Back to Fundamentals

Doug Nolan

The Dow (DJIA) jumped 545 points (2.1%) in Wednesday's post-midterms trading. The S&P500's 2.1% rise was overshadowed by The Nasdaq Comp's 2.6% and the Nasdaq100's 3.1% advances. Healthcare stocks surged, with the S&P500 Healthcare Index up 2.9% (Healthcare Supplies index jumping 4.5%). Led by Amazon's 6.9% (113 points!) surge, the S&P Internet Retail Index gained 6.1%. From October 29th trading lows to Thursday's highs, the S&P500 rallied 8.1% and the Nasdaq100 jumped 9.6%.

The post-election bullish battle cry was a resolute "back to fundamentals!" With the market surging, analysts were proclaiming "reduced uncertainty" and "the best possible outcome for the markets." The President and Nancy Pelosi both adopted restrained tones and spoke of efforts to cooperate on important bipartisan legislation. Prospects for a market-pleasing infrastructure spending bill have improved. What's more, a positive spin was put on the return of Washington gridlock. Less Treasury issuance would support lower market yields generally, ensuring the U.S. economic expansion maintains ample of room to run. The weaker post-election dollar was said to be constructive for global liquidity.

The EEM emerging market ETF rose 1.9% Wednesday, pushing the rally from October 29th lows to 11.0%. The South African rand and Indonesian rupiah gained 1.5%, as most EM currencies temporarily benefited from the weaker dollar.

Wednesday provided a good example of news and analysis following market direction. Stocks were up, so election results must have been positive. I would tend to see Wednesday's trading as heavily impacted by the unwind of hedges - and yet another short squeeze. After trading as high as 20.6 in Tuesday trading, the VIX (equities volatility) index ended Wednesday's session at 16.36, an almost one-month low.

Market weakness in the weeks leading up to the midterms created an unusual backdrop. A pivotal election combined with a vulnerable market backdrop ensured a double-dose of hedging activity heading into Tuesday. And with the election having avoided "tail risk" outcomes (blue wave and Democratic control of both houses, or Republicans maintaining full control), post-election trading saw a significant reversal of risk hedges and bearish speculations.

It didn't, however, take long for the joyful "gridlock is good" rally to face a reality check. The President's tweet: "If the Democrats think they are going to waste Taxpayer Money investigating us at the House level, then we will likewise be forced to consider investigating them for all of the leaks of Classified Information, and much else, at the Senate level. Two can play that game!" NYT: "Jeff Sessions is Forced Out as Attorney General as Trump Installs Loyalist." And then came Friday's (post-election) barbs from the director of the White House's National Trade Council:

November 9 - Bloomberg (Andrew Mayeda and Shawn Donnan): "White House trade adviser Peter Navarro warned Wall Street bankers and hedge-fund managers to back down from their push for President Donald Trump to strike a quick trade deal with China's Xi Jinping. 'As part of a Chinese government influence operation, these globalist billionaires are putting a full-court press on the White House in advance of the G-20 in Argentina,' Navarro said… Their mission is to 'pressure this President into some kind of deal' but instead they're weakening his negotiating position and 'no good can come of this.' Navarro said investors should be re-directing their 'billions' of dollars into helping rebuild areas hit by manufacturing job losses. 'Wall Street, get out of those negotiations. Bring your Goldman Sachs money to Dayton, Ohio, and invest in America.'"

As another extraordinary market week came to its conclusion, the bulls "Back to Fundamentals" mantra from Wednesday was being hijacked by the bear camp. From my analytical perspective, the outcome of the midterms wasn't going to materially alter the Bursting Global Bubble Thesis. Global financial conditions continue to tighten. Very serious issues related to China's faltering Bubble remain unresolved. Italy's political, financial and economic problems won't be disentangled anytime soon. And the midterms weren't going to solve the more pressing issues in the U.S., certainly including inflated asset and speculative Bubbles and a Federal Reserve determined to stay on the policy normalization course.

November 8 - Wall Street Journal (Justin Lahart): "Anybody who thought the Federal Reserve might scale back its plans for future rate increases after all the recent turmoil in the stock market has to be disappointed. The Fed on Thursday left interest rates unchanged, and it didn't change much else. The statement it put out following its two-day meeting contained only minor tweaks from its September statement. It noted that the unemployment rate had declined since its September meeting (as opposed to 'stayed low'), and that business investment has "moderated from its rapid pace earlier in the year" (rather than 'grown strongly'). The two things roughly offset each other and both have been clear from the data."

