- Deutsche Bank Strategist Alan Ruskin argues that the mood for risk appetite in the markets is shifting. Ruskin references infamous 2007 “We’re still dancing” quote from Citi CEO Chuck Prince. The developing fiscal story in the US will end up being very bad news for either stocks or bonds.
LONDON – “Has the music stopped playing?”
That’s the question posed by Deutsche Bank Macro Strategist Alan Ruskin in a note circulated to clients on Wednesday. Ruskin’s question – which references a famous comment from the Citi CEO Chuck Prince just before the financial crisis – is in its simplest terms whether or not risk appetite in the markets has started to shift.
“As long as the music is playing, you’ve got to get up and dance,” Prince told the Financial Times in July 2007, just as the subprime mortgage collapse, which would eventually lead to the crisis, began to crystallise. “We’re still dancing,” he added.
Prince’s comments related to the cheap credit-fuelled buy-out boom happening at the time, and later became synonymous with the hubris shown by many major bank executives in failing to spot the crisis coming, even as the US subprime crisis worsened in the summer of 2007.
Ruskin repurposes the comments to ask if what’s going on in the markets right now a shift away from the prevailing narrative of recent years. His conclusion? “The music may not have stopped completely, but there is a change in tone.”
What is happening, Ruskin argues, is a developing fiscal story in the US that will end up being very bad news for either stocks or bonds. Here’s Ruskin in his own words (emphasis ours):
“Our worry here is as follows: If the US comes through with even a modest fiscal package in 2018 (call it a 0.5% of GDP increase in the cyclically adjusted primary deficit), the yield curve from short to back-end has plenty of scope to backup.
“If there is no fiscal package of even that modest magnitude, then the market’s next big questions have to relate to what this says about the dysfunction of the US political process, and any fallout in the mid-term elections. Political dysfunction could at the margin help T.Bonds, but may then damage global risk through the equity channel.
“The point is the US fiscal story sets up a fork in the road, whereby either the bond leg, or the equity leg, will not be nearly as risk friendly and vol suppressing as it has been in 2017 so far.”
A similarly worrying pattern has started to emerge in the UK, where more and more companies have started to issue profit warnings in recent months, suggesting that some sort of downturn may be on its way.
“UK quoted companies issued 75 profit warnings in Q3 2017, significantly above average for the period and well above the 45 issued in the previous quarter. The biggest quarterly rise in profit warnings in almost six years has come directly after one of the biggest falls, reflecting the unpredictable economic climate,” a report from EY notes.
Here’s the chart:
Companies aren’t the only ones affecting the mood music – central banks are also disrupting the tune.
Central banks are expected to start the reversal of the policy of ultra-low interest rates, even as the world shifts into a period of political uncertainty, in the form of events such as the election of President Donald Trump and the UK voting to leave the European Union.
The US Federal Reserve is expected to hike rates several times next year and in 2019 and shrink its $4.4 trillion balance sheet as part of a retreat from the monetary stimulus that has characterised policy in the years since the 2008 crisis.
Meanwhile, the European Central Bank is widely expected to announce cuts to its asset-purchase program on Thursdsay and the Bank of England has warned market participants that it may raise rates as soon as November.
All these factors point to a reversal in risk taking.
Peter Elston, chief investment officer, Seneca Investment Managers, said: “There’s much talk about when the bull market in equities will end. We believe it will be around 2019, ahead of an economic downturn in 2020, but it’s vital to take action well in advance.
“This month we further reduced our equity holdings across all of our funds. With a global economic downturn expected in 2020, a bear market will set in ahead of this. We have created a framework to reduce our risk exposure gradually over time to avoid the need for drastic asset allocation changes once the market does turn.”