Too Bad There’s No Truce in Slower Profit Growth
(Bloomberg Opinion) -- The trade truce that was reached between U.S. President Donald Trump and Chinese leader Xi Jinping pushed global and U.S. stocks higher by the most since Wednesday. Yes, that does feel a bit underwhelming — and for good reason.
First, last week’s big rally in equities suggested investors were anticipating some type of détente. Second, the 90-day cooling off period when no new tariffs will be announced only kicks the can down the road without solving the core issues that led to the trade war. As the top-ranked rates strategists at BMO Capital Markets reminded clients, “any meeting which only results in a plan to have another meeting, was a bad meeting.” That leaves markets at the mercy of the fundamentals such as the economy and corporate profits, neither of which are looking robust. Both Federal Reserve Chairman Jerome Powell and International Monetary Fund Managing Director Christine Lagarde admitted as much last week in separate speeches. DataTrek Research framed it nicely in a note to clients Monday, pointing out how fourth-quarter profit forecasts have declined steadily to 13.6 percent from 16.1 percent at the end of October and 17.1 percent at the end of September. That might shock investors accustomed to 25 percent or better growth in the first three quarters of the year. “The bottom line here is that we may get more of a Hanukkah rally than the traditional equity melt up associated with St. Nick,” DataTrek co-founder Nicholas Colas wrote in the note.
To be sure, it’s hard to argue the market is wrong. It’s also hard to deny the strong rebound in equities, with the S&P 500 Index rising 4.85 percent in the five days ended Nov. 30 for its biggest weekly rally since 2011, and the MSCI All-Country World Index jumping an impressive 3.27 percent. “There’s a lot of potential for the rebound to go on,” Nader Naeimi, a Sydney-based fund manager at AMP Capital Investors, told Bloomberg News. This is the first time in a long time “you think you’ve got to go and put your foot on it — just go. The biggest risk was (a hawkish) Fed and trade. That’s being reassessed.”
BOND TRADERS DO SOME HAND-WRINGING
The bond market sent an ominous signal on Monday as one part of the yield curve inverted for the first time since 2007. More specifically, yields on five-year Treasury notes fell below those on three-year notes by 0.7 basis point. This is concerning because an inverted yield curve has historically preceded a recession. There are a few caveats, however. This is only one small part of the curve, and not the more widely watched difference between two- and 10-year Treasury yields, although that part of the curve is extremely narrow after falling below 20 basis points on Monday. Also, an inverted yield curve doesn’t necessarily result in a recession in a matter of weeks, months or even quarters. Some recessions followed an inversion by as much as two years. Still, the trend is what’s disturbing as it shows bond traders are growing less confident in economic growth and the faster inflation that usually results, even with the weekend’s trade truce between the U.S. and China. “Do not become overly wrapped up in short-term reactions produced by trade policy headlines,” Arbor Research & Trading data scientist Ben Breitholtz wrote in a research note Monday. “Slowing global economic data changes and heightened monetary policy uncertainty continue to rule the roost.” That might explain why Fed Vice Chairman Richard Clarida said in an interview with Bloomberg Television Monday that he remains more concerned about falling short of the central bank’s 2 percent inflation objective than running above it.
YUAN’S MOVE MAY BE MOST IMPORTANT
One underappreciated factor in the big jump in so-called risk assets such as stocks is the appreciation of China’s yuan. The currency soared as much as 1.17 percent Monday, the most since February 2016, before ending at 6.8830 per dollar. This moves it further away from the psychologically important 7 per dollar level, which many investors and strategists said would most likely spark a flight of capital from China and throw global markets into a tailspin. Chinese officials have allowed the tightly controlled currency to weaken from about 6.2690 per dollar in April to 6.9757 on Oct. 31 as a way to counter U.S. tariffs. It’s probably no coincidence that the MSCI All-Country World Index bottomed out for the year on Oct. 29 as the yuan was on its way to its weakest level since 2008. Morgan Stanley thinks that China’s markets may have turned a corner after the Group of 20 dinner between Trump and Xi. The firm upgraded China to “overweight,” saying “the agreement to keep talking for 90 days during which tariffs are paused is an upside surprise.” It expects the MSCI China Index of stocks to rise 9 percent in 2019, compared with a 6 percent gain for emerging-market equities as a whole. Others are not as optimistic, with China’s economy still dealing with rising corporate defaults and a bear market in stocks. “The trade situation is slightly better than before, but there’s no substantial development,” Hao Hong, a strategist with Bocom International Holdings, told Bloomberg News.
