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Quotidian Investments Monthly Commentary – November 2016

December 5, 2016

One of the quirks of the US presidential election system is that there is a long inter-regnum period between the outgoing president actually departing and the president-elect assuming office.  Despite the fact that we have known the recent election result since 9thNovember, Trump does not take over the reins until 22ndJanuary and so markets are effectively in a period of limbo.

In the days immediately following the outcome of the election the US stockmarket (and especially sectors such as biotechnology and pharmaceuticals) soared upwards but it has since been treading water and in the doldrums.  As ever, the US is mimicked by world markets. Until the present vacuum is filled by Trump’s eventual accession, equity valuations are seemingly being based upon conjecture and guesswork. 

In the meantime, Obama is yesterday’s man and now spends his time on a valedictory world tour cementing the hallmark of his tenure as being a period of impressive oratory but very little effectiveness or achievement; honeyed words not matched by action.  Under his stewardship the US national debt has more than tripled and now stands at $19.8 trillion.  Worse still the Committee for a Responsible Federal Budget expects a further $4.6 trillion of debt to be added over the next 10 years as the long-term effect of Obama’s financial incontinence.

With a sense of optimism that turns a blind eye to hard economic reality the US government hopes to fund that deficit through a huge increase in the supply of Treasury bonds.  However, there is just a little problem with this fanciful sanguinity in that investors are becoming ever less willing to lend money at parsimonious yield rates to spendthrift governments.

In the week after Donald Trump‘s election victory investors withdrew more cash out of US fixed-income funds than at any time over the last three years. Foreign governments had already been selling US Treasury bonds hand-over-fist ahead of the presidential election. This is highlighted by Treasury International Capital (TIC) data released last week that showed the liquidation trend already firmly entrenched in September.

For example, China holds a mind-boggling $1.157 trillion in US Treasury securities (the second largest holder on the planet) and they’ve been selling those Treasuries to fight against yuan devaluation.  They have plenty of inventory left to sell as they contend with capital flight and a pullback in trade.  The sell-off thus far from this source could just be the beginning.

Saudi Arabia is another heavy seller of US Treasuries.  In fact, they’ve liquidated nearly one-third of their Treasury holdings since the start of the year.  With its income from oil diminishing greatly as the price of oil has declined, we are likely to see even more selling.

The good news is that with everyone selling bonds, that money is looking for a place to land and historically that landing site has inevitably been the US stock market.  The fact is that many US blue-chip companies have stronger balance sheets than most national governments and are a palpably safer place for capital investment.  In our view this will propel US stocks much higher in 2017.  The Dow Jones index has closed and held above 18,500 already this month and, from a technical perspective, that will validate the next move higher.

On 30thNovember the FTSE 100 closed at 6783.79 (a fall of –2.45% for the month and +8.67% for the 2016 year to date).  However, the mid-cap and small-cap indexes have still not performed nearly so well thus far this year.

By comparison, the Quotidian Fund’s current valuation shows an increase for the month of November of +2.42% and for the year to date the Fund is now -15.10%.  The Fund’s monthly uplift was much better than that until a 3% across the board markdown on the last trading day of November temporarily took some of the shine off.  Yet again this markdown was based entirely on political speculation and has nothing to do with economic common sense.

On the immediate horizon there are three issues of market-moving potential. One of these issues is economic and the other two are political:

Throughout 2016, despite market rumours to the contrary, we have consistently pinned our colours to the mast in terms of US interest rates by repeatedly stating our belief that the next increase in rates will be made at the Federal Reserve’s meeting in December.  We still expect, with a degree of confidence, that the Fed’s mid-month meeting will deliver a small increase of 0.25% to US interest rates.  That should not disturb market sentiment although it would not surprise us to see a short-term flurry of negativity; it is in the self-interest of market makers to create uncertainty in the certain knowledge that it will cause some investors to panic and sell their holdings.  Strangely, and to the sole benefit of the market makers themselves, those same investors will buy back in at higher prices once they feel ‘safe’ again.

The primary elections towards appointing a new President in France are under way and there has been a palpable move to the right of centre politically.  The country’s left wing is fragmented and in complete disarray; Hollande is rapidly heading for the exit door and the velocity of his departure will be facilitated when he fails to win the socialist primaries in January.  It is highly probable that the final outcome will be fought out early in May between Francois Fillon (moderately right of centre) and Marine Le Pen (far right).  Both of these candidates are Eurosceptic and the result will certainly disturb the complacency and self-satisfaction of the EU apparatus in Brussels.

Long before that denouement in France, on the first Sunday in December the Italian referendum will determine the fate of their current Prime Minister (Matteo Renzi, who brought a socialist and pro-EU agenda into office with him). Renzi’s Government has implemented numerous reforms including a relaxation of labour and employment laws with the intention of boosting economic growth.  None of this has had the slightest positive effect on the Italian economy or its lamentable unemployment rate and euro-scepticism in that country is rampant.  Whilst the referendum is not directly concerned with the euro or Italy’s membership of the EU, the outcome will have a profound effect on both of these issues. If the ballot delivers a ‘no’ result (as seems a foregone conclusion) then it will further shake the foundations of the EU and the future of the euro in much the same way as Brexit did.

The Eurozone remains dysfunctional.  There is no fiscal union, no political union, no shared debt nor genuine banking union (all of which should have been essential precursors to the launch of the Euro).  Even the Euro’s founding economist (Otmar Issing) has now disowned it.  His comment on 16thOctober that “one day the house of cards will collapse” is telling indeed.  His implication was that this fateful day would be sooner rather than later.  Our view is that the EU in its current form will implode under the weight of its own hubris by 2021 at the latest.

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