We normally do not use this column as a place to focus on the merits, or lack thereof, of a particular investment asset, be that the common shares of a publicly traded company, mutual fund, hedge fund or what have you. But we do focus from time to time on particular strains of human thought that translate into specific investment strategies – growth, contrarian, momentum and all the rest. Our theme today is that particular way of looking at the world that translates into a strategic approach called the “perma-bear,” or one who is perennially positioned for a bear market, year in and year out. In service of that theme we will call out one particular asset – a mutual fund called the Hussman Strategic Growth fund.

The stated investment objective of this fund is “long-term capital appreciation, with added emphasis on the protection of capital during unfavorable market conditions.” How would that have worked for you if you had invested, say, 10 years ago for “long term capital appreciation?” Well, your average annual return over those 10 years, your most recent quarterly statement would have told you, was minus 7.2 percent. Minus 8.8 percent over the last five years. Even over the last twelve months, which includes a near-bear market in fall 2018, your total return was in the red – minus 3.8 percent.¹ Such is the experience of one of the market’s best-known perma-bear vehicles.

Reality Bites the Bear

We present this data with no particular animus towards the Hussman fund per se, but rather to underscore the challenge reality presents to anyone who begins each calendar year prepared for the sky to fall. The chart below shows every instance of a bear market in the S&P 500 since 1946, represented by the pink column showing the peak-to-trough duration of each event.

As the chart shows, there were ten specific instances of bear markets – defined as a fall of 20 percent or more from the previous peak – over the roughly three quarters of a century since the end of the Second World War. You can see from the proportions of pink and green shading on the chart that for the vast majority of this time the market has not been in bear country. Now, there certainly have been times when the bear showed up with more frequency, notably the period from about the mid-1960s to the early 1980s. But since the market bottomed out in August 1982 – fully 37 years ago – there have been a total of three bear markets. It is easy to see why a perma-bear strategy has not been a successful long-term approach for this period. The question we find interesting, though, is what keeps anyone in these strategies. The answer, we suspect, lies in the psychological phenomenon of loss aversion – the outsize impact a monetary loss can have on one’s state of mind even if that loss is more than compensated for by monetary gains over time.

The Allure of the Broken Clock

Loss aversion is why investors remember with absolute crisp-clear clarity where they were the day Lehman Brothers filed for bankruptcy, or Black Monday when major stock indexes fell more than 20 percent in a single day. Does anyone remember where they were on some random day in March when the S&P 500 gained two percent, or even how you felt on December 31, 2013 when the S&P 500 posted an annual return of more than 30 percent? No – that’s the asymmetric power of loss aversion. It explains what we sometimes call the “broken clock theory” and we think it also explains why perma-bear strategies like the Hussman fund continue to attract investors despite a sustained track record of underperformance.

A broken clock is right twice a day. It’s wrong for all the other minutes, but for those two minutes, it’s right. Take that analogy out to the market. If you’re a perma-bear, on any given day you will be out there on CNBC or Bloomberg News explaining why the world is about to come crashing down on that day. Most of the time you will be wrong. But on those rare occasions when you proclaim doom and doom ensues – well, you are hailed as a god of finance. In 1987 a Lehman Brothers analyst named Elaine Garzarelli predicted that the market would crash – and it did! Lucky or not, Garzarelli’s star ascended to the brightest heavens of financial punditry. Likewise, Hussman and other perma-bears bathed in the spotlight as the markets fell apart in 2008. Those moments matter, because they register so clearly and distinctly in our brains. Loss aversion. Those two minutes of being correct punch above their weight, never mind the other 1438 minutes of being wrong. This is clearly irrational, because in the end you come out worse when the results of being wrong all those minutes add up. But that’s what behavioral finance is all about – irrationality rules the day, and the perma-bears stay in business.

Now, to not be a perma-bear does not mean that one has to be a Pollyanna, ever optimistic that the sun will shine down on all of creation all the days. There are times to take a more wary view of the evolving state of things, and there are times to be more positive. As we have noted in a number of recent columns, we see many reasons to cast a wary eye on potential developments in the year to come. But to be perpetually pessimistic about market prospects would not, in our opinion, serve the long-term interests of our clients, and we prefer to look to evidentiary data than to fall prey to the loss aversion trap.