WSJ: "Treasury Bond Auction Draws Weakest Demand in Nearly a Decade." Thursday's 30-year auction incited spiteful name calling: "weak," "sloppy," and "nasty." It's worth noting that 10-year Treasury yields traded to 3.25% election night, the high going back to April 2011. Benchmark MBS yields ended Thursday at 4.10%, also the high since 2011. Ten-year Treasuries enjoyed a little relief late in the week as equities reversed lower, ending Friday at 3.18%, down three bps for the week.

Dollar post-election weakness reversed sharply into week's end. After trading down to 95.678 Wednesday, the U.S. dollar index surpassed 97 on Friday before closing the week up 0.4% to 96.901. After closing at 41.63 on Wednesday, emerging market equities (EEM) sank almost 5% to close the week at 39.80.  
Perhaps more noteworthy from a global liquidity and "risk off" perspective, EM bonds came under renewed pressure this week. Brazilian 10-year (local currency) bond yields jumped 27 bps (to 10.41%). Russian yields surged 31 bps (8.91%) and Mexican yields 23 bps to a multiyear high (8.85%). Ominously, Mexico's 10-year (peso) yields are up almost 100 bps in six weeks. Brazil, Russia and Mexico dollar-denominated bond yields also turned higher, seemingly ending eight weeks of relative bond market calm.

After a recent modest pullback in yields, Italian 10-year yields jumped eight bps this week to 3.40% (Italian CDS up 11 to 270 bps). With German bund yields declining two bps (0.41%), the Italian to German 10-year sovereign spread widened 10 bps to 299 bps. European periphery bonds notably underperformed, with spreads to bunds widening 11 bps in Greece, eight bps in Portugal and five bps in Spain.

For me, Back to Fundamentals means a return of "Periphery to Core Crisis Dynamics" - rising yields, widening Credit spreads, de-risking/deleveraging, faltering global liquidity and, to be sure, China.

November 9 - Bloomberg: "China aims to boost large banks' loans to private companies to at least one-third of new corporate lending, said Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission. Shares of lenders retreat on the mainland and in Hong Kong. Guo's comments are the latest attempt by authorities to try to improve funding access for China's non-state companies… It's the first time financial regulators have given targets on private lending, a reflection that earlier efforts haven't triggered the necessary credit activity… The target for small and medium-sized banks is higher, at two-thirds of new corporate loans, Guo said…"

November 9 - Bloomberg (Tian Chen): "Chief economists at Chinese brokerage firms should make efforts to guide market expectations and also effectively promote and analyze government policies, says the head of the nation's top securities regulator. Economists should properly understand, interpret and promote President Xi Jinping's remarks on supporting private companies, Liu Shiyu, chairman of the China Securities Regulatory Commission, said at a meeting with economists this month. The analysts should cherish the reputation of the industry, improve their ability to conduct research and properly use their influence on the public, Liu said…"

Beijing faces the critical issue of a deeply maladjusted economic structure that, at this point, requires in the neighborhood of $3.5 TN of annual (and sustained) system Credit growth to keep the Bubble from deflating. Moreover, the last thing China's incredibly inflated banking system needs is rapid growth in risky late-cycle lending. Determined to rein in non-bank "shadow" lending, Beijing faces no good alternatives. Granted, Chinese officials have the capacity to recapitalize their banking system down the road. And markets to this point have been comfortable with the implied Beijing guarantee of banking system liquidity and solvency.

There is, however, a very serious problem brewing: Systemic risk expands exponentially during the "Terminal Phase" of excess, as rising quantities of increasingly risky loans imperil the entire financial system. The past two years have seen extremely rapid (speculative "blow-off") Credit growth in two particularly problematic sectors: lending against equities and apartments - both at inflated prices. There will come a point when the market begins to question the validity of Beijing's banking system fortification. This type of waning confidence could initially manifest in the currency market.

November 7 - Reuters (Kevin Yao and Fang Cheng): "China's foreign exchange reserves fell more than expected to an 18-month low in October amid rising U.S. trade frictions, suggesting authorities may be slowly stepping up interventions to keep the yuan from breaking through a key support level. Reserves fell by $33.93 billion in October to $3.053 trillion… The drop was the biggest monthly decline since December 2016, and compared with a fall of $22.69 billion in September."

