free rate” changes the assumptions for other asset classes. That must be the biggest risk currently to equity markets, as the level of interest achieved on government debt on many major developed country’s bonds is offering a negative real return: i.e. the return on the bond is below the rate of inflation.

Equities soared on Monday, bonds fell in response and yields rose, but not significantly. From the start of the crisis the Federal Reserve’s monetary policy has been the driver of economic recovery. Fiscal stimulus has played a minor role. With Donald Trump’s initiatives, there could be a significant role reversal. The question will be how gently will bonds and the Federal Reserve react to these changes should the new regime be successful? If the adjustment is a gentle one then equity markets will adjust over time as economic growth picks up. If, on the other hand, the Federal Reserve and bond markets take fright so will equity markets.

Posted on April 25, 2017 .