April sure has been an interesting month, and we are only midway through it! In just the last two weeks, the U.S. has seriously sparred with its greatest economic competitor (at least by size of economies), China, and its greatest military competitor, Russia. The President of the United States had the offices of his private attorney raided by the FBI, perhaps pushing the President closer to a constitutional showdown over the fate of Special Counsel Robert Mueller. Additionally, the world has finally woken up to what Facebook’s (and Google’s) business model is—obtaining and selling any information that anybody on the planet would need to sell you something—and became alarmed. This, of course, produced the time-honored tradition of hauling the CEO de jour, in this case Mark Zuckerberg, in front of Congress to be publicly chastised. I guess they didn’t generate $40 billion in revenue last year selling banner ads. Who knew? Whatever the case, specter of potential constraints on some of the biggest companies in the world’s business models should give some pause, no?
And yet, despite this flurry of hooks to the body and straight right hands to the head, the financial markets seem to just be brushing it off, absorbing the blows, and moving forward. For the month of April, the S&P 500 is up nearly 1%, high-yield bond spreads are tighter by about 6%, S&P short-term implied volatility as defined by the VIX index has fallen from 21.49 to 17.61, and implied short-term Treasury volatility as measured by the Merrill Lynch MOVE Index has fallen from 56 to 51. The Treasury yield curve has continued to flatten, however, which could be seen as a sign of stress over economic growth. On the other hand, this flattening has, as a long-term trend, been going on since the second half of 2013.
So what gives? In the end, it all comes down to what I like to call “The Money River.” Trillions of dollars make up the river, and the river is always moving. At the end of the day, the water has to go somewhere, and in the case of money, sometime in the afternoon of every business day, thousands of money managers and investors check the screens and the accounts and find they have collective billions to put somewhere by day’s end. A lot of that “somewhere” is in the riskier, yielder sectors of the financial universe. Personally, a one-year Treasury bill over 2% looks pretty good given the state of the world. However, I guess we just haven’t had that “Oh Shoot!” (I cleaned that up) moment that creates the Hoover Dam to block the river and divert all the water to under the proverbial mattress.
Is that knockout blow coming anytime soon? As I wrote last week, the battle over trade is a serious problem. Even if six months from now we manage to iron out our problems with China, Europe, NAFTA, and the Trans Pacific Partnership (first we pulled out, now we may want to get back in!), the uncertainty is palpable, and that is a negative for economic growth. With regard to a potential confrontation with Russia over Syria, that would certainly qualify as an “Oh Shoot” moment. It makes me nervous and makes that greater than 2% one-year Treasury bill look mighty attractive, but the risk markets seem to be putting their chips on cooler heads prevailing. Thank God “Mutually Assured Destruction” is still alive and well. With regard to President Trump and his multi-front battles as well as the upcoming mid-term Congressional elections, I don’t really see a market knockout blow there either. Don’t get me wrong, it is a big deal. However, President Trump has pretty much gotten the Republican agenda done already; he cut taxes and has rolled back regulations. Even if the Democrats take over and even if they managed to impeach the President and then convict him in the Senate (which I think is a pretty low probability), there’s still a Republican in the White House. With that in place, the Democrats can’t undo tax reform or put back the regulations the President rolled back by executive order. Therefore, as far as risk markets are concerned, I don’t think it will be a big deal.
2018 has a long way to go, and many unforeseen things can happen. However, from what the risk markets can see through their swollen eyes and aching ribs, the blows can continue to be shaken off and they can keep moving forward.
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