The seven black swans

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DXY is still weak, EUR strong and CNY, whoa, is suddenly breaking upwards:

Commodity currencies were generally weak:

Gold is threatening higher:

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Brent is threatening lower:

Base metals are still trending down:

As are big miners:

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EM stocks were spanked:

US high yield is ignoring oil, the EM plod goes on:

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US bonds were bid and the curve keeps flattening:

European spreads widened:

Stocks saw US soft and Europe firm:

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Plus the euro broke out against the Aussie:

Today let’s canvass Societe Generale’s Seven Black Swans:

  • No US Tax Cuts (30%)
  • European Policy Uncertainty Shock (25%)
  • Sharp market Repricing (15%)
  • China Hard Landing (15%)
  • Upside Surprise on Fiscal Accomodation (15%)
  • Stronger Capex (10%)
  • Fast Track reform in Europe (5%)

Policy uncertainty has long been part of our risk factors linked to busy electoral agendas. For Europe, there is still a busy electoral agenda ahead. Nonetheless, with the French Presidential election now safely concluded, we have lowered the risk of a drag from European policy uncertainty shock from 30% to 25% risk to our Black swan relating to this risk factor. Our main concerns at this stage are about Italy and an ugly Brexit.

Across the Atlantic, the risk has shifted increasingly to finally seeing no US tax cuts delivered in FY18. We see a 30% risk that Trump will fail to deliver tax cuts, which would see the US economy slowing sharply as early as 2H18. There is also the risk of upside surprise on fiscal accommodation, and this is true for both the US and Europe.

Fast track reform in Europe remains a hope, but we set a low probability on this at just 5%. We are slightly more hopeful as seen from the chart below that corporations may increase investment more than we expect. Our baseline discounts enough reforms in the euro area to offset demographics headwinds over the coming decade, but this will only come slowly and there is scope for disappointment. We link these to the political risks of anti-establishment parties wining a majority in a euro area member state.

In China, the risk of a policy error is an ongoing issue. With the approach of this autumn’s Congress, we believe the near-term risk of a China hard landing is reduced. We have thus lowered the risk hereof to 15% from 20% previously, but expect to raise it again after October.

Low interest rates are the lynchpin of global markets, should confidence in the ability of central banks to respond to either upside or down side risks decline significantly, the risk is to see a sharp market repricing. This links in closely to confidence that the current expansion can continue for the foreseeable future.

I’ll add the following:

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  • No US Tax Cuts (30%) Seems to us the risk here is much more about underachievement than failure. Still, Trump ineptitude is clear hence DXY weakness.
  • European Policy Uncertainty Shock (25%) This is now all about the Italian election. European valuations are much lower than US so there is some built-in hedge.
  • Sharp Market Repricing (15%) Possible!
  • China Hard Landing (15%) I would put this at 10% now but 35% next year.
  • Upside Surprise on Fiscal Accommodation (15%) Meh.
  • Stronger Capex (10%) Meh.
  • Fast Track reform in Europe (5%) Meh.

MB Fund allocations more or less match this risk matrix and continue to out-perform (these are relative to MSCI):

  • overweight European stocks;
  • underweight US stocks;
  • underweight Australian stocks;
  • overweight Aussie bonds (creeping out the curve now);
  • no property!

The fund has cleared compliance and will launch officially on July 1st. We’ll be in touch with many of you a few weeks before then to begin signup if you’re registered. If not, sign up!

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.