November 9 - Bloomberg: "Chinese President Xi Jinping's mantra that homes should be for living in is falling on deaf ears, with tens of millions of apartments and houses standing empty across the country. Soon-to-be-published research will show roughly 22% of China's urban housing stock is unoccupied, according to Professor Gan Li, who runs the main nationwide study. That adds up to more than 50 million empty homes, he said. The nightmare scenario for policy makers is that owners of unoccupied dwellings rush to sell if cracks start appearing in the property market, causing prices to spiral."

Contemplating an economy with 50 million empty apartments entangles the mind. Granted, this is not a new issue. For years, a steady flow of workers vacating the countryside for booming urban centers has provided seemingly endless housing demand. But after a decade (or two) of cheap Credit and booming mortgage lending growth, China now confronts an inescapable comeuppance: a historic speculative Bubble with the prospect of declining prices, a speculative bust, massive oversupply and an acutely vulnerable financial sector.

The Shanghai Composited dropped 2.9% this week (down 21.4% y-t-d). China's CSI Financials index sank 4.3%, and Hong Kong's Hang Seng Financials fell 2.9%. China's renminbi dropped 0.95% this week vs. the dollar, increasing y-t-d losses to 6.47%. Copper sank 4.7%, increasing y-t-d losses to 19%. It's stunning how quickly crude and commodities indices erased what were until recently decent 2018 gains. Everywhere, it seems, Perceived Wealth is Vanishing into Thin Air. What is it that Warren Buffett says about when the tide goes out?

November 9 - Bloomberg (Saijel Kishan): "After beleaguered hedge fund managers had their worst month in seven years, many are bracing for an industry D-Day: Nov. 15. That's the deadline for investors to put managers on notice to get some -- or all -- of their money at year end. If history is any guide, the rush for the exits will be swift and accelerate. Clients have already pulled $11.1 billion even before funds fell into the red for the year. The last time the industry careened toward annual losses was in 2015…The fallout: clients withdrew $77.2 billion between the fourth quarter of that year and the first quarter of 2017 -- the biggest withdrawals since the global financial crisis. Investors can cash out of most hedge funds quarterly after giving 45 days notice."

"Hedge Funds Face Reckoning After Worse Month Since 2011," was the headline to the above Bloomberg article. Other notable headlines this week included: MarketWatch: "Hedge Funds Are on Pace for the Worst Annual Year Since Lehman Brothers." WSJ: "Quants are Facing a Crisis of Confidence;" "Quant King D.E. Shaw Finds Stock-Picking Can Be Difficult;" and "Tech Swoon Stings Hedge Funds." Also from Bloomberg: "Hedge Fund 'Hotels' Burned Managers Who Sought Refuge in October." And from the FT: "Hedge Funds Overly Optimistic on Risk, SocGen Finds."

The odds of de-risking/deleveraging dynamics attaining destabilizing momentum are mounting. Many hedge funds now have losses for the year, which forces managers to take down both risk and leverage in anticipation of year-end outflows. I believe deleveraging is now having a growing impact on marketplace liquidity around the world - and across asset classes. Yields are rising and spreads are widening throughout global fixed-income. Unstable equities markets around the globe are indicating a fragile liquidity backdrop. And this week's $2.68 (4.3%) drop in WTI has all the appearances of a major leveraged speculating community panic liquidation (portending challenges for the - to this point - resilient junk bond market).

Bloomberg this week posed a most-pertinent question: "When will funding squeezes impact the Fed?" The market continues to focus on building rate pressures throughout the money markets, with added concern now that year-end funding issues are coming to the fore. The system is, after all, in its first experimental unwind (QT or "quantitative tightening") of some of the Fed's QE holdings. Market analysis is only further challenged by the enormous issuance of T-bills necessary to fund ballooning fiscal deficits. Three-month LIBOR added another two basis points this week to a decade high 2.61%. The effective Fed Funds rate (2.20%) remains stubbornly near the top of the Fed's target range (2-2.25%). There are also hints of waning liquidity in the mortgage marketplace. Furthermore, ebbing foreign demand at Treasury auctions is a rising concern.

At this point, conventional analysis has yet to factor in the liquidity impact from speculative deleveraging - in terms of money market rates, fixed-income yields and the risk markets more generally. The degree to which speculative leverage has accumulated over this long cycle is The Momentous Unknowable. Indeed, there's a portentous lack of transparency for something of such vital importance. For the most part, the contemporary realm of speculative leveraging operates outside of traditional banking. As such, it was just too convenient for the Bernanke Fed and global central bankers to ignore this issue as they collapsed borrowing costs, flooded the world with liquidity and committed to market liquidity backstops.

