“The most dangerous moment comes with victory” – Napoleon Bonaparte
Nothing more to worry about?
For months, even years, last weekend’s French presidential elections have lurked in investors’ subconscious, growing in menace with every poll that told us of Marine Le Pen’s creeping popularity. Identified by many as the key risk for this year – the catalyst for the beginning of the end of the euro, Marine Le Pen’s predicted ascension to the Presidency formed the centrepiece of the alleged popular revolt against globalisation and all its gilded disciples. However, the euro endures for now and may even be showing tentative signs of flourishing. Meanwhile global trade, the vehicle often blamed for delivering populism onto Western economies, is showing similar signs of life. US stocks are again making new all time highs, while the markets ‘fear gauge’, the VIX, has sunk to levels not seen since the early 1990s. Should the apparent absence of things to worry about now be the thing that keeps us up at night?
Many investors look at the period ahead and focus on the risks they can see – at the beginning of this year everyone seemed understandably preoccupied by the various potential electoral minefields in Europe. However, in reality, like icebergs, most of the future risk picture is always going to be submerged from view, and the danger is that we exaggerate the risks we can see, just because we can see them. Donald Rumsfeld was laughed at when he said it, but his now clichéd musings on the ‘known knowns’, ‘known, unknowns’ and ‘unknown unknown’s’ still provide us with the most succinct and semantically accurate framework for viewing the surprises, both positive and negative, that the future will dump in our laps.
The world economy to the rescue…
Underneath all of this, but central to investment portfolio performance, remains the ongoing progress made by the world economy. The continuing interaction of the learning curve with new technology remains a powerful and durable driving force, one which the last few hundred years of history tell us we are far better off betting with than against. However, to the evident frustration of some analysts, this growth environment, described on a quarterly basis by GDP data and more regularly by other series, does not map precisely to quoted corporate earnings. The trend level of global and national output growth matters, but more as a means of understanding the approximate climate for businesses, governments and consumers rather than in the precise, month-to-month fashion demanded by much of the commentariat – contrast this quarter’s soft US output data with what looks to be the strongest quarterly earnings growth from US companies seen since the end of 2011.
This latter point is part of the story that allows us to continue to recommend owning more equities than usual in our tactical overlay portfolio. First quarter earnings reports all around the world and across most sectors are showing the kind of pep that the survey data has been telling us about since last summer. High, but far from asphyxiate, equity valuations in the US are not an impediment to further upside whilst the prospects for earnings and dividend growth continue to look so healthy. Meanwhile the European corporate sector may finally be rewarding stretched investor patience by starting to make good that yawning earnings chasm relative to their peers in the US.
This increasingly reassuring fundamental backdrop, allied to still very accommodative central bank policy around the developed world may go some way to explaining the multi decade lows in the VIX, an index designed to measure implied volatility in US equity markets. The index will no doubt bounce eventually as normal service resumes. However, our ability to profit from that bounce is complicated by technical factors associated with a persistently upwards sloping futures curve, as well as the inherent difficulties in accurately forecasting volatility.
Even after the French Presidential election, there remain plenty of things to worry about – there always are. Unknown, unknowns are part of it as well as all the usual cast of current favourites from resurgent protectionism to an imminent Chinese economic apocalypse. However for the moment, the dominant factor influencing our tactical portfolio is that increasingly robust global economic backdrop and the effect that will continue to have on corporate earnings and dividends and, further down the road, inflation. Diversification across geographies and asset classes remains the best and least expensive way of protecting yourself against that unknowable future in our opinion.