By: Guy Adami, Director, Advisor Advocacy
Published April 26, 2017
Although there are many interesting things going on in the world right now, I thought I would start with some comments made last week by IMF Managing Director Christine Lagarde. When asked about the upcoming French elections, Lagarde said a strong showing by Far Right candidate Marine Le Pen would certainly unveil major disorder and the risk of dislocation. To define what “a strong showing” means, Le Pen would need enough votes to qualify for a May 7 runoff by the top two vote-getters. Well, guess what? Given Lagarde’s definition of “strong showing,” Le Pen did just that, as she qualified for the final election on May 7.
What would a Le Pen Presidency Mean for the Markets?
Now for the major market disorder and risk of dislocation part—well, there has been some disorder, as the Dow Jones has rallied over 400 points these last two days, but somehow I don’t think that was the disorder and dislocation that Lagarde was thinking about. To understand why Lagarde was concerned about a strong showing from Le Pen, it is important to have an understanding of who Le Pen is and why she is such a big deal. Let’s start with this: Le Pen has gone out of her way to curry favor with Vladimir Putin and has promised to hold a referendum to take France out of the European Union.
Now, let’s go back to the comments from Lagarde. Given the market reaction to the Brexit vote and our presidential election in November, it would be easy to discount any talk of market disruption. In both cases, the extreme sell-off was short lived and the subsequent equity rally very strong. So in some ways, this two-day market rally should have been predictable. However, has the market become too complacent in the wake of both Brexit and President Trump’s victory?
Complacent Markets a Result of Impending Tax Reform
Well, the volatility index suggests that may in fact be the case as the French election isn’t the only game in town. Growing tensions with North Korea, Iran, and Syria continue to be discounted by the market, and an uprising of historic proportion in Venezuela is also being overlooked. The question that begs to be asked is why?
From my vantage point, it all comes down to the market’s anticipation of fiscal stimulus and tax reform. Comments from our Secretary of Treasury Steven Mnuchin today provided the market with everything it needed to rally. In his own words, “Tax reform will happen whether health care reform is done or not. . . We’re pretty close to being able to bring forward what’s going to be major tax reform. . . I’m confident we will get the debt ceiling raised. . . We will keep our AAA rating. . . Our number one priority is economic growth achieved through tax reform, regulatory reform, housing reform, and cyber security.” All these quotes were extraordinarily market friendly. In a world where algorithms react to words, Mnuchin’s comments provided quite the bullish elixir. Of course one week ago, the very same Mnuchin said that tax reform would be delayed because of the failure to pass a new health care bill.
The bottom line is, when market forces are at work, participants hear and see what they want to hear and see. Without much fanfare, Japanese 10-year yields returned to zero for the first time in five months. Of course the market didn’t care about this either, as the Bank of Japan had put forth a yield curve control policy in an attempt to create momentum for a long awaited economic recovery. Let me say that again: the Bank of Japan instituted a yield curve control policy. Think about that for just a minute. I’m not smart enough to be an economist, but I’m pretty sure this won’t end all that well. And one last word on complacency—with seemingly so many asymmetrical risks on the horizon, one would think that the volatility index (VIX) would be elevated. Well, today we have the VIX trading down towards levels we last saw in 2014.