COMMODITIES TRADERS YAWN
The commodities market, which is where one might expect to see the biggest reaction from the U.S-China trade truce, seemed a bit indifferent. The Bloomberg Commodity Index jumped only about 0.5 percent, also its biggest gain since Wednesday. The reaction was a bit muted despite West Texas Intermediate oil prices — a key component of the index — surging as much as 5.73 percent for its biggest gain in two years. Perhaps commodities traders are more focused on the global economic slowdown, which is reducing demand for raw materials. The IMF in October downgraded its forecast for global growth to 3.7 percent this year and next from the 3.9 percent projected three months earlier. It was the first cut since July 2016, and as noted above, Lagarde said in a blog post last week, “now we are facing a period where significant risks are materializing and darker clouds are looming.” Perhaps ironically, gold was up on Monday despite the general “risk on” environment in markets and the fact that the precious metal is generally viewed as an asset to buy in times of turmoil. For all the early optimism, however, differences on difficult issues such as Chinese industrial policy and intellectual property regimes remain vast and tough negotiations now lie ahead with the temporary pact due to expire March 1, according to Bloomberg News’s Shawn Donnan. “Once the afterglow of this dinner meeting fades, reality will begin to set in fairly quickly,” Eswar Prasad, a Cornell University expert on both Chinese economic policy and trade, told Bloomberg News. “I don’t see an easy path within the 90-day window to resolve the differences they have.”
CHEAP EMERGING MARKETS LURE
Both the MSCI Emerging Market Index of equities and currencies jumped the most in a month on Monday, but that’s probably not a surprise to investors. That’s because they pumped $2.63 billion last week into exchange-traded funds that invest in emerging-market stocks and bonds, the most in 10 months, data compiled by Bloomberg show. Despite the worsening outlook for global economy, emerging markets have looked fairly strong of late. The MSCI index of stocks gained 4.06 percent in November in its biggest gain since January, while the currency gauge jumped 1.46 percent, which was also its biggest advance since January. The case could be made that the steep losses in eight of the previous nine months mean that emerging-market investors have already discounted the bad news. These markets are also getting some relief from the speculation that the Fed may slow the pace of rate hikes after this month. Also, at about 12 times earnings, emerging-market stocks are still about their cheapest since the end of 2015. During the rally of 2016 and 2017, the ratio rose above 16 times earnings. Some of the biggest gainers Monday were Taiwan, Russia and South Africa, where the benchmark stock indexes all rose more than 2 percent. In the currency market, the pesos of Argentina and Colombia were the big winners, along with South Africa’s rand. “It is apparent that both sides have a strong incentive to continue the dialogue,” Jean-Charles Sambor, deputy head of emerging-market debt at BNP Paribas Asset Management, told Bloomberg News in reference to the U.S. and China. “We think that there is still too much negativity priced in, and we should be poised for a rebound in the short term.”
In a few hours, at least at the time of this writing, Australia’s central bank is expected to announce that it’s keeping its benchmark interest rate unchanged at 1.50 percent, which is where it has been since mid-2016. But that’s hardly the news. The local currency has shown some life lately, with the Bloomberg Correlated-Weighted Index of the Australian dollar versus its major peers rising almost 5 percent from a 29-month low in early October. Some of that is surely due to the tamping down of trade tensions between the U.S. and China, which is a top destination for Australian goods. It’s also important to note that the country’s economy looks to be on more solid footing. The government is forecast to say in a few days that the economy expanded at about the same rate in the third quarter as it did in the second quarter, or 3.4 percent. That was the fastest pace since 2012. The Reserve Bank of Australia said a few weeks ago that the unemployment rate could fall further in the near term based on leading indicators of labor demand. For the Aussie to continue its rebound, currency traders will need to see a relatively hawkish central bank.
G-20 Gives Markets a Short-Term Respite: Mohamed A. El-Erian
The U.S. Yield Curve Just Inverted. That’s Huge: Brian Chappatta
Stocks Can Forget About a Big Leap From Trade: Stephen Gandel
Qatar Leaving Is an Ominous Sign for OPEC: Liam Denning
China’s Bonds Get a $2.5 Trillion Test Run: Francesco Garzarelli
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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