Investors are pausing, Bond markets are rewinding and everyone wonders if we are going to have a replay of the last four years - or the four before that.

October saw US equities swing first up and then back down to be slightly off, but saw long bonds, which had a very strong Q3, give it all back and end up almost literally where they started June, down over 7% on the month and not far from where they were a year ago.

As suspected, the dramatic short squeeze in China at the very end of the third quarter caused some forced buying/covering, but saw little real follow through, consolidating at around 2/3rds of the initial gain, as traders wait for the allocators; who are still on the sidelines. Japan meanwhile, whose move in August was essentially equal and opposite to China’s in September, is also consolidating - not least trying to digest the latest domestic political events.

‍The dollar meanwhile unwound all of the August and September weakness -principally against the Yen - while Gold continued to drive upwards, as did bitcoin. Oil, gyrated around on GeoPolitics, ending volatile but flat.

US Election an excuse to hit pause

The US Election is almost upon us and while the traders have been shifting back and forth, asset allocators and long term investors seem happy to remain on the sidelines, or, as we put it in the October monthly, waiting to react rather than trying to predict. Even then, and assuming (fingers crossed) that the actual process is smooth, we are still unlikely to be in much of a position to make a decision this week or this month, as we won’t really know much more about actual policy, needing to disentangle campaign rhetoric from practical government. There is also a reasonable possibility of a rerun of the Al Gore/ George Bush 2000 saga, with things dragging out until December, which markets didn’t like very much at all. Nor would they this time.

The markets will try to react this week of course, and here previous experience suggests fading whichever market move greets the result, since it would say more about pre-positioning than anything else. Currently markets look to be pricing in a decent sized Trump win, which suggests a bit of caution, not because we are making a prediction, but rather, in a manner similar to the Brexit vote in 2016 and with sterling at 1.50 on a predicted ‘remain’ win as the vote came in, the price is largely all ‘one way’. But even as we write this, things are moving around with some polls and now the betting markets…

Post Election, the incentive for both sides will be to talk things down a bit - whoever wins

The US yield curve is now upward sloping again from anything beyond one month to 10 years as the markets focus on the fact that neither candidate appears serious about reducing the Budget deficit. The ETF we use as a proxy for the long bond (TLT US) has given up over half the gains it made from the lows in October last year and looks very unattractive right now, not only on our Model portfolio conviction scoring system, but also across almost every technical indicator we look at.

Markets have a tendency to put an economic ‘explanation’ on market moves and a weak bond market could be ‘blamed’ on either ‘too much growth and thus inflation’ or too little growth and thus stagflation and debt issuance’. Either way, it has unwound all the strength over the summer and is close to where it was a year ago.

Post Election, we suspect that the current, ‘glass half full’ analysis of the US economy may switch the other way, primarily because there is a big difference in the perceived KPIs for government, the big headline figures that look good (and markets focus on) rather than the more detailed numbers that are less so and are actually the issues being voted on.

Small business confidence doesn’t look like it believes the Harris campaign on support for them, while the Citi Economic surprise index - that had been beating the gloomy predictions that had supported the bond markets during Q3, have just rolled over.

Post election, win or lose, team Harris would have less incentive to keep the good stories going in the media, while team Trump would also want to talk everything down (except the markets).

For example, as we noted in ‘tails wagging dogs’, unemployment at 4% may be seen as a pure indicator by the bond markets, but the headline number bears little relation to the experience in many demographics. Nor does that fact that, while year on year inflation is now down, actual price levels for groceries are 30% higher in the last 3 years. Equally ‘strong GDP growth’ - the third of the Trifecta - isn’t quite so strong if it comes at a time when the nominal Debt is expanding faster than the nominal GDP.

Meanwhile, not only is saying the stock market is at all time highs not resonating with people on benefits, but also, whichever team is on the losing side will have a big incentive to talk equity markets down as ‘a vote of no confidence’ in their opponent..

Short Term Uncertainties ; Don’t forget Thanksgiving

There was no real October surprise, and certainly not the BRICS currency one we raised the possibility of last month. Progress is being made, for sure, but it is clearly not yet ‘oven ready’. Gold however, continues to believe in the story, as do we.

As to actual policies, so far the Harris camp hasn’t committed to anything much in detail that might affect the markets, while the main early impact from Trump would come from his day one promise to ‘ drill baby drill’, which appears to be having more influence on the oil markets at the moment than the middle east tensions are, Other campaign promises on things like tariffs need greater clarity as to scale and purpose. Most investors see little need to be brave here.

As such, it is unlikely that there is going to be much new positioning in the near term, not least because of the calendar. As noted in previous years, while end September is often the year-end for a lot of mutual funds - with associated forced buying/selling by managers and tax harvesting by US investors - Thanksgiving is the de facto year end for many hedge funds and alternative managers, which means there is only going to be a little over three weeks between the election and ‘year end’, after which books tend to be squared.

One thing both parties in the US appear to agree on is the need to curtail the threat from China, which in reality is an economic one. As such the foreign policy establishment is progressing its mix of existing tariffs, restrictions and sanctions without feeling the need to wait for political approval.

