Tatton News Archive

New article from Tatton Investment Management: Fattening 'tails'

2 September 2019, 12:00am

It does not happen often that market-moving news emerges after we have finished writing The Tatton Weekly. Last week proved to be an exception. Having just commented on how politics and the prospect of fiscal easing by US and European governments had been taken positively by markets, Donald Trump released a Twitter tantrum which some have likened to him â€œlivestreaming his own meltdownâ€. The reason this specific tirade caused one of the largest and sharpest falls in the US stock market this year (the Dow Jones fell intraday by as much as 700 points, after markets had largely come to ignore his periodic outbursts), was because he announced further substantial tariff hikes against China.

This shocked markets for three reasons. Firstly, the imposition of tariffs is one of the few measures the US president can execute without the damage-limiting â€˜checks and balancesâ€™ mechanism of US congress. Secondly, a previous Trump tweet of a postponement of the previous wave of tariff hikes had led to the impression that a trade deal might be forthcoming in the autumn. And third he referred to Chinaâ€™s leader Xi and the US central bank chairman Powell as â€œenemiesâ€ of America.

His various comments to the press and via tweets during the G7 summit at Biarritz â€“ â€œhe [Trump] may have second thoughts about his tariff announcementâ€ and â€œother G7 leaders congratulate me on the state of the US economy, but ask why the American media hate my country so muchâ€ â€“ all reinforced the image of a highly volatile individual who may be hard to trust or to be taken serious as a negotiation partner. No wonder markets rallied again, when the Chinese side was quoted that it was â€œwilling to resolve trade war with calm attitudeâ€ and hinting it would not â€œretaliate for nowâ€.

The impression the UKâ€™s new leader gave over the course of the week could not have been more different to Trumpâ€™s. Boris Johnson may have been ridiculed for displaying subservience towards the US president in Biarritz, but back at home he has proven to be a man with a plan and determination. His action to curtail parliamentâ€™s ability to hold him and his government to account in the run up to the next Brexit deadline is highly questionable for a parliamentary democracy but compared to his predecessor he is clearly forcing the Brexit issue to be resolved. This will either be through some last-minute negotiation success that allows him to see the existing, but altered, withdrawal deal with the EU pass through parliament, or through forcing his opponents to bring down their own government, which would most likely lead to a general election before year-end.

Either way, Johnson would be unlikely to remain in power if he not only divided parliament, but also the country by forcing through a no-deal Brexit. The likelihood of a no-deal Brexit has therefore not necessarily increased and the relatively stable currency markets this week are evidence that this is a widely held belief. However, what the strengthening of Â£-Sterling over the course of August as a whole does tell us is that his political strategy (of allocating more funding towards the various areas that have suffered most under the years of austerity of his preceding Conservative governments) is welcomed by capital markets. Whether this is in preparation for a general election or to soften the onset of Brexit is undetermined, but it is certainly more constructive for the UK economy than the dithering of his predecessor.

It appears that the coming weeks will be unnerving and uncomfortable, but everything points to a rising probability that the extended era of uncertainty and fiscal austerity that has held back UK business is coming to an end. Whether that be a Johnson government or an opposition government uniting parliament towards one course or the other cannot be known, but he has made sure that the decision has become much harder to postpone.

For those wondering what this weekâ€™s title has to do with what we have written, we need a brief detour into investment theory. Expectations of future investment returns â€“ and historic observations tend to provide reasonable guidance for them â€“ present themselves usually somewhat as illustrated below:

Over a shorter time horizon however, say the next 12 months, the return distribution of even well diversified portfolios will at times display the â€˜fat tailâ€™ shape. And this is precisely the effect politics are currently having on return forecasts for the next 12 months. If Trump and Brexit-related trade restrictions do not materialise then we can expect considerable upside potential as pent up business investment is unleashed and further stimulated by favourable credit conditions. If it all goes horribly wrong in politics (which it rarely does), then a worldwide recession is relatively likely, and consequentially investment returns will be bad until we emerge on the other side.