Markets Leave Fantasyland and Glimpse the Future
(Bloomberg Opinion) -- Monday was supposed to be one of those rare days when everyone knew what was going to happen in markets. Reports over the weekend that the U.S. and China were close to a trade deal would surely cause stocks to soar. Except they didn’t. The S&P 500 Index fell the most in more than three weeks, dragging down the MSCI All-Country World Index with it. The message is that any deal is unlikely to immediately counter the negative forces that are increasingly working against the global economy.
The challenges can be seen in the Citigroup Global Economic Surprise index, which fell to minus 32.4 on Friday, suggesting the incoming data is missing estimates by the greatest degree since mid-2013. What’s more concerning is that it looks as if the U.S. economy, which has been the primary driver of global growth in the second half of last year, can no longer be counted on to lift others up. The Federal Reserve Bank of Atlanta’s GDPNow Index, which aims to track growth in real time, has fallen to 0.3 percent, while a similar gauge from the Federal Reserve Bank of New York is under 1 percent. “To be fair, some of this is no doubt due to the (U.S. government) shutdown, but that factor is far from strong enough to explain the depth of the current weakness,” the top-ranked rates strategists at BMO Capital Markets wrote in a Monday research report. Stocks have been on a remarkable run this year, with both the S&P 500 and MSCI All-Country World Index up about 11 percent. But much of that was to correct the largely inexplicable tumble in late December. Stocks can only gain so much on sentiment. At some point, investors will need to see valuations justified by the fundamentals, but that doesn’t look like it will be happening anytime soon. “The fact that we’re seeing diminishing returns every time one of these sort of good-news stories comes out over the weekend tells me that” a U.S.-China trade deal is now mostly priced in, Brian Nick, the chief investment strategist at Nuveen, said on Bloomberg Television.
BONDS AND FINANCIAL CONDITIONS
In this environment, the bond market takes on added importance. No doubt, the drop in bond yields in response to the dovish turn by the Federal Reserve and other major central banks has supported stocks this year. Government bond yields globally have dropped from 1.60 percent on average in November to less than 1.30 percent last week, according to the Bloomberg Barclays Global Aggregate Treasuries Index. But this situation is a bit of a Catch-22 for markets. The more stocks rally when bond yields are falling, the easier financial conditions get. And the easier financial conditions get, the more likely it is that the Fed starts to think it should keep raising interest rates. In testimony to the Senate Banking Committee last week, the first thing Fed Chairman Jerome Powell highlighted was how “financial markets became more volatile” at the end of last year and how “financial conditions are now less supportive of growth.” Bloomberg News’s Mark Cudmore points out that U.S. financial conditions are rising back toward the level where traders may start to price in a Fed rate hike for 2019. That’s especially true given Powell’s comments. And in that context, stocks seem to be stuck in a sort of no man’s land.
EM FLOWS TELL THE STORY
For more proof that a resolution to the U.S.-China trade talks may not be the market-boosting event that many expect, take a look at emerging-market fund flows. Despite escalating talk last week that the two economic superpowers were close to a deal, inflows to exchange-traded funds that buy stocks and bonds from developing nations totaled almost $400 million in the week ending March 1, data compiled by Bloomberg show. That’s about a third of what traders put into those products in the previous five-day period, according to Bloomberg News’s Ben Bartenstein. “The overall strong inflows year-to-date show that the environment is definitely more supportive of EM,” said Delphine Arrighi, a London-based money manager at Merian Global Investors. Still, “investors are taking a pause here until they see how the China-U.S. situation evolves, and will reassess whether the risk of a global slowdown is indeed receding.” Emerging markets would likely be seen as the primary beneficiary of any deal that would boost global trade. But global trade is on the downswing because of a slowing global economy. The leading indicator of shipping costs — the Baltic Dry Index— has dropped to its lowest level since mid-2016, and four of the 10 gauges tracked by Bloomberg to assess the health of global trade are now below their long-run averages, compared with zero in November.
