The Radix Market View: Brexit, Bitcoin and Bears
2018 was a difficult year for investors. Globally, the world’s biggest stock markets closed the year down, more than reversing the gains that had been made at the start of the year. The FTSE 100 ended the year down 12% whilst the Dow-Jones closed 5.6% lower. Crypto-markets fared much worse. Bitcoin, which started the year at close to US$ 15,000 lost more than 75% of its value to close the year at c. US$ 3,700.
But, whilst stock markets — which many consider to be overvalued — suffered heavy losses, the global economy was predicted to grow 3.7% in 2018 fuelled by 3% and 6.6% growth in the US and Chinese economies respectively. The UK economy and European Union also saw economic expansion despite BREXIT and wider global economic headwinds.
So, what happened in 2018 and what can we look forward to in 2019?
2018 Summary
Stock markets kicked off 2018 in an upbeat mood. US President Donald Trump had cut corporate taxes, putting a staggering $1.5tn money back in the hands of US corporations. Many predicted this would fuel a boom in US economic growth, further cutting record low employment rates, increasing wages and therefore spending.
Any excitement was short-lived, as President Trump soon turned his attention to China. President Trump has blamed China for trading on unfair terms and stealing US intellectual property, signing into law tariffs on $250bn of Chinese goods and threatening tariffs on a further $250bn. In return, China has imposed tariffs on $130bn of US goods, in particular harming US vehicle sales. In addition, President Trump has also turned his fire on the US Federal Reserve, blaming it for harming US growth prospects as it continues its policy of gradually increasing interest rates. Presidents often steer clear of interfering in the US Central Bank’s decisions so as not to harm its perception of independence.
Across the pond, in Europe, BREXIT has been weighing on the UK economy and, to a lesser extent, on the European economy. BREXIT uncertainty appears to have put business investment in the UK on ice with many businesses. Many businesses have warned of the negative impacts a no-deal scenario may cause, in particular to the manufacturing process relied on by car manufacturers. Other businesses have started to stockpile food and medicines. As negotiations continued and it became clear Europe would not give the UK an easy ride, Prime Minister Theresa May sought to build ties with other nations, dancing her way through a trade mission in Africa.
In Europe, German Chancellor, Angela Merkel announced she would be stepping down in 2021 following a poor showing at the polls in 2017. As Chancellor Merkel’s problems mounted, Europe needed a new leader who came in the form of France’s President, Emmanuel Macron. However, President Macron has, himself, suffered a series of setbacks in 2018. His reforms have not resulted in improved economic growth or lower unemployment and his approval ratings have tumbled, making him one of France’s most unpopular presidents at this stage in his presidency. In December, the President suffered a further blow when the ‘gilets jaunes’ (yellow vests) protests, his government had earlier dismissed as the work of a few “trouble-makers”, grew in popularity and violence, forcing a climb-down and economic concessions.
Italy’s new populist government also did its best to make waves in Europe, presenting a high-spending budget which rattled Europe and the markets. Rome was reprimanded by the European Commission and told to reduce its budget or face fines. This prompted a negotiation which saw Rome cut just 0.4% of what it planned to spend.
From a consumer perspective, the end of 2018 saw a surprise fall in consumer confidence and spending. Both UK high-street and online retailers saw weakness in sales in the lead up to Christmas prompting UK stalwarts like Waitrose to issue trade statements warning of weakness and missed expectations. ASOS, the UK online clothing giant, also reported weaker than expected growth pointing to slowing demand on the continent — in particular in France and Germany — for its gloomy outlook. House price growth has slowed to a crawl, with both buyers and sellers deserting the market and all of this at a time when the raw economic numbers suggest that wage growth is outstripping inflation and UK workers should, in fact, feel richer for the first time in many years.
Given the relative political and economic uncertainty hanging over the global economy, 2018 was a reasonably good year for global growth.
The look-ahead to 2019
Global growth is expected to remain broadly flat in 2019, with the IMF downgrading its forecast from 3.9% to 3.7% — in line with 2018.
