Market Bottom Feeders Decide It’s Time to Feast
(Bloomberg Opinion) -- One of billionaire Warren Buffett’s more well-known market maxims is to be fearful when others are greedy and be greedy when others are fearful. It sure looks as if a lot of investors are taking that to heart. After tumbling to the cusp of a bear market on Christmas Eve, defined as a 20 percent plunge from peak to trough — turning December into the worst month for equities since February 2009— stocks have started to show signs of strength.
The broad MSCI USA Index ended up a slight 0.11 percent Wednesday, which seems small but was a big victory considering it opened down as much as 1.58 percent. The gauge is now up 6.77 percent since hitting a 20-month low on Dec. 24, its best five-day stretch since December 2011 . What Wednesday’s action suggests is that anyone who wanted to get out had already probably done so in December. Consider State Street Global Markets’ monthly index of global institutional investor confidence. Released a week ago, it dropped to 79.8 for December, the lowest in data going back to 1990 — lower even than during the financial crisis. The measure has some authority because unlike survey-based gauges, it uses actual trades and covers 15 percent of the world’s tradable assets. That smacks of maximum fear, which doesn’t seem to quite jibe with the data. Mastercard Inc. said last week that holiday sales in the U.S. increased a solid 5.1 percent to more than $850 billion between Nov. 1 and Dec. 24. The more than 60 economists surveyed by Bloomberg don’t forecast gross domestic product falling below 2 percent until 2020. As for stock valuations, they now seem to incorporate almost all of the negative news.
The widely followed cyclically adjusted price-to-earnings ratio developed by Yale University Professor Robert Shiller compares the S&P 500 Index with its average earnings over the previous 10 years to account for economic swings. The current CAPE ratio suggests that stocks are trading near their long-term average risk premium when compared with bonds, according to Bloomberg Intelligence. “It’s a natural concern that stock corrections mark the beginning of something terrible, particularly after the 2000 and 2008 bear markets that destroyed investors’ confidence in equities,” the BI strategists wrote in a research note. “However, history shows that corrections are often natural in the scope of longer-term bull markets.”
KEEPING A WARY EYE ON BONDS
No matter how cheap or fairly valued equities may look, investors can’t seem to ignore the signals being sent by the bond market. One of the most reliable indicators of a pending recession — the gap between the three-month and 10-year U.S. Treasury yields, shrank to a post-crisis low of just 18.6 basis points in New York trading early Wednesday, according to Bloomberg News’s Emily Barrett. As most everyone knows, the so-called yield curve typically flattens and inverts before a recession. The Federal Reserve Bank of Cleveland uses the three-month/10-year part of the yield curve to calculate the odds of a recession in the following 12 months. When the gap was 47 basis points two weeks ago, it put the odds of a recession at 24 percent. So when they do the calculation again in two weeks, it “will surely show a material increase in the chance of a recession within the next 12 months,” the top-ranked interest rates strategists at BMO Capital Markets pointed out in a research note Wednesday. The important thing to remember, though, is that an inversion doesn’t cause a recession. Also, it took an average of 21 months for a recession to start after each of the last five (substantial) yield curve inversions going back to 1980, according to Deutsche Bank. And, there’s always a chance that the Federal Reserve adjusts monetary policy in a way that allows the economy to avoid a recession. The near-term forward spread, which reflects the difference between the forward rate implied by Treasury bills six quarters from now and the current three-month yield, fell below zero on Wednesday for the first time since March 2008, suggesting that money-market traders expect the Fed to cut rates within a year or so, according to Bloomberg News’s Gregor Stuart Hunter.
OPEC GETS EARLY START
Much of the rebound in U.S. stocks on Wednesday was credited to a sudden spike in crude prices, which boosted the shares of oil, gas and energy-related companies. But what spurred the rally