In this space last week we presented the case for smooth sailing through the remainder of 2019. If anything, that case would seem even more compelling today, with investors tossing away their safe haven stockpiles of gold, Treasury notes and Japanese yen while pouring into equities. US stocks are set to close with gains for the fifth week in a row, for the first time since February. The trade war, the market’s favorite fetish object, seems to be receding further now, with concrete talk of phased eliminations of currently in place tariffs (though there is still no set date for that signing ceremony of a “phase one” deal).

Lest anyone become too complacent about the general state of things, however, we will use this week’s platform to examine another data point that could be a key influencing factor in 2020: corporate earnings. Estimates have been coming in for fourth quarter earnings (which will start to be released come January) and the picture they paint is not a healthy one.

The Dance of the Analysts

“Corporate earnings” sounds like the most sober and rational of processes – it’s just a bunch of numbers, after all, painstakingly presented to be in compliance with precise accounting standards. In reality, though, the earnings exercise is more like the kabuki theater popular in Japan: ritualistic, highly stylized, and ultimately more about image than reality. Analysts at major investment firms routinely present their estimates about what they expect earnings to be for the companies they cover in the months ahead, usually up to a 12 month window (called “next twelve months” or NTM in Wall Street parlance). They update these expectations from quarter to quarter as the actual release dates for the numbers approach.

For example, back in June of this year, at the end of 2019’s second quarter, the average consensus estimate by analysts for S&P 500 companies in the fourth quarter of this year was a growth rate of 5.64 percent. In other words they expected that earnings would grow year-on-year from December 31 2018 to December 31 2019 by that percentage rate.

By September, this Q4 consensus estimate had fallen from 5.64 percent to 2.19 percent. As of this week – less than two months after the September estimate – that number had fallen further still to minus 1.43 percent (these estimates are all courtesy of FactSet LLC, a data research firm). Yes – earnings that were expected to grow by almost six percent are now, according to the analysts, on track to actually fall by more than one percent.

Clearing the Low, Low Bar

Here’s where the kabuki element really kicks in. Whereas that 5.64 percent number back in June was apparently too high, the minus 1.43 percent number (if history serves as a guide) is almost invariably too low. In other words, when S&P 500 companies actually do start releasing their Q4 earnings numbers come January, it is likely that they will come out a bit ahead of what the analysts think. This then becomes the “positive surprise” to which grinning financial news anchors will refer when they explain why Company ABC’s stock price is up. Earnings beat! It’s an elaborate performance, this earnings dance, and everyone is in on it. On average, from earnings season to earnings season, anywhere from 60 to 80 percent of all companies experience these “positive surprise” events. It’s optics, but it usually works.

Reality Bites Back

But Earnings Kabuki can only go so far, and now is where we turn to the real math of valuation. Whatever the final number turns out to be for Q4, it is fairly likely to be closer to minus 1.4 percent than to 5.6 percent. Moreover, Q4 will come on the heels of three weak earnings seasons already this year, so that the final growth number for calendar year 2019 is likely to be somewhere close to zero – as in, zero earnings growth.

The earnings number matters because the relationship of a stock price to the underlying earnings of the company is one of the most widely used metrics – the P/E ratio – to assess whether a stock is relatively cheap or expensive. The chart below shows the trend of the P/E ratio over the past three years. We show here both the last twelve months (LTM) P/E which reflects actual historical earnings over the four prior quarters, as well as the next twelve months (NTM) P/E where the denominator consists of those analyst projections for earnings in the next four quarters.

So what does this chart tell us? At first glance it doesn’t seem so bad. Both P/E ratios shown here are well below the high point reached at the height of the last go-go phase of the bull market in late 2017. The LTM P/E ratio (in green), in fact, is right around its three year average. Not a screaming bargain by any means, but not outrageously expensive either.

The NTM number (blue) tells us something a bit different, though, and it relates back to our lead-up exposition of Earnings Kabuki. Note how the NTM P/E has gone up in the past couple weeks so that it is now meaningfully above its three year average. Why is that? Partly because stock prices have been going up (numerator) but also because analyst estimates (denominator) have been going down. The effect of reduced earnings expectations, all else being equal, is to make valuation measures go up, and therefore become more expensive.

