Wednesday, Sept 16Hamish Risk | September 16, 2020
If you’re a US hedge fund manager, does a Trump Presidency or a Biden Presidency suit you better? As far as your returns are concerned that shouldn’t matter, what matters is that you get the final result correct, says Joachim Klement from Liberum, citing a recent academic study that highlights the divergence in returns between those managers that got it right and those that picked the loser in previous elections. Politics does matter. Ahead of today’s FOMC press conference Pantheon Macro’s Ian Shepherdson says it is clear from the central bank’s emphasis on employment that they think the risk of overshooting inflation is much smaller than the risk of undershooting employment for the foreseeable future, and as such, they have much more room for manoeuvre. They will not blink, he says. Capital Economics aren’t so sure there is the level of labour market slack that the Fed is projecting, maintaining that there may be rising wage pressure ahead. As we highlighted last week here, the Fed has taken the mantle of the king of the doves, and this has driven the euro higher over the summer. ECR Research identifies a short-term buying opportunity to pick up some cheap euros, before the euro marches higher towards $1.30. Finally, in our regular ESG segment, TD Securities focuses on the US election, and the implications for the ESG sector, where the momentum for adoption has been somewhat muted compared to Europe.
behavioural finance hedge fund returns US presidential elections Liberum
1. Why getting the US election right matters for returnsPolitics matters for investing, whether you like it or not, and being able to realistically assess the economic effects of policies and elections is a key advantage if you want to make money, says Jaochim Klement at Liberum in his regular ”Thought for the Day” note. The first step towards this end is for investors to overcome their political bias. Klement says investors see the world not as they want it to be, but as it is. Believing in political fantasies might keep you in the good graces of politicians and maybe your circle of politically like-minded friends, but it certainly won’t help your portfolio, he says. How big the difference between investors who understand political trends and their impact on the economy and market can be is relatively easy to show, according to Klement. He points to this recent study from a group of researchers from the University of Central Florida who measured the “political leaning” of US equity hedge fund portfolios. Klement says the study found that around the time of a Presidential election, hedge fund managers shift their portfolios in the direction that benefits the likely winner of the election, but investors who are better at predicting the outcome have an advantage because they can position their portfolio more aggressively towards the stocks that will benefit from the eventual winner and do so before other investors do. Indeed, Klement says the alpha earned by hedge fund managers varies significantly depending on their ability to incorporate Presidential elections into their portfolios, with the bottom quartile of hedge fund managers by political sensitivity earning an annualised alpha of 1.2% in the election year and the top quartile managers that are best able to exploit politics in their portfolios earning an alpha of 5.6%. Klement’s Thought for the Day note is a complimentary note, and almost always provides insight and nourishment, particularly in the area of behavioural finance. Contact Jaochim below to get added to the list.
employment Fed policy Inflation Pantheon Macro
2. The Fed’s pursuit of maximum employmentIt is not clear if the first FOMC meeting since the release of the Fed’s new Monetary Policy Strategy will bring any real shift in policy, but it is clear from the central bank’s emphasis on employment that they think the risk of overshooting inflation is much smaller than the risk of undershooting employment for the foreseeable future, says Ian Shepherdson at Pantheon Macro. This switch of emphasis in monetary policy strategy is born of exasperation with the breaking down of the Phillips Curve relationship between unemployment and inflation, he says. Shepherdson notes that wage inflation – the key driver of price inflation in the Fed’s cost-push view of the world – rose by much less than expected in the later stages of the pre-Covid cycle, thanks to the absence of a premium for scarce labour. Sheperdson says that if this is the new normal – and no one knows for sure why labour scarcity failed to generate a wage premium – then the Fed has much more room for manoeuver. Interestingly, Shepherdson notes that the Fed still believes that a loose labour market will exert disinflationary pressure – in other words their view of the Phillips Curve is asymmetric. The bottom line, says Sheperdson, is the Fed has now made an inflation overshoot an explicit policy objective, in the wake of an almost unbroken 12-year streak of undershoots in the core PCE measure, and the central bank will not blink and is not even thinking about thinking about rates hikes.
US labor market wage inflation Capital Economics
3. The labour market isn’t as slack as slack as you thinkWith initial jobless claims still running at close to one million per week, it could be argued that, at 8.4% in August, the US unemployment rate is not capturing the full extent of the slack in the labour market, says Paul Ashworth at Capital Economics. But he says the survey evidence and the job turnover data paint a very different picture – suggesting that there is less slack now than there was coming out of the financial crisis a decade ago. The unemployment rate for permanent job losers has risen during the pandemic but, up to now at least, the rise resembles the very mild 2001 recession rather than the 2009 slump explains Ashworth. He suspects that the more modest permanent job losses explain why small businesses are saying it is still surprisingly difficult to fill jobs and why households believe that jobs are still relatively plentiful. If there really is less labour market slack than widely believed then that could have important implications for wage growth – and possibly price inflation too, says Ashworth. The resilience of earnings growth would be another reason to believe that price inflation may rebound more quickly than expected given the severity of the downturn in the real economy.
EA economy euro ECR Research
4. A buying opportunity in the euro beckonsWhat will nudge the euro either side of the recent relatively tight trading range following the move that took the euro 8 big figures higher in July? The intensity of the Fed’s guidance probably holds the key, but as Edward Markus of ECR Research writes in a note today, the euro may correct lower in the short term, which he says probably presents a buying opportunity. Markus says this correction may come as sentiment towards Europe takes a negative turn as COVID cases flare up again which likely to negatively impact the European economy and is therefore negative for the euro. However, Markus says that as long as the $1.14-$1.15 level holds, he forecasts a continuation of the medium term uptrend that could take the currency pair up to $1.30 in the months ahead. This, says Markus, is because the Federal Reserve will “out-dove” the ECB (As Ollari Consulting highlighted in last week’s briefing), and have to hit the monetary accelerator harder than its European peer since a great many debts worldwide are in dollars. In addition, he says, it is also unclear how much fiscal stimulus will be applied in the US. Indeed, Markus says as it stands now, the extent of US fiscal stimulus will be limited, meaning the Fed will have to hit the monetary accelerator even harder.
ESG US Elections TD Securities
5. What does the US election mean for ESG?Gennadiy Goldberg at TD Securities has issued a report ahead of the US election, which he believes will be a key fork in the road for the rapidly-growing ESG sector. He says the re-election of President Trump is likely to offer little support to the ESG agenda, as has been the case over the past four years as the Trump administration withdrew the US from the Paris Climate Accord and rolled back numerous environmental regulations. A Biden victory, on the other hand, is likely to bring US re-engagement in multilateral climate talks, a reversal of environmental deregulation, and push the US toward stricter ESG policies according to Goldberg. He argues that even though tough new ESG policies may not have sufficient support in Congress even in a Blue Wave scenario, portions of the “Green New Deal” may be incorporated into the agenda going forward. Despite the absence of US government support, Goldberg notes, the ESG sector has grown by leaps and bounds over the past four years in any case. He believes this has been aided by international leadership on ESG, investor pressure, a shift in generational preferences and more ESG integration into broad-based investment analysis. Indeed, Goldberg says it is worth noting that the Bloomberg Barclays ESG Agg outperformed the Global Credit Agg index since the start of the year on a risk-adjusted basis.