Investors Are Getting Creative to Tackle a Booming Economy and Trump's Policies
(Bloomberg) -- Investors in U.S. markets are facing the strongest economy in years, and the most erratic politics. Some are embracing the challenge of reconciling the two.
For Jason Evans at hedge fund NineAlpha Capital LP, the answer is to grasp short-term opportunities. At William Blair & Co., which oversees more than $61 billion, Brian Singer is using game theory to sort signal from noise. And Jim Vogel, a market veteran at FTN Financial, is drawing on lessons from recent history and keeping his eye firmly on the Federal Reserve.
Right now, most investors are focused on a U.S. economic expansion that’s forging ahead and the upswing in corporate earnings, with events in Washington taking a back seat. Financial-market volatility is low and demand for American assets is buoyant. The Fed’s trade-weighted dollar gauge has climbed more than 9 percent from its 2018 low, Treasury rates have been held largely in check in the face of a large supply ramp-up, and the S&P 500 Index is near record highs.
Some worry, however, that this composure simply increases the chances of getting sideswiped in an environment where a presidential tweet, administration fracas, or development in the special counsel’s investigation could upend expectations. With the stakes rising as midterm elections approach and trade tensions still brewing, market swings could soon intensify.
“This environment is good for trading,” said Evans, NineAlpha’s co-founder and a former head of Treasury trading at Deutsche Bank AG. “It’s more precarious for positioning.”
His core strategy is focused on trading market dislocations, including distortions in the yield curve, which can intensify in a broader market selloff.
“The whole political calculus right now – I have no idea how to discount it, other than I believe the realm of outcomes we are likely to get are probably going to be more than encapsulated in the risk controls we have, including even an impeachment.”
Brian Singer at William Blair is tackling the political situation head on, in an attempt to tease out what might happen. The firm’s head of dynamic allocation strategies uses game theory to explore motivations of decision makers and understand likely actions and outcomes. He’s found that strategy helpful to devise positions around populist macro themes, including Brexit in the U.K.
Singer said he sees U.S. politics contributing to market volatility in the lead up to the midterm elections, but so far he expects the overall impact on positioning to be neutral. While there has been much talk about a possible presidential impeachment should Democrats win back the House of Representatives, it may be more of a pre-election tool, Singer says. His analysis suggests that neither major party would really benefit from seeing such a scenario through to the end.
“Our focus in terms of interest rates and asset prices in the U.S. is in effect two public policy entities: the Federal Reserve, and everybody else,’’ Singer said. He said his strategy is prioritizing the input from the Fed, because “most of what we see coming out of the U.S. political arena from our perspective falls into the category of noise.”
In Memphis, Tennessee, FTN’s Vogel is also looking at political risk through the lens of the Fed. But the reference point for his analysis is historical rather than behavioral, and he doesn’t have to reach back as far as the political scandals involving former U.S. leaders Richard Nixon and Bill Clinton.
“We have a couple of templates that are reasonably recent of what political dysfunction can do to investor and business confidence, and the most recent example is the debt ceiling crisis of 2011,” Vogel said.
That threat to shut down the government came the year after Republicans re-took control of the House, and was their first protest over what they deemed excessive spending under the administration of Barack Obama. The standoff led credit assessor S&P to strip the U.S. of its AAA rating. As turmoil spread across the globe, then Fed Chairman Ben S. Bernanke committed to another two years of easy interest rates, spurring Treasury yields to historic lows at the time.
While Donald Trump has also flirted with the idea of a shutdown, Vogel says the dominant market risk today is trade protectionism. The challenge for investors is in picking the timing: Markets reacted very little to this week’s heavily-telegraphed imposition of U.S. tariffs on about $200 billion in Chinese goods, as well as the response from America’s biggest trading partner.
“We’ve been talking about what’s almost become the mythical $200 billion for three weeks now, and it’s hard to trade it because it’s just been looming,” Vogel said.
Treasury 10-year rates increased to their highest levels since May as trade concerns eased this week, rising as high as 3.09 percent Wednesday as traders moved closer to the Fed’s rate hike path for 2019. The Bloomberg dollar index is down around 0.4 percent this week, while S&P 500 futures are little changed from last Friday’s level.