Earnings in 2020

Here is where we see some cause for concern in 2020. While that Q4 2019 estimate has come down, the numbers for 2020 are only just coming onto the kabuki stage. Right now the estimate for Q1 2020 is growth of 5.3 percent, while the same Q1 estimate back in September was 6.9 percent. Expect those numbers to start creeping lower as the time approaches.

Now stand back and think about what it all means in an environment of slowing global growth. US GDP growth is expected to have a hard time getting north of two percent, while Europe and Japan will be fortunate to have any growth at all. Companies are going to have a hard time generating robust earnings in the high single digit or low double digit range (where the expectations for 2020 have largely been) unless some organic growth driver unleashes a new wave of demand. This, in our opinion, could be one of the most significant headwinds to market performance next year.

MV Financial hosted a webinar discussing how to get the most from DC Health Link for small DC Employers. We covered the following:

• • MV Financial Experience with DC Health Link
  • DC Health Link Background/Issues
  • Considerations When Designing Your Health Plan & Employer Plan Options
  • DC Health Link Lessons Learned Since 2016 & Employee Impact
  • Commonly Neglected Health Benefit Options
  • Employer Planning Considerations & Strategies
  • MV Financial Client Plan Analyses
  • HRA Strategy
  • Open Enrollment & DC Health Link Functionality

The webinar can be listened to and reviewed here.

October is typically a month-long Halloween experience in the stock market: sometimes the month is full of tasty treats, as it was in 2017. Sometimes it dishes out some nasty tricks, which was the case last year (not to mention all-time Hall of Infamy years like 1929, 1987 and 2008). With the month now having come to an end we can now say that 2019 was one of the more treat-filled Octobers. After a bit of a rocky start, the S&P 500 regained its footing and added about two percent to the already sizable double-digit gains for the year to date. As it stands now the benchmark index is up close to 25 percent for the year.

Of course, there are two more months to go before the year closes out, and as always there are plenty of bad things that could happen between now and then. More often than not, though, an upbeat October tends to set the stage for a holiday rally as money managers pile into whatever is working to get their portfolios in line for year-end performance reviews. We see that as a plausible case for this year given the state of play in the three factors that been the biggest influencers in market direction for the year to date: namely, the slowing global economy, the US-China trade war, and central bank monetary policy.

Slow But Positive

The global economy is slowing, and everybody knows it. The IMF has reduced its growth outlook several times this year, most recently last week. Europe is shuffling along at about one percent real growth, while the latest US GDP figures show our growth rate to be closer to two percent. China is expanding at its slowest rate in thirty years, India is having all manner of trouble and recession threats loom in usually dynamic Singapore and Hong Kong (political unrest is having a real effect on the latter’s fortunes).

Just a couple months ago, this slowing growth trend seemed to have asset markets convinced that a recession was on the immediate horizon. The five percent-plus retreat in US stocks in August was driven in large part by those fears. But good job numbers kept coming in, consumers kept spending, and now it is clear that the absolute earliest arrival date for a recession here at home to be proclaimed would be next year’s third quarter. In other words, we would have to see negative real GDP growth for the first six months of 2020 – a scenario almost no one paying attention to the data thinks likely.

So what could send the slow economy off the rails? Enter Factor #2 on Mr. Market’s list of influencing factors: the trade war.

Much Ado About Tariffs

The ebbing and flowing of trade war rhetoric and occasional new tariffs has driven some of the bigger moves both up and down on the market this year. Economists have been clear since this issue first came on the scene in early 2018 that tariffs and other protectionist trade weapons could shave whole percentage points off global GDP. From where we sit now, in late 2019, a couple things seem clear. First, the trade war is not going to go away. It won’t go away even if Trump is defeated in November next year, because the structural problems that exist between the world’s two largest economies are real, and they will need to be addressed by whoever is in the White House come January 2021.