At this point, I seriously doubt the Fed has a solid grasp of the (direct and indirect) sources of the Trillions of global liquidity that have flooded into U.S. securities and asset markets over the past decade. I take them at their word that they don't see the degree of leverage that would typically indicate a Bubble. Yet this has been the most atypical of global Bubbles. I am not convinced the Fed knows where to look for the leverage most germane to today's global Bubble. And, I'm compelled to add, the whole world seems oblivious. Speculative deleveraging is not on the Fed's radar, and this is a problem for the markets.

The paradox at the heart of the US stocks rally

Buybacks and passive investing combination should worry even equity Bulls

Supriya Menon

Whichever way you cut it, the scale of the post-crisis US stocks rally has been impressive.

Investors brave enough to have bought and held since March 9 2009 have enjoyed a 310 per cent cumulative return from the S&P 500, or 16 per cent a year. The index has gone 3,510 days without a fall of more than 20 per cent — its longest winning streak on record, backed by a pretty remarkable performance in the benchmark’s constituents. Corporate earnings have risen 8 per cent a year — in line with the long-term average — while gross profit margins have expanded to a historic high of 11.3 per cent.

And yet for all this, there’s a paradox at the heart of the rally. It appears to be the most unloved bull market in living memory.

Intuitively, a record-breaking run should have been accompanied by equally unprecedented levels of investor backing. Yet the data tell a different story. Investors have been rather unenthusiastic participants.Comparing the amount of money invested in equity funds to that flowing into fixed income funds over the nine-year period, it turns out that investors have allocated about twice as much of the total capital they’ve invested to bonds than to stocks. That’s the first time this has happened in any of the equity bull markets of the past three decades.

To unravel this conundrum, there are other, more structural, factors to consider. The first of these is share buybacks. Spurred on by a sharp fall in the cost of debt finance relative to equity, companies in the S&P 500 index have bought back just close to $4.5tn of their own shares since 2009, equivalent to about a quarter of their total market capitalisation. That is an even higher figure than the $3.5tn of US government bonds the US Federal Reserve amassed under quantitative easing.

On average, large-cap US groups have repurchased $380bn more shares than they have issued each year. That’s a dramatic reduction in the supply of stocks that we estimate accounts for about a third of the S&P 500’s gains since 2009.

And investors should know that the buyback trend is unlikely to reverse any time soon. Thanks to the Trump administration’s tax cut on corporate cash repatriated from overseas, share repurchases could become an even bigger feature of the investment landscape over the next 18 months to two years.

So far, US companies have brought home about a third of the cash they had accumulated abroad. This means there is still up to $2tn of it sitting idly in overseas accounts. Further boosting the pot available for buybacks are multi-nationals’ foreign profits — US firms are generating an additional $100bn of international earnings every quarter. It’s for these reasons that analysts such as those at Goldman Sachs believe share repurchases could exceed $1tn this year.

But there is more to the equity market shrinkage than share buybacks. There is also a shortage of tradable stocks. For this, it is not US companies that are to blame but their shareholders — or rather, the growing number of investors who prefer to own their piece of corporate America via index-trackers.

Since 2009, the proportion of US equity fund assets held in passive rather than actively managed vehicles has grown from 25 per cent to more than 45 per cent. Most of that money has flowed into S&P 500 index-trackers run by one of the world’s three largest money managers. These three investment houses between them now control about 20 per cent of the largest 100 stocks in the benchmark.

This has serious implications for the functioning of the equity market. The mechanics of index-tracking dictate that the shares of companies with large weightings in the main indices attract the lion’s share of investment flows irrespective of their underlying fundamentals. And when a large enough percentage of stocks is owned by shareholders who can’t vote with their feet, the process of price discovery starts to break down.

In other words, the growth of passive investment appears to be creating a captive market: capital can flow in easily, but struggles to come back out, reducing the total amount of shares that can be traded.

So if the S&P 500’s record-breaking does indeed reflect changes in the supply of tradable securities and in the motivations of equity investors, then it could be argued that future market corrections will be shallower than those of the past. The sell-off we saw in January proved to be shortlived. It could be that the one that began in October fizzles out too.

More worrying, though, is that the combination of buybacks and passive investing could lead to a significant misallocation of capital in the world’s biggest economy. That’s something that even the equity market bulls should be concerned about.