OIL ZIGS AS HEDGE FUNDS ZAG
Maybe it has something to do with the reports of hedge funds’ outrageous compensation packages or the sense that they are privy to secret formulas that give them an edge on the markets, but for some reason people tend to love to see hedge fund bets go awry. Putting aside a small increase Monday, oil is one area where hedge funds are falling short. They increased their wagers on rising Brent crude prices for an eighth consecutive week, the longest streak since 2012, according to ICE Futures Europe data for the seven days through Feb. 26. But instead of rallying, the international benchmark posted a weekly loss for the first time since early February as President Donald Trump warned OPEC to “take it easy” in cutting supplies, and U.S. economic data fell short of expectations, according to Bloomberg News’s Alex Nussbaum and Ben Foldy. Brent lost 3.1 percent for the week after rising 25 percent to start the year. “It’s sort of really push-pull in the short term between some fairly constructive bullish set-up on the supply side but really overshadowed by questions on the demand side,” Tamar Essner, director for energy and utilities at Nasdaq Corporate Solutions in New York, told the reporters. “At the same time, you also have Trump doing everything to push for lower oil prices.” Hedge fund bets suggest they believe the longer-term picture is still bright. OPEC production fell by more than half a million barrels in February, according to a Bloomberg survey. U.S. drilling-rig activity, meanwhile, hit a nine-month low last week as investors push companies for spending cuts amid the uncertain outlook.
NORDIC CURRENCY MELTDOWN
Trump said over the weekend that the dollar is too strong and that U.S. companies might benefit if it were weaker. But because the dollar is freely traded, the Trump administration and the Fed can do little to weaken it. But a good old-fashioned banking scandal might do the trick. Any currency linked to a Nordic country got hit hard Monday after Finnish broadcaster YLE contended that Nordea Bank Abp, the biggest Nordic bank, handled about 700 million euros ($793 million) in questionable funds in a growing money-laundering scandal for the region. YLE cited leaked documents covering 2005 to 2017, adding to a picture forming of Nordic banks that, often through their Baltic units, became hubs for Russian criminals eager to channel their funds into the West, according to Bloomberg News’s Kati Pohjanpalo and Frances Schwartzkopff. (Nordea said in a statement that many of the allegations in Monday’s report represented old claims that the bank has already responded to.) The Swedish krona and Norwegian krone were the two biggest losers on Monday among the 31 major currencies tracked by Bloomberg, falling at least 0.75 percent. For Sweden’s currency, things keep going from bad to worse. The krona has depreciated about 5.50 percent this year, reaching an all-time low late last month against the basket as measured by the Bloomberg Correlated-Weighted Indexes. The upside is that the weak krona may be supporting Sweden’s economy. A report on Friday showed a key manufacturing gauge unexpectedly recovered in February from a three-year low, boosted by a rise in export orders. That comes after a report on Thursday that revealed that the economy expanded at twice the expected pace at the end of 2018, also helped by exports.
Much of the focus Monday was centered on rising speculation that the U.S. and China are close to a trade deal that could lift most or all U.S. tariffs as long as Beijing follows through on pledges ranging from better protecting intellectual-property rights to buying a significant amount of American products. But the annual National People’s Congress, which starts Tuesday and runs through March 15 — involving some 3,000 government representatives — is potentially a more important event for markets. The government will announce its economic growth targets as well as new laws surrounding foreign investment. The new laws, if passed, will “increase intellectual property protection and limit technology transfer,” according to the strategists at Cantor Fitzgerald. Citing a person familiar with the matter, Bloomberg News is reporting that China is planning to cut the value-added tax rate that covers the manufacturing sector by 3 percentage points as part of measures to support the slowing economy. That cut could deliver a boost worth up to 600 billion yuan ($90 billion) or 0.6 percent of GDP, according to estimates by Morgan Stanley.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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