Global markets are showing signs of being in the late stages of a game of Jenga, and investors need to play cautiously, argue two BlackRock executives.
Jenga is a game in which players take turns removing one block at a time from a tower constructed of 54 blocks. Each block removed is then placed on top of the tower, creating a progressively taller, yet more unstable, structure.
The game ends when the tower falls and the loser is the person who made it fall.
“To us, the 2018 investing regime is evolving much like a late-stage game of Jenga, with the Federal Reserve and Treasury clinically and methodically removing the blocks of stability from underneath the financial and real economy ‘towers’,” wrote Rick Reider and Russell Brownback.
Mr Reider, who is BlackRock’s chief investment officer of global fixed income, and Mr Brownback, who is an absolute return portfolio manager at the firm, said monetary policy restrictiveness, fading fiscal stimulus, and growing economic uncertainties have made markets vulnerable.
“In our view, this vulnerability is evidenced by the recent acute spike in market volatility.”
The VIX, a key measure of US equity volatility, spiked more than 25 per cent at one point overnight, before ending the session 5.5 per cent higher. Since early May, the VIX has traded in a range of 10 to 15. It closed on Tuesday in New York at 20.7.
In an overnight tweet, Allianz chief economic adviser Mohamed El-Erian said there was a volatility regime change taking place, and he saw the VIX resetting in the 15 to 20 range.
“Remember, this market transition – away from ample and predictable liquidity support (particularly central banks) and towards more fundamentals-driven (with an overlay of uncertainty due to divergence, trade policy, etc.) – is inherently volatile,” Mr El-Erian also tweeted.
‘Far more benign’ Fed view
The BlackRock executives said they have a different view on the current market narrative that “robust” US economic growth and corporate profits are poised to press a capacity-constrained economy into a mode of overheating that will prompt the US Federal Reserve to seek a restrictive policy stance.
Fed policymakers, including chairman Jerome Powell, already have flagged the potential for the Fed to lift rates higher than neutral.
“Our base case monetary policy scenario is far more benign, as increasingly skittish financial markets, along with signs that previous tightening has already started to bite parts of the real economy, suggest to us that the tightening cycle is nearing its end. To be clear, though, we do not think the Fed will mistakenly become too restrictive.”
Mr Reider and Mr Brownback argue that yellow lights are flashing on the economy in particular with regard to “forward expectations”.
In fact, Caterpillar’s chief financial officer Andrew Bonfield overnight sought to ease investors concerns about the outlook for the company’s earnings by saying it’s simply not feasible for the industrial equipment maker to continue to grow as fast as it has. Its profits surged 120 per cent in the first quarter, 99 per cent in the second and 47 per cent in the third.
“There does come a time when you grow at more normal levels,” Mr Bonfield told Reuters.
US equities attractive
The BlackRock executives pointed to weakness in both the US housing and auto markets as reflected in declining mortgage applications, housing turnover, and a reduced rate of home-price appreciation as well as a notable decline in used car prices.
“All things considered, we’re increasingly convinced that the Fed will not allow the Jenga tower to topple. Instead, we see a looming slowdown in the march toward ‘normalisation’ and a subsequent victory declaration regarding the Fed’s dogged pursuit of policy neutrality.”
BlackRock sees value in the short-end of the Treasury market, in particular two-year notes and sees an emerging opportunity in five-year notes. “US equities are increasingly attractive to own outright at ever cheaper valuations, just as corporate buybacks are set to resume after the third quarter earnings season ends.”
Still, Mr Reider and Mr Brownback said there are opportunities for investors. “After all, no matter how precariously the Jenga tower is leaning, a player can’t win unless they remove a block and carefully place it on top.”