The start of 2019 will continue to be dominated by the US — China trade war. With President Trump threatening more tariffs, if he doesn’t get a deal, and China running out of US goods on which to impose tariffs, the impact on the world’s two biggest economies could be significant. Indeed, US farmers are already feeling the heat, with reports of unsold soy-beans — a significant import for China — growing into ‘mountains’ in farm fields.
On the third day of the year, the US investment darling Apple issued a trading statement warning of missed forecasts due to a slowdown in demand for its products in China — in particular, driven by lower iPhone sales.
Stock markets, which started the year down, turned gloomier driven by a fall — prompted by the Apple news — in the share prices of companies whose fortunes are closely tied to a significant proportion of sales from the Chinese mainland. Bitcoin, which has recovered from its 2018 low of US$ 3,200 — a recovery perhaps driven by some sentimentality with its meteoric rise at around the same time in 2017 — has remained steady and is trading at US$ 3,800 a coin.
US growth will be further weakened — at least in the first quarter — by the partial government shutdown, which shows no signs of being resolved. With Democrats now in control of The House of Representatives, President’s Trump’s ability to pass legislation is now seriously hamstrung. Whether they believe border security is an issue or not, agreeing funding for the wall would be too big a political win for President Trump just as both parties look towards the 2020 Presidential race. So, a stand-off looks likely, unless the Democrats and the President can find something that makes the President look like he hasn’t just caved in completely. Equally, any economic measures that might boost President Trump’s popularity before elections will, most likely, suffer setbacks.
China’s issues extend beyond its trade fight with the US. A slowing economy coupled with an ageing population will hurt economic growth. Whilst concerns are focussed elsewhere it’s important to note that China still has to deal with the concerns about its debt-fuelled economic growth and the large shadow banking industry which dominates finance in some parts of the country. Indeed, China’s many unresolved financial issues coupled with pressure from its trade war with the US, may throw its economy off kilter, tipping the global economy into a slow-down or, worse still, recession.
The UK and Europe will continue to be dominated by BREXIT. Parliament is due to vote on the BREXIT deal on the 14th of January and forecasts suggest that, as before the New Year, the Government does not have the support it needs in the House to win the vote. What happens next is anyone’s guess… Will the UK leave in March 2019 or will seek to extend the withdrawal period? In addition, what will the impact on the UK and Europe, the UK’s biggest trading partner, be of the UK’s departure — especially if the UK leaves without a deal? Many questions remain unanswered but, one thing is may well be certain: with warehouses full of many goods such as food and medicines as businesses try to limit the possible disruption from a disorderly exit from the EU it is likely that the UK’s trade with the EU will be lower this year than it was last year.
Fears of a global recession, led by the US, were further fuelled when, early in December, the yield curve momentarily inverted. Put simply, the return on longer-dated treasuries (US government bonds) fell below the return on shorter-dated bonds. Normally, you would expect longer-dated bonds to pay more interest as they carry more risk since you have to wait longer to get your money back. The yield curve has been a relatively good indicator of historic recessions, with all recessions in the last 60 years being preceded by an inversion in the yield curve within 9–24 months of it starting.
One final thought… Just before Christmas President Trump lambasted The Federal Reserve for increasing rates, once again, prompting investors to flee the stock market and triggering a rather extraordinary turn of events. In a surprise move, US Treasury Secretary, Steve Mnuchin (a former Goldman Sachs banker), felt compelled to call the US’s six biggest banks as he tried to reassure investors all was well. In a public statement announcing the unusual move, the Treasury Secretary confirmed the banks had “ample liquidity” to fund operations. The timing of the Treasury Secretary’s intervention was a surprise, with many commentators wondering whether it could further undermine confidence in the markets and economy suggesting there was no reason for the intervention. One commentator noted, “The problem with his comments [is] he’s either incredibly out of touch, or he knows a problem nobody else knows.”
The clouds may well be gathering…
Questions:
1. What are your thoughts on where crypto is heading and how would a fiat crisis affect crypto when at US$ 100bn market cap?
