The birth of tragedy?

The interplay between considered analysis and emotional decision making at work in markets today brings to mind Friedrich Nietzsche's book The Birth of Tragedy. In it the German philosopher explains Greek tragedy plays by looking at the tension between Apollo, the god of rational thinking, and Dionysus, the god of instinct and emotion. These opposing forces battle for control of the narrative.

The fear in markets right now is that the Dionysian is in the ascendency and that policy mistakes or the fear of policy mistakes will raise risk premiums, halt the expansion, and slay the bull market.

In the remainder of this article I look at three key battlegrounds for markets today and the internal struggle they face between Apollo, the rational, and Dionysius, the emotional.

Read the full monthly letter by UBS Chief Investment Office


The Fed

Apollo: Strong economic and earnings data have allowed the Fed to justify hiking rates toward normal levels. However, with oil prices falling, credit spreads widening, volatility increasing, and politics complicating matters, the rational course of action now looks to be a slower pace of rate hikes.

Dionysus: But the Fed easing off is not a given. The central bank might want to prove its independence amid President Trump's criticism of higher rates, signal confidence in the economy through rate hikes, and build more cushion to counteract future downtowns.

Politics

Apollo: President Trump knows that his time as President is likely finished if the US economy were to fall into recession before the next election. He is therefore reportedly closely monitoring the impact of his China policy on markets.

Dionysus: But when a Tweet pledging "very positive change, on trade and far beyond, between our two great nations," can be followed a day later with a CFO in handcuffs, and a reminder that the tweeter is a "Tariff Man", we know that cold rationality is not guaranteed when it comes to this negotiation.

Market sentiment

Apollo: Little in the economic data indicates that a recession is near and valuations this year have fallen by the fifth largest annual amount in the past three decades.

Dionysus: But in the short term, momentum can be a powerful, if more emotional than rational, force in markets. Stocks are now trading below all of their 50,100, and 200-day moving averages.


Investment conclusion

Our overweight positioning on global equities and emerging market sovereign debt places us in the corner of Apollo: slower pace of rate hikes, reconciliation on trade, and a more fundamental-driven market would support our positions. But our positions could suffer if the Fed indicates a hawkish stance for next year, tariffs proceed, and markets remain driven by risk-aversion.

We also made certain changes to our positioning this month. Within equities, we open an overweight in emerging market stocks. Within fixed income, we take profit on our 10-yr US Treasury position.

With any resolution to the current narratives potentially leading to a large move either way, we also temper our pro-risk positions. For investors who can invest in options, we recommend a put spread on the S&P 500.

See the preferences tab for our full positioning.

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