Supriya Menon, senior multi-asset strategist at Pictet Asset Management


The agony of the value investor

A contrarian strategy fares badly much of the time

IN APRIL 1962, Joan Whitney Payson watched the New York Mets, a collection of cast-offs from rival baseball teams, lose their first ever game. Mrs Payson, the Mets’ owner, soon left for a summer in Greece. News of further defeats reached her by telegram. So she asked that she be told only when the Mets won. “That was about the last word I heard from America,” she recalled. The Mets lost 120 of their games that year.

One of the worse things about a losing streak, noted Mrs Payson, is you can never tell when it will end. Investors in “value” stocks know the feeling. These stocks, which are distinguished by a low price relative to the book value of a firm’s assets, have fared badly in the past decade (see chart). A longer run of history, as well as intuition, suggests that buying shares that are cheap relative to their intrinsic worth should eventually pay off. But it can be a long wait before the telegram arrives.

A bad run also breeds doubt. Perhaps the growing importance to the economy of intangible assets, such as brands and ideas, makes book value an unreliable signifier. Similar arguments were made during the late 1990s dotcom boom, only for the value approach to be vindicated.

The truth is that value is a contrarian strategy. That means it fares badly much of the time. Suffering and doubt are the price value investors must pay.

The cardinal distinction between a share’s price and its value goes back to Benjamin Graham, the father of value investing. Price is a creature of the market’s mood, he wrote. In booms, it is set by the greediest buyer; in busts by the most fearful seller. A stock’s value, in contrast, is enduring. It is anchored by the worth of a firm’s assets. The enterprising investor can profit from finding stocks that sell for much less than their value, said Graham. There have since been countless studies showing that value stocks do better than “growth” stocks, their antithesis, over the long haul.

In Graham’s day, the value premium was the prize for finding truly cheap stocks. But computing power has made it easier to compare company accounts. So why might the strategy still work? One reason is that the profits of firms with tangible assets suffer in economic downturns, when costly plant and buildings cannot be redeployed. The value premium is thus a reward for bearing business-cycle risk. Another reason is the mistakes of other investors. They giddily extrapolate the initial success of new and exciting growth stocks. Frumpy value stock gets left behind—until sanity returns.

Still, the recent losing streak is testing the value faith. Perhaps the strategy has stopped working because it is so well known. This idea is dismissed by Cliff Asness, of AQR Capital Management, in a recent essay. The value gap between cheap and dear stocks has not been whittled away. If it had, where was the windfall?

Perhaps the flaws lie with book value. Under accounting rules, factories or office buildings count as capital assets on a firm’s books, because they yield benefits over a long horizon. But spending on R&D and advertising is treated as a running cost, like wages or electricity, even though firms’ know-how and brands are assets, too. That means a lot of real, but intangible, value is missed by price-to-book ratios. Yet serious value funds will rely on a broader set of metrics than just book. And still they suffer.

How much is evident from their anguished letters to investors. Their verdicts are blunt. “Our results have been far worse than we could have imagined,” wrote David Einhorn, of Greenlight Capital, a value-oriented hedge fund, in a recent example of the type. The self is flagellated (“the market is telling us we are wrong, wrong, wrong about almost everything”). And then faith in the investment “process” is sworn afresh. As Mr Asness wryly notes, there is a pinch of “we’re losing because everyone else is an idiot” to all this. But where faith is, there is always doubt. When your strategy loses money, writes Mr Asness, you feel like Casey Stengel, the Mets’ coach in 1962, who, after surveying his team, was moved to ask himself, “Can’t anybody here play this game?”

This agonising is not for most people, says James Montier, of GMO, a fund-management firm: “They don’t want to be wrong for as long as it takes.” Value investors hope to be rewarded for being so out of step with everyone else for so much of the time. But a select few can endure—and even enjoy—it. People of this sort could be heard, a few months into that disastrous first season, saying, “I’ve been a Mets fan all my life.”

Did the Global Order Die with Khashoggi?

A world in which all that matters is the deal is one where citizens do not know what to expect from their leaders and countries do not know what to expect from their allies. Such an unpredictable and unstable world is not one that we should blindly accept.

Ana Palacio

pompeo and mohammed bin salman

WASHINGTON, DC – Earlier this month, Jamal Khashoggi – a Washington Post columnist and prominent critic of the Saudi government – walked into Saudi Arabia’s consulate in Istanbul to pick up documents that would enable him to marry his Turkish fiancée. Instead of receiving help from his country’s government, he was tortured, murdered, and dismembered by a team of its agents.

