By Peter Brown
There are only two fears in this market and they are the risk of inflation and the vagaries of US President Donald Trump.
It was an inflation reading in late January that pushed this market into a stampede of profit-taking, but it is the lunacy of possible trade wars that is keeping the selling going.
Inflation is a key issue, because globally, debt levels are very high. Debt is at high levels for both sovereign and corporate markets.
The US, in particular, is out of control: Its sovereign debt has risen from $10tn (€8.12tn) in 2010 to $18tn this year. And it is still rising.
Corporate debt has also risen, mainly due to the policy of central banks of pumping money into financial assets, which is called quantitative easing.
It has offered cheap funding to some of the world’s largest stock market-listed giants.
Corporate borrowings increased by $3.5tn in the last few years, much of which was used to fund share buy-backs.
Debt to equity is above 100% for over a third — a staggering number — of the S&P 500 firms.
Sixty S&P-listed companies have, incredibly, debt levels above 200% of their equity.
The question is whether this matters all that much.
In my opinion, it does. That’s because even a small rise in interest rates will cause these stocks to underperform.
A hike in interest rates by over 1% could spell out some more serious issues. The problem is that many investment funds benchmark themselves against the MSCI World stock market index.
That means these funds have to be almost 50% exposed to big and mid-cap US equities.
It is a scary proposition, yet few people realise just how exposed their investments and pensions are.
Passive funds will not rebalance out of this sector as the benchmark MSCI determines the asset weightings.
The risk is heavy losses because behaviour is lemming-like in nature.
Just to balance the argument, we may not get any increase in inflation.
If this is the case, the danger may be averted. But sooner rather than later those debt levels will come home to roost.
Regardless, stocks with debt to equity ratios greater than 100% inevitably underperform in the medium to long-term.
President Trump is a totally different matter.
I am not going to try to rationalise his policies but he is an impactful actor on the markets. The latest rant is on trade wars and tariffs.
No one wins a trade war despite President Trump insisting that he will emerge victorious from the scrap.
The world has spent decades trying to reduce barriers to trade and we should be horrified that President Trump may reverse all that effort in short shrift.
I think he totally misunderstands the issue anyhow. The president wants to put tariffs on steel imports to hurt the Chinese, yet he imports steel from Canada, Mexico, and South Korea.
I think there are indeed issues with China and trade in general that need resolving.
But there are proper lines of communication for such disputes, for which knee-jerk policies that attract tit-for-tat responses are not the answer.
The consumer is the loser in the end anyhow, as the importer passes the tariff on to the end price.
A global trade war at this stage of the economic evolution is sheer madness but then most of President Trump policies come under that category.
The world has to live with President Trump. It is something market participants have had to get used to. President Barack Obama spent eight years in power and had little to no effect on the markets.
This market is split between bulls and bears.
Volatility has increased and that is understandable. Fundamentals are still good, interest rates are low and there is growth.
But a trade war is a very serious matter and could reverse all the hard work done by central banks and their low-interest rates.
Hopefully, President Trump moves on to another hobby horse soon. Meanwhile, avoid the big cap US corporate stocks.
Peter Brown is a founder of Baggot Investment Partners.