The second thing that seems clear now, though, is that both sides are looking for ways to improve the optics of the situation. “Optics” is the best way to describe the so-called Phase One agreement due to be signed by Trump and his counterpart, Chinese President Xi Jinping, later this month (the venue for this signing was supposed to be the Asia Pacific Economic Conference in Chile, but that event was just cancelled on account of massive street protests in the capital city of Santiago). It won’t get at any of the really hard questions such as intellectual property or US access to the domestic market, but it will soften the rhetoric and probably do away with at least some of the tariffs currently in place.

Markets will continue to react to trade headlines, even when the headlines appear to be substance-free or outright misleading. But in the absence of a sharp reversal by either side from the current position of détente, the current optics appear good enough for most investors.

Doves Rule the Skies

Finally we come to the third market-driving factor: central banks. Here there is very little mystery about what is going on behind oak-paneled doors in Washington, Frankfurt or Tokyo: the doves are in power and the doves are going to stay in power, because absolutely none of these economies are in danger of overheating. Inflation is barely two percent in the US (less than that by the Fed’s preferred measure of Personal Consumption Expenditures). It is on life support in Europe and Japan. The ECB is still buying bonds, the Bank of Japan is the biggest institutional investor in the Japanese stock market, and the Fed has reduced rates three times this year (and will almost certainly resort to more cuts and/or QE if the macro numbers turn further south).

For now, the coordinated dovishness of the principal central banks should continue to act as a support level, keeping asset prices from falling too far into correction territory. However, of the three factors we have discussed here, this is the one that could potentially go pear-shaped sooner rather than later. Central banks have spent the last decade deploying every weapon in their arsenal – and inventing new ones to boot – in the fight to sustain what has been by historical standards a relatively fragile economic recovery. As long as markets have confidence in the bankers and their tools, that support level should hold. But confidence is not what it was. In Europe there is a very heated debate going on as outgoing ECB head Mario Draghi hands the reins over to incoming head Christine Lagarde. Draghi’s move back in September to rev up the QE engine is seen by many, particularly in Germany and other “northern” economies, as misguided. If Europe falls into recession next year (which is more likely than one happening in the US), expect this controversy to become very prominent and potentially damaging.

In summary, then, we would say that 2019 is turning out better than one might have expected. We’ll take those calm seas for now, but we are preparing for plenty of potential squalls ahead in the year to come.

As portfolio managers, we at MV Financial establish benchmarks against which to measure the performance of assets under our management over time. We do this not to obsess over short-term performance – most of our portfolios are established with long-term financial goals and risk considerations in mind – but as a way of getting hard-nosed feedback from the market to either reaffirm or challenge our prior assumptions and make informed changes appropriately. Consistent with our own investment philosophy, we employ two primary benchmarks: a risk benchmark that mirrors the risk-adjusted objectives of our strategic models (ranging from a strong growth orientation to income preservation), and a style benchmark that incorporates the different asset classes we typically employ for purposes of prudent diversification. This approach works well in our opinion and helps guide constructive performance review discussions with our clients.

The Wall of 60/40

But there is an inescapable reality that increasingly seems to be an indelible feature of the global capital markets: practically any benchmark that incorporates some mainstream asset class other than large cap US equities and intermediate-term US bonds will very likely fall short of a simple large-cap stock / bond mix over practically any measurable period. The age of the relentless benchmark – encapsulated in its simplest form by some percentage mix of the S&P 500 and Barclays US Aggregate Bond index (e.g. 60/40) – is upon us. Will it haunt portfolio managers forever, or is there still such a thing as mean reversion? It’s our business to analyze phenomena like this, figure out what it implies for our investment philosophy and portfolio construction methodology, and share our thinking with our clients.

The Ageing of Modern Portfolio Theory

For as long as anyone managing money today has been around, the bedrock of portfolio construction has been Modern Portfolio Theory (MPT), the origin story of which traces back to a paper in the Journal of Finance magazine by University of Chicago Professor Harry Markowitz in 1952. MPT has evolved somewhat over the ensuing years, from simple Markowitz mean-variance analysis to the three-factor models of Kenneth French and Eugene Fama in the early 1990s that in turn pointed the way to the abundance of factors touted by the quant-driven strategies on offer today. But the core of MPT has remained largely intact: asset class diversification aimed at achieving the optimal level of return achievable in the market for a given accepted level of risk (where risk is defined as the magnitude of variance around the average tendency of returns). The so-called “efficient frontier” is supposed to look like a more or less linear progression from ultra-safe assets like short-term Treasury securities to volatile categories like emerging market equities and illiquid venture capital.