It is a shocking crime that raises some serious questions, not least regarding the appropriate balance between defending human rights and maintaining long-standing (and lucrative) alliances. More fundamentally, the sheer brazenness with which the Saudi government had Khashoggi killed – not to mention Western leaders’ weak response – has underscored for people around the world just how coldly calculated geopolitical machinations really are.

Transparency is usually a virtue to be encouraged. Here, however, the revelation comes at a cost. The belief that principles, values, and rules hold at least some weight in international relations has a stabilizing effect. As that belief is shaken – say, by the poisoning earlier this year of the former Russian double agent Sergei Skripal and his daughter on British soil – the global order is damaged, perhaps beyond repair.

The delegitimizing effect of such episodes is exacerbated by a broader abandonment of formalities – such as workplace dress codes and standards for communication – that has been fueled by the rise of social media. As our public and private lives are blurred, public figures are under pressure to appear as “real” and “normal” as our neighbors and colleagues. Even Pope Francis has released a rock album.

Of course, not all of these shifts are necessarily bad. The breakdown of formal structures can create space for independent thinking and innovation. The danger comes when no new framework emerges to help guide our behavior – and, more important, the behavior of our leaders – to ensure that it adheres to some shared values or reasonable expectations.

US President Donald Trump embodies this risk. Since coming onto the political scene, Trump has shattered expectations about how a US presidential candidate – and, subsequently, a US president – should behave. While there is nothing fundamentally wrong with a political leader communicating frankly and directly with his or her constituents, the tone and style of Trump’s delivery – largely via Twitter – is highly damaging. His below-the-belt insults, racist dog whistles, and unfounded attacks on the media and other democratic institutions are deepening political and social divisions, while diminishing respect for the presidency and the US more generally.

Trump’s unprecedentedly transactional – and highly erratic – approach to foreign policy is similarly destabilizing. To be sure, Trump’s deal-making was initially framed to some extent by broader values, especially increasing the “fairness” of US relationships, from security cooperation with NATO allies to trade ties with China. Despite Trump’s “America first” rhetoric, such actions seemed to be focused more on rebalancing the system than destroying it.

Trump’s response to the Khashoggi episode, however, is fully decoupled from any overarching values. To be clear, US presidents, together with European leaders, have been coddling Saudi Arabia for decades, and leaders worldwide often base their foreign-policy decisions on realpolitik, rather than moral considerations.

But this is the first time a US president has unabashedly acknowledged the purely transactional nature of their policy decisions. The Saudis, Trump declares bluntly, are “spending $110 billion on military equipment and on things that create jobs” in the US. “I don’t like the concept of stopping an investment of $110 billion into the United States.”

Notwithstanding the dubiousness of the figures involved, Trump’s comments are a bald statement of monetized interest. The comfort, even pride, with which he makes such statements indicates that we really have entered a new era, in which we cannot expect our leaders to clear even the low bar of trying to fit their decisions into a rules- or values-based narrative.

This is dangerous, because such narratives are vital to maintain the credibility of the global order and the support of domestic constituencies for it. Just like effective leadership and respect for the rule of law, a certain amount of faith in the system – even if it is qualified by frustration with inequality or impunity – is essential to its survival.

A world in which all that matters is the deal, in which there is no ethos guiding our actions and underpinning our governance systems, is one where citizens do not know what to expect from their leaders and countries do not know what to expect from their allies. Such an unpredictable and unstable world is not one that we should blindly accept.

It is not too late to respond to Khashoggi’s brutal murder in a way that reinforces, rather than undermines, the rules on which we all depend. German Chancellor Angela Merkel’s suspension of arms sales to Saudi Arabia is a good start, even if it was driven largely by her desire to shore up support for her Christian Democratic Union ahead of regional elections in Hesse; so, too, is the current pushback from Washington against a business-as-usual approach to Saudi Arabia.

But more must be done, with principled leaders declaring clearly that what happened in Istanbul is not acceptable. Otherwise, we will effectively be giving up the discourse of values and rules – a decision that could well leave us with no coherent and stabilizing discourse at all.

Ana Palacio, a former Spanish foreign minister and former Senior Vice President of the World Bank, is a member of the Spanish Council of State, a visiting lecturer at Georgetown University, and a member of the World Economic Forum's Global Agenda Council on the United States.