Goldilocks Is Getting Chased Out of the Markets

(Bloomberg Opinion) -- The S&P 500 Index was on its way to another winning day Tuesday before reports of trouble in the U.S.-China trade talks sent shares lower. Even so, the decline was negligible, and the benchmark is still up 13 percent for the year. Not only that, stocks are on track for their best quarter since soaring 15 percent in the July through September period of 2009. The remarkable thing about equities’ performance is not so much that they have rebounded so strongly from December’s sell-off in the face of a slowing economy and earnings growth, but just how many failed to see it coming and still don’t seem to believe it is happening.

“The pain trade for stocks is still up,” Michael Hartnett, the chief investment strategist at Bank of America, wrote in research note Tuesday. He’s right. The firm’s closely monitored monthly investor survey found that allocations are just a net 3 percent “overweight” to global equities, the lowest level since September 2016. That’s hardly the stuff of animal spirits. There’s also evidence that investors are stockpiling cash in a defensive move. Money fund assets stand at $3.11 trillion, up from $2.93 trillion at the end of November, according to the Investment Company Institute. If you listen to Cantor Fitzgerald, it’s a good time to get defensive after stocks received a positive jolt from the Federal Reserve’s dovish pivot at the start of the year. “A Goldilocks scenario for markets requires low inflation, steady to accelerating growth, and a Fed at the ready to ease quickly,” its strategists wrote. “We’d argue that two of those three conditions are soon to be absent.” In other words, low inflation may persist, but economic growth is decelerating and the Fed is probably more inclined to raise interest rates at least once this year.

And while the Fed and Chairman Jerome Powell are likely to repeat on Wednesday that the central bank will be patient before raising rates again or tightening monetary policy, the risk for equity markets is that it is not as dovish as anticipated. After all, the rebound in stocks, drop in bond yields and narrowing in credit spreads this year has caused financial conditions to be as loose as anytime in the past five years, according to the Bloomberg U.S. Financial Conditions Index. As much as the Fed doesn’t want to be seen as responsible for driving the economy into a recession, it also doesn’t want to be seen as fostering bubbles in the markets.

THE REAL PAIN TRADE
As painful as it has been for bearish investors to watch the run-up in U.S. stocks, it’s been even more painful seeing the big gains in Europe’s equity market. The STOXX Europe 600 Index has been on a tear, jumping 4.16 percent since mid-February to trounce the S&P 500’s 2.41 percent gain. The European benchmark is now at its highest level since September. Although some of this performance reflects the notion that perhaps Europe’s economy may finally be starting to turn the corner along with a more dovish European Central Bank, it could also be a sign that it’s just getting too expensive for the bears to continue carrying positions betting on a drop in European equities. The Bank of America survey found that being short European equities is seen as the most crowded global cross-asset trade. Citigroup Inc.’s economic surprise indexes show that the degree to which euro-zone data is missing estimates is the smallest degree since November.

CHINA PROXY IS A CONCERN
It’s not just U.S. bond traders who are losing confidence in the economic outlook. In Australia, three-year government bonds yields  dropped below the central bank’s policy rate for the first time since September 2016, underscoring how growth jitters are fueling bets for interest-rate cuts globally, according to Bloomberg News’s Masaki Kondo and Ruth Carson. Yields on three-year debt — more sensitive than longer maturities to rate moves — dropped as much as 5 basis points Tuesday to 1.495 percent. The Reserve Bank of Australia, which highlighted concerns over consumption growth in its March meeting minutes published Tuesday, has kept its cash rate target at a record-low 1.50 percent since August 2016. Although Australia has its own economic problems, this move in the bond market should be concerning for market participants around the world because Australia is viewed as a proxy for China given the close trade ties between the countries.

WILD HOGS
Pork, also known as “the other white meat,” is about to become more expensive. As African swine fever ravages China’s hog herd, the world’s biggest, the supply scare has sparked an increase in panic buying for Chicago futures, according to Bloomberg News’s Lydia Mulvany. The June lean hog contract is up about 14 percent this month, on pace for a record gain, while a measure of historical volatility has been hovering around the highest since at least 1986. The potential impact on supply means “we can make a bullish case or a crazy wild bullish case,” Rich Nelson, chief strategist at Allendale Inc., told Bloomberg News. China has stepped up its purchases of U.S. pork , buying 23,800 metric tons in the week ending March 7, the most since late April 2017 and the third biggest in data going back to 2013, the Department of Agriculture reported Thursday. At least farmers are happy.

JUST TRUMP BEING TRUMP?
New Brazil President Jair Bolsonaro is called the Trump of the Tropics. So there were sure to be some fireworks when Bolsonaro visited the White House on Tuesday. And there was. Trump said he’s “very inclined” to make Brazil an official U.S. ally during an Oval Office meeting with Bolsonaro. The agreement to grant Brazil status as a major non-NATO ally would provide the country preferential access to U.S. military equipment and technology, according to Bloomberg News’s Justin Sink and Simone Iglesias. Brazil would become just the second Latin American country — after Argentina — and 18th nation overall to receive the designation. Traders weren’t impressed. Perhaps they viewed the gesture as an empty promise, as the Brazilian real barely budged and the Ibovespa index of equities fell.

TEA LEAVES
Whatever the Fed announces Wednesday, be prepared for an outsized market move. The S&P 500 Index dropped 1.54 percent after the Fed’s Dec. 19 monetary policy meeting and soared 1.55 percent after the Jan. 30 decision. The strategists at LPL Research note that stocks haven’t moved either up or down by more than 1.5 percent on successive Fed decisions since 2011. Get used to it. With the federal funds rate at the lower end of the range that is considered “neutral,” the outlook for monetary policy less predictable. That situation fosters a lot of volatility. One reason volatility was so low in recent years, even as the Fed hiked rates nine times and began shrinking its balance sheet, is because the Fed’s “dot plot” of rates and economic projections meant that everyone knew what the Fed was going to do, when it was going to do it and by how much it was going to do it. There was no mystery. The other thing to consider is that the Fed chairman held a press conference after only a few meetings each year. Now there’s one after every meeting, raising the odds that some off-the-cuff remark could send markets gyrating.

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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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