Apple is no longer core. It has slipped out of the top 5 in China. But it is still tied into the China manufacturing eco-system

Also worth thinking about the narrative coming out of China’s singles day (11/11) which used to be compared to the US Black Friday - also coming up this month - until the Chinese numbers got so large. Perhaps one factor in Warren Buffet selling down his Apple stock is that Apple is no longer even in the top 5 phones in China and with no Chat GPT allowed in China, it’s new ‘edge’ is blunted in that market.

Medium Term risks - Thinking beyond stage one.

US allies in Europe, the UK, Australia, South Korea and Japan, seemingly without much thought of the possible consequences have also been imposing tariffs on China and are now struggling with the response.

Thus while the (globalist minded) UK economic establishment last month appeared to green light a Tax, Spend and Borrow Budget, with apparently little in the way of what Thomas Sowell calls Thinking Beyond Stage One, the same might be said of the speed with which the EU decided to mimic US tariffs on Chinese EVs and other electronics.

For governments that employ ‘nudge units’ there seems a lack of behavioural insight in so much of policy at the moment

Just as filling in a spreadsheet with a new level of tax revenue based simply on a higher rate multiplied by a fixed number of tax payers runs into the reality that people change their behaviour, so the idea that China won’t respond in kind to higher taxes or tariffs demonstrates stage one thinking, including the fact that the China market is extremely important for the luxury goods makers in Italy and France as well as the auto makers in Germany - especially the higher end like Mercedes and BMW. Both premium German automakers rely on China for around 30% of revenues and have seen sharp falls in sales recently. VW has given profit warnings and is cutting workers in Germany.

Compare this to Chinese EV makers BYD, where sales are booming but exports are less than 10% of the total A tit for tat trade war is going to be much harder for exporters to China rather than the other way around.

The EU pursuing US backed sanctions on Chinese EVs without expecting retaliation on European luxury goods seems very stage one thinking

And it’s not as if European companies can rely on the WTO, China can simply increase existing domestic taxes on luxury goods. Moreover, Luxury sales in China are down in any event (not as conducive with ‘Common Prosperity’) and wines sellers for example are already facing issues with inventory; it’s sufficiently large for high end wines that new import volumes have collapsed. Now, China is talking about anti dumping on French Brandy. All of this is probably a factor in LVMH being 30% off its peak and the European Luxury goods sector, which had been doing well since 2020, has had a poor year.

Some might switch to Europe and personal imports (the official 30% of sales to China is underestimated by the impact of international shoppers).

As previously noted, the Xiaomi Porsche Taycan ‘lookalike’ is a quarter of the price and while it is unlikely to do much in exports, it threatens Porsche in the previously lucrative China market, as well as other markets outside Europe and the US. It’s fastest version also just beat the Porsche’s one around the Nurburgring (for those that like that sort of thing).

The problem is that the cutting edge is often where margins are thinnest - until you get scale

The problem for the Germans is they make cars in China as well (so does Tesla of course) and it’s the same for Apple, where the problem is that 80% of its supply chain are in China, making it very difficult to leave even if you wanted to.

In addition, the problem with the cutting edge and superior technology at lower prices is that the cutting edge is where margins can be the thinnest and with Apple excluded from Chinese AI, the new iPhone cutting edge is blunted. Indeed, we are already seeing discounts in China on the new Apple IPhone 16+ and, like everything tech related, competition is fierce and margins are challenged.

Cars are now tech. And Tech is fiercely competitive driving prices lower.

Long Term Themes - Maybe a weak $ is not a plan just yet

Talk of tariffs and trade brings us to the US $. If, as it appears from his rhetoric, Trump’s aim is to use tariffs as a stick to force onshoring - very much in the European style - then it might be good for US jobs, but not good for US corporates, as domestically produced versions of Chinese (and other) products would be highly competitive domestically and if anything dis-inflationary. Higher income taxes, lower benefits costs and no subsidies for incoming corporates would more than offset the tariff income foregone (which would ultimately have come from US consumers anyway.)

Economic ju-jitsu - is the west now going to be the supplier of ‘cheap labour’ to the East, trading access to its markets in return for jobs and foreign Capital?

But the investment argument is still for diversification

A deliberately weaker $ would allow US corporates to compete internationally, but in these areas the cost gap is so large that it would be of little help. International companies, assuming they put cap-ex into the US and employed US workers would be in a competitive position, especially if they had access to low US energy prices. Meanwhile a strong $ would make it worthwhile in terms of remitted profits. This goes to the point of international investing versus the source of profits; European or Asian companies generating profits from manufacturing in and selling to the US would require diversification of equity holdings.

Equally, it may be that the US Private Equity industry expands on the model it has successfully deployed in the UK of buying up listed and unlisted equities (as previously discussed in a comment about the book Vassal State by Angus Hanton ) using the still cheap dry powder and the still powerful Dollar. This would make the case for investing in the sort of companies that might attract such flows.

Then perhaps, they might let the dollar go….

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