Beware of Central Bankers Bearing Gifts

The efficient frontier has been about as robust a frontier in recent years as the French Maginot Line in the Second World War (i.e., not able to withstand assault). Up to a point, investors get additional return for their incremental assumption of risk. That point, to be specific, is US large cap stocks. The chart below illustrates this phenomenon. It shows the ten-year trendline for the S&P 500 (the thick red line) and for the Barclays Aggregate Bond index (the think dark purple line) against a handful of other asset classes. All the other assets – from REITs to small cap stocks, developed and emerging non-US markets and commodities – are riskier than large cap stocks and bonds (again, as measured by volatility around expected returns).

The uselessness of the efficient frontier over this ten-year period is perhaps best illustrated by looking at that relative performance of emerging market stocks – the riskiest asset on that chat represented by the pink line – and the least-risky alternative of US bonds. In terms of absolute cumulative performance, these two asset classes returned almost exactly the same over this period. Taking on all that additional risk to invest in emerging markets, it turned out, bought you no incremental performance gain over investing in safe, plain-vanilla bonds. For an entire decade.

There may be many explanatory factors at work here, but one looms large above them all: easy money from central banks. The coordinated dovish policies of global central banks over the last ten years brought about two accomplishments: first, maintaining continual downward pressure on interest rates (which in turn makes bond prices higher) and, second, pushing traditional fixed income investors out of their usual safe habitats into riskier assets.

But “riskier” only up to a point. When we say “traditional fixed income investors” we are talking about the likes of insurance companies and pension funds: large institutional investors with very conservative investment policy mandates. Disappearing bond yields required these investors to go further afield, but they were never likely to venture too much past high quality, dividend-paying large cap stocks. Hence the disruption of the risk frontier at the point of US blue chip stocks and the relative underperformance of all those other, riskier asset classes. The disruption comes courtesy of the Fed, the ECB and the Bank of Japan.

So have central banks slayed Modern Portfolio Theory for once and for all? We would not bet on it. The monetary policy phenomenon of the past ten years is already showing signs of wear and tear. At some point the Great Bull Market of the 2010s will come to an end, and at some point thereafter a new one will rise. We know neither when nor how any of this will come to pass. But when it does, we would imagine it more likely than not that the relationship between risk and return will look more like the efficient frontier of old than the domineering 60/40 wall of today. But those will be decisions for a future day. The more immediate task is to prepare for what we believe will be a tricky set of currents to navigate in 2020, which has the potential to be a very strange year indeed.

Arian Vojdani was featured in a Bloomberg Radio segment today discussing market outlook. The segment can be listened to here.

Wednesday, November 6^th 3:00-4:00 EST

Most DC-based employers with less than 50 employees are using DC Health Link for its health insurance, yet many are not maximizing its potential in order to gain the most from this platform.

DC Health Link, when used properly, is an excellent tool for small employers to provide benefit options that rival many Fortune 500 companies. Unfortunately, many employers aren’t using the system correctly and are experiencing these common problems:

• Higher than expected costs, depending upon the insurance carriers chosen.
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This webinar will unravel the complexity of DC Health Link, helping employers understand:

• How to set up multiple benefit groups to lower plan costs and direct budgetary dollars efficiently.
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• DC Health Link’s problem resolution process.
• Helping employees who lack social security numbers.
• Solutions for employees living out of area.
• Proper open enrollment that helps employees select the appropriate plan to meet their personal needs.

Speaker:

Joe Potosky, CLU, ChFC is the Head of Employee Benefit Services for MV Financial and has over 25 years of experience in the design and management of employer-provided group benefit plans (health, welfare and retirement plans). Joe specializes in employee benefits for employers with less than 50 employees. He is sought after for his insights on employee benefit issues, including healthcare and pension reform.