Crypto markets are very closely linked to ‘smart money’ now. The listing of BTC on exchanges such as the CBOE and CME changed the game for crypto markets as regulated financial institutions (institutional investors such as investment funds, hedge funds etc.) now had a way to invest in crypto. Whatever happens to stock markets, the crypto markets will generally follow. In a downturn (as we saw last year), they may well lead as investors abandon ‘riskier’ investments for safe-haven assets.
So, why is this? Crypto-currencies are, from an investment point of view, speculative assets which are high risk but afford high returns. Therefore, regulated FIs will only invest when they are feeling bullish. This isn’t necessarily the case right now, as we saw with the surprising strengthening of the Japanese yen last week — a currency investors flee to for ‘safety’ in times of uncertainty. Ultimately, if market sentiment remains subdued, then it should be expected that crypto markets behave in much the same way.
The irony of Satoshi’s wish for BTC to be a way to circumvent the traditional financial system is that BTC is now, to an extent, in song with the very system Satoshi hoped it would overcome. If we have another global financial crisis then it is, for the reasons highlighted above, likely that crypto prices would drop. Money will become tight and the last thing you do with funds when they are tight is invest them in assets where you may or may not get your money out. At least, that would be the rational approach.
2. What are your thoughts on data indicating the BTC price is uncorrelated to the stock market?
A recent article analysing the correlation of BTC with the stock market (specifically the S&P 500 index) highlighted that, in 2017, when stock and crypto markets made record gains, BTC had an almost perfect beta value with the stock market of 0.92. In 2018, however, BTC had a beta of 0.30, suggesting only a loose correlation.
Isn’t it interesting that the year (2017) BTC becomes a mainstream asset and gets listed on futures exchanges, essentially providing regulated financial institutions with a way to invest, we get a large spike in its price and a very strong correlation with the stock markets?
The lack of correlation in 2018 isn’t a surprise. As the price of BTC dropped institutional investors likely sold down and banked their profits at the start of 2018, largely abandoning BTC markets to retail investors. The price of BTC essentially went sideways (and then down) for the year.
The point is this: At an $70bn market cap, it’s easy to see why you need the big boys (institutional money) to play in order to move the dial meaningfully. Institutional investors are unlikely to invest in, what they would consider to be, riskier asset classes unless things are looking up and any potential losses from highly volatile and unpredictable crypto-markets can be made up elsewhere.
3. What are your feelings about debt and QE?
Donald Trump isn’t right about many things but he may well be right about how the steady increase in rates in the US is going to hurt the economy. Borrowing is steadily becoming more expensive, and that’s borrowing on everything — mortgages, cars, business loans etc. However, more expensive borrowing — if it results in a reduction in borrowing — isn’t a bad thing as debt levels (public and private) have been ballooning globally for the last decade.
In the UK and EU we have had it so good for so long that we seem to have forgotten what a normal interest rate environment looks like. Prior to the financial crisis average interest rates in the UK were c. 4–5% for a period of 10+ years. So let’s imagine a scenario where rates ‘normalise’, increasing people’s mortgage repayments by not-insignificant amounts and couple that with a financial crisis — job losses, wage cuts, etc. Mortgages are cited specifically because, in the UK, people generally borrow to buy homes at the margins of affordability. The result, as you can imagine, could be fairly catastrophic and explains some of the thinking behind why the Bank of England insists on stress-testing banks on a scenario that envisions a, seemingly extreme, 30% drop in UK house prices.
As for our central banks, they seem to have been essentially been hamstrung if another financial crisis were to materialise now. Interest rates are at historic lows and the effectiveness of cutting them further is questionable. As for QE, you cannot keep pumping ‘liquidity’ into the system by buying bonds forever — even commercial paper. As we have seen with the ECB, the good bonds eventually run out and you end up having to buy riskier and riskier assets… The levers of monetary policy will, therefore, be much less effective if another crisis were to materialise soon.
In short, the world does not appear to be in a good place to deal with another crisis should one arise soon.
