Gold, stocks or fixed income

Friday, 13th July 2018 10:40 - by Shant

There is an interesting dynamic going through the market at the moment as the equity markets continue to brush off the fears over how the trade wars will play out. 

Tariffs issued by the US have naturally prompted the major trading partners to retaliate, and with president Trump's combative stance, there seems to be little sign that this is going to die down any time soon.  Not that complacency is a surprise in the current market mindset.  We have had a plethora of instances where investor fears have been swiftly placated, resulting in a return of the major Wall St indices towards their record highs - the rest of the world following naturally.  

Is this perhaps a steadfast rebuttal of public governance?  Heavy buying of US Treasuries would suggest not.  It is more to do with buying all things US at the moment, with the momentum firmly in favour of US assets as the economy turns it around with some stellar data and bearish sentiment either side of the new year naturally reversed.  The US budget deficit caused a major sell-off in T-Notes at the start of the year and this prompted some heavy selling of US paper out of Japan.  As said, things have turned tail since and we suspect with all the BoJ money being printed, traditionally risk-averse and thrifty Japanese investors can see where the beacon is shining the brightest.  

Such is the appetite for US assets, that Gold is also being shunned at a surprising rate.  We are now trading below the $1250 mark and through some technical levels at $1235 there is the prospect of a return through £1200.  The yellow metal has and always will be a long-standing safe haven asset, but yield seekers see little value in it at the moment.  Suggestions that central bank selling to realise USDs needed to cover liabilities are all plausible reasons to the rate of decline seen in recent weeks and months, while the natural correlation with a rampant USD is having as much as, if not more of an impact in all metals - base or precious.  

Consequently, the US yield curve continues to flatten.  While the theorists are quick to point out that this signals a US economic downturn or recession coming closer in on the horizon, the above flow distorts this view.  As yet, the 2yr vs 10yr spread remains in contango - upward sloping - but has contract to a little over 25bps as the front end responds to the Fed dot plot and the prospect of 4 hikes this year.   This is not set in stone as some Fed members still consider 3 as appropriate at this stage.  The pace of US growth is, however, forcing the market to firm up its expectations and the consequences are noted as above.  

The last time the (2yr/10yr) spread was this low was ahead of the great financial crisis which gathered momentum through 2008.  2007 was when it first started with the sub-prime crisis hitting the markets that summer.  The difference now is that the banks are supposedly better capitalised and leverage among domestic mortgage holders is lower than it was before.  Leverage in the capital markets, however, is somewhat of a mystery given who you listen to.  Either way, equity markets have been precipitous for some time now with the added factor of a reduced store of safe haven assets - or so the market is telling us.  

At a time when there is so much uncertainty in the world - and yes it can go both ways - we see this kind of extremes as a potential warning sign.  Markets can remain irrational and overstretched for some time, but there are warning signs nevertheless.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.