Joe has provided speaking engagements for organizations such as DC Health Link, Maryland Association of Health Underwriters, National Association of Insurance and Financial Advisors (Maryland Chapter), NonProfit HR National Conference, Goodwill Industries’ National Conference, and numerous MV Financial webinars.

Joe is an attorney with an MBA and holds the professional designations of Chartered Life Underwriter and Chartered Financial Consultant. He also holds the Patient Protection and Affordable Care Act certifications form the National Association of Health Underwriters and is a Certified Health Savings Adviser.

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Arian Vojdani was quoted in a CNBC.com markets piece discussing the current state of markets. The piece can  be read here.

In last week’s market commentary we argued the case for why a near-term melt-up – a giddy rally in the stock market through the remaining months of 2019 – might be in the cards. One week later we see continued evidence that, if not exactly a go-go 1999-style event, conditions seem to be in place for at least consolidating the already sizable gains made in the market this year. The earliest batch of Q3 corporate earnings is out and, while not particularly stellar, the numbers seem to fall roughly within consensus expectations. The Fed meets next week and is likely to come through with another rate cut (at least according to the Fed funds futures market, where a 0.25 percent cut presently has an 82 percent probability of happening). Sentiment around the trade war seems contained now that a largely cosmetic “mini-deal” seems set to happen. Sure, the IMF came out with another downward revision to global growth this week, and yes, China’s Q3 GDP growth was, at six percent, its lowest in 30 years. But slowing growth is not new news, and it’s probably more a story for 2020 than for today. So what could go wrong?

Inversion Reversion

This week we look at the situation from another angle, that of the yield curve. Recall that back in August the inversion of the yield curve at the significant segment between 2-year and 10-year Treasuries was big news. A 2-10 inversion historically is a prescient harbinger of recession, and suddenly it seemed like we were barreling towards an imminent reversal of fortune in GDP growth. Or were we?

Look at that chart above, showing the trendline for the 2-year and 10-year Treasury yields over the past twelve months. Do you see the inversion? Can you make it out? Just follow the arrow…to that little dip at the end of August where, for a few days, the 10-year yield fell as low as 5 basis points (0.05 percent) below the 2-year yield. That was the dreaded inversion. And then it was no more. As of this week, some six weeks after the inversion began, the 10-year yields about 15 basis points more than the 2-year, which is also about where the average spread between the two maturities has been for the last twelve months.

Shades of 1998

So no inversion, no recession, right? Well, not for now. Just before the end of this month we will see how real US GDP growth fared in the third quarter. The consensus estimate is for a quarter-to-quarter gain of 2.2 percent – not fantastic, but not negative. If the consensus is more or less on target then – simply according to basic recession math – the earliest date on which the Business Cycle Dating Committee of the National Bureau of Economic Research could call “recession” would be whatever day in April 2020 the Bureau of Economic Analysis releases its Q1 2020 GDP report. And for that to happen we would have to experience negative growth both in the fourth quarter of this year and the first quarter of next. Right now there is really nothing out there to suggest that today’s economy – for we are already in Q4 – is going to serve up negative growth.

Here is another reference point. In the chart below we show the same graph as above – the 2-year and 10-year yield trends – for calendar year 1998. See if you can spot the similarity.

See that little inversion? In July 1998 the 10-year yield briefly fell below the 2-year. And throughout that year the spread between the two bonds was very tight – 16 basis points, very much like the 17 basis point spread we have seen in this calendar year 2019. As we now know, a recession didn’t happen in 1998, and one would not happen until 2001 (though the market started tanking a year before that).

Now, the economy of 2019 is not as strong as the economy of 1998 was (for proof, just look at the absolute value of the interest rates back then, ranging between four and six percent, compared to the sub-two percent trends of today). Global trade is under threat and businesses are investing less in their growth. But consumers are still spending, central banks are still printing money and ham-fisted political leaders are still groping for face-saving ways to get out of some of their more egregious missteps on the global stage (see: trade war, Brexit). The negatives will come back into sharper focus at some point. From where we sit, though, it seems less likely that the appointed hour will show up before this year winds down to a close.

This past week we finalized our regular quarterly commentary, summarizing the main goings-on of the recently ended third quarter and opining as to what may lie ahead. “Lots of noise and elusive growth” roughly encapsulates our take on the global economy in the months to come. While that outlook may lend itself to intermediate-term portfolio allocation decisions on the more conservative side of the risk-return tradeoff, as we have suggested, it does not mean that the directional trend will be a one-way trip down. Indeed, there is a case to be made that a melt-up – a frenzied run-up in risk asset prices with little regard for the quality of individual names – could be in the near-term cards. Whether that happens or not will depend not so much on the underlying structural context, but on the optics of headlines, primarily those surrounding the US-China trade war and to a lesser extent some new developments in Brexit.

Exodus from Quality

You frequently hear market pundits toss around the term “crowded trade” and may wonder what they are talking about. A crowded trade is just another term for momentum, and for much of this year the momentum has been with higher-quality assets, e.g. ultra-safe government and high-grade corporate bonds, rich dividend-paying stocks with relatively predictable size and timing of cash flows. Recession-resistant consumer staples names have done well; industrial manufacturers tied to the ups and downs of the business cycle (and vulnerable to the trade war) have fared poorly in comparison.

The more crowded a trade gets, of course, the more expensive it gets. Supply and demand. At some point, the price of entry intimidates new demand, and the price of exit becomes appealing as soon as the rationale for staying in the trade looks weaker. For example, high dividend stocks are great if fixed income interest rates are hovering in the low single digits (or, even more so, in negative territory). If bond rates suddenly back up, that dividend yield play suddenly looks much less enticing.

Enter the Headlines

To an almost absurd extent, the market has been obsessing over the US-China trade war for a good part of the last eighteen months. The issue is important, of course, given that we are talking about the two largest economies in the world and what the future of global trade will look like. But the daily market moves throughout this period have tended to react in exaggerated fashion to headlines which in turn mostly emanate from the Twitter feeds of the principals involved in discussions, most of which are light on content, heavy on empty platitudes, and not infrequently outright misleading.

You are probably aware that trade negotiations are going on this week in Washington. Given how the market has been reacting, it would be tempting to think that something momentous is brewing. It’s not: there seems to be a reasonable probability for some kind of modest truce, or what the pundits are calling a mini-deal, that would essentially hold off on higher tariffs for a while and help US farmers sell a few more agricultural products to China. Nothing about this truce, if it does in fact happen, will in any meaningful way address the real structural problems between the US and China that have always been at the core of the dispute. But no matter – this is all about optics, not substance. A “mini-deal” is a better outcome than a no-deal, and that’s all the trader-bots need to indiscriminately fire up the buy orders.

Tiptoeing Over the Low Bar

But wait, there’s more! A melt-up is even more likely when a second piece of kindling is tossed onto the fire alongside the main catalyst. Playing second fiddle to the trade war happy talk is, of all things, Brexit. Just in the last twenty four hours evidence has emerged that the EU is ready to green-light “serious” talks with the UK to work out the seemingly insurmountable obstacle of Northern Ireland (i.e., the problem of a “hard border” between Northern Ireland, which is part of the UK, and the Republic of Ireland, which is and will remain part of the EU). The details about how this would work are not known. What is known is that UK Prime Minister Boris Johnson and Irish Taoiseach Leo Varadkar believe a deal is within reach after meeting on Thursday, and EU Council president Donald Tusk is convinced the sides are close enough to an outcome to bring the EU team back to the table. Just two days earlier, any of this would have seemed the least likely of options. But Tuesday’s “chasm” turned into Thursday’s “bridgeable gap.”

Now, asset markets outside the UK haven’t paid much attention to Brexit to date. But the general consensus is that in the scheme of things a smooth, managed Brexit would be preferable to a hard crash out of the EU. Not as good as just staying in the EU, of course. Just like a truce in the US-China trade war is preferable to another scaling up of tariffs or putting limits on US investment flows to Chinese assets. Not as good as going back to the pre-tariff world, and far short of the even more desirable outcome of a constructive solution to the actual problems at the heart of this economic relationship.

But good enough, for now. Good enough for a melt-up, perhaps. But the problems, including the more structural problem of elusive growth, are not likely to go away any time soon.