John Stopford, in an interview recorded on the 2nd of November, previews the US midterm elections.
Lindsay Williams: With me now is John Stopford, who is the Head of Multi-Asset Income at Investec Asset Management in London, and we are now going to preview the US midterms and also look at why the markets are suddenly risk-on. John, one of the great mysteries of my life – there are many of them but one of the great ones is the US electoral system. Tell us about the midterms. Why are they so important?
John Stopford: Well, as the name implies, they are halfway through a presidential cycle. At the moment, Donald Trump’s party, I mean he is not exactly a typical Republican but the Republican Party has a majority in both the lower house, the House of Representatives, and the upper house, the Senate, and, with him as President, that means it is easier for them or for him to get legislation passed. He has got the support broadly of both houses.
So the midterms are important because, typically, the ruling party, if the President loses seats in the middle of the electoral cycle and if the Republicans lose enough seats to the Democrats, they will lose control of the House of Representatives and then it will be much harder for Trump to push his legislative agenda. The Republicans are likely to cut taxes further, do certain other things and that could have a big bearing, both on the US economy but also on financial markets.
Lindsay Williams: You are quite right – the financial markets at the moment are embracing the upcoming midterms for whatever reason. Also there is earnings season but that is another matter, but let me read you something from The Economist today, which says:
“As America prepares to go to the polls on November 6, the country is more divided and angry than it has been in decades. Campaigning for the midterms has been marred by politicians routinely treating each other as rogues, fools or traitors.”
In recent days, a supporter of Donald Trump has sent bombs to 14 of his opponents, etc., and there was, of course, the tragic slaughter at the synagogue in Pittsburgh. So with this sort of background, what do you think is going to happen? I mean this is a very simple question but a very difficult answer.
John Stopford: Yeah, it is a difficult answer and, as we have learned in recent elections, opinion polls, they have a large margin of error. At the moment, the opinion polls suggest that the Democrats will, indeed, win a majority in the House of Representatives but a lot of people doubt whether that is true, whether that is capturing the mood of the country.
Donald Trump’s approval ratings have improved. He is throwing everything at it to try and bring out his base. His base is believed generally to be a bit more likely to turn up and vote than a lot of disillusioned Democrats and so it remains highly uncertain. It is a somewhat binary event, so yeah, we will see next week I guess.
Lindsay Williams: Yes, I suppose we will but also, on the other hand, you have got the politics and you have got the circus that surrounds the politics but also you have got the US Federal Reserve and US earnings, which is probably more important to you at Investec Asset Management in London.
John Stopford: Well, yes, to some extent. I think we have clearly had a big correction in markets, partly driven by concerns that future earnings are likely to be a little bit more disappointing, driven by policy tightening, as you mentioned, driven by trade fears. Now we are seeing a little bit of a bounce as people wonder, you know, might Trump do a deal with President Xi when they meet at the end of November. Traditionally, the end of the year is a better time for equities in the run-up to Christmas and January. Post-midterms historically has actually been quite good for equities. You know, might the Fed be a little bit more cautious, given some volatility? Then, if Trump can secure the House of Representatives, does that mean we get more progress policies?
So the market is I think fairly low conviction at the moment. After a large fall, it is not unusual to get a decent bounce. The underlying environment we would argue is broadly deteriorating but we are still in an economic expansion. We are likely to see earnings growth next year. The risk of a recession in the next 6-12 months still looks pretty low.
The big wild card I think remains the Fed. Unfortunately, policy tightening in the US so far has mostly impacted other people like South Africa, like Turkey, like Argentina and so on. It hasn’t really impacted the stock market that badly and it hasn’t impacted the US.
So there is nothing really to stop the Fed continuing to tighten, particularly as things like labour market data (which we saw today) is pretty strong. We have got wage growth now above 3%. We have got an unemployment rate of 3.7. We have got strong employment statistics. It is not obvious why the Fed, other than being jawboned by Donald Trump are going to stop raising rates.
Lindsay Williams: When I have been speaking to your colleagues in the last 6 months, particularly Philip Saunders, he said that the risk was – I think he sort of went out on a limb there and he said the risk was that there would be a melt-up in the US stock market and it almost seems as though that melt-up has started. Do you think that if Mr Trump prevails, that there will be the melt-up and, if he doesn’t prevail, will there still be a melt-up because of earnings and the rather sort of steady posture of the US Federal Reserve, I mean almost a bastion of stability when there is much noise elsewhere?
John Stopford: I am a little bit more cautious I think than that. I think from oversold levels, of course, you can get a decent bounce. The earnings data in this sort of cycle is not as bad as – it is actually quite good. It is not bad in the way that the market is perhaps fearing but I think we are gradually seeing the liquidity screw being tightened by the Fed and I think it makes it hard for the market not to derate to some extent through time. So all earnings are doing I think are offsetting other forces that make it hard for stocks to rally and, arguably, quite a lot of psychological damage is being done in this latest move.
So I think we will rally. Whether we will rally back to new highs, whether we will carry on I think may depend on how much economic momentum there is but I think at this point the market is having to contend with higher bond yields, tighter monetary policy and I think all earnings do is maybe stop the stock market from entering a bear market rather than being a melt-up scenario. Maybe moderate gains from here is the best we can hope for but I think it is going to be increasingly volatile, given the policy backdrop and given some of the other concerns.
Lindsay Williams: When I first started in the financial services industry many, many moons ago, John Stopford, one chap, a wise old chap, said to me when there is a lot of volatility after a market has been in a prolonged bear phase or a prolonged bull phase, as we are in now, when volatility is the watchword, then it normally means that people are posturing and don’t really know where the next move is going to go. He would always say to me that usually means that there is going to be a change of trend and there has been extraordinary volatility in, for example, the S&P 500, the Dow Jones, etc., in the last few days. Do you think that that is a precursor for a change in trend?
John Stopford: As I said, I think quite a lot of psychological damage has been potentially done by October. It is interesting that the sort of statistics in terms of number of markets – if you look sort of across all of the equity markets around the world, all of the bond markets, etc., the proportion that are up this year versus down is tiny and, in fact, it is low relative to pretty much any historical record.
So most people are sort of sitting on fairly painful returns this year. They went in very bullish and so I think it is problematic. We know we are sort of 10 years into a bull market. We are 10 years into global economic expansion. Those are both pretty mature. We know the central banks, particularly the Fed, are now tightening and QE is ending.
It is quite plausible that we could be around the beginning of a bear market. Typically though bear markets take time to sort of gestate and they typically don’t hit home until close to the peak in the economic cycle and that still doesn’t look quite to be in yet and traditional measures of how tight policy are are also not quite there yet. So, typically, the yield curve inverts before the final end of the bull market and the final end of the cycle. That hasn’t quite happened yet in the US and so on.
So I think he is right – it suggests a lot of people don’t know what is going on and I think actually the safest course of action is probably not to be a hero at the moment and to sort of monitor how things are going. There are opportunities though. We do think that, bizarrely, despite the pick-up in volatility, option pricing on equity call still remains very low.
So you can protect yourself against this bull market continuing by buying call options (it doesn’t cost a lot) and then you can run an otherwise pretty defensive portfolio. That is essentially what we are doing and so if the bull market carries on, we will make some money. If it doesn’t, we are not going to be too badly hurt. So yeah, I think there are strategies to exploit this kind of uncertainty.
Lindsay Williams: It sounds like a Goldilocks scenario from your point of view. John, thank you very much for your time. John Stopford is the Head of Multi-Asset Income at Investec Asset Management in London.
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