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Investors Are Getting Creative to Tackle a Booming Economy and Trump's Policies

Erratic U.S. Politics Inspires Creative Thinking Among Investors

(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.

Investors Are Getting Creative to Tackle a Booming Economy and Trump's Policies

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.

Risk Controls

“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.

Midterm Volatility

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.

Confidence Hit

“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.

Fed Focus

Focusing on the Fed’s response to any political spillover may provide firmer guidance, and Treasury yields could face downward pressure should the central bank express stronger concerns about the impact of trade disputes on the economy. Vogel expects the Fed will be watching business and consumer confidence as an early indicator: While tariffs are a potential threat to growth further down the track, sentiment could deteriorate quickly.

Greg Valliere, chief global strategist at Horizon Investments in Charlotte, North Carolina, sees a more generalized risk to investor confidence.

“If global investors begin to think that the U.S. is beginning to look less stable politically, that could have an impact on markets,” he said.

For this reason, he also considers monetary policy a crucial guide for investors. “It’s important to know that while Trump is very erratic, there are other people like Jerome Powell that the markets have great faith in,” Valliere said, referring to the current Federal Reserve chief.

For a story on how America is captivating investors, click here.

Provided investors take their cues primarily from the U.S. central bank, markets may remain in a holding pattern at least until the Sept. 26 Fed meeting. Policy makers will then update their projections for interest rates and the economy, which last envisaged two more hikes this year and three in 2019.

As the economy remains strong, the Fed may stay the course. That could be enough to keep the political noise in the background and to allow U.S. rates and the dollar to resume their upward trek. Should political concerns become more pressing as the midterms draw closer, investors may need to reassess their strategies.

To contact the reporters on this story: Emily Barrett in New York at ebarrett25@bloomberg.net;Liz Capo McCormick in New York at emccormick7@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Jenny Paris

©2018 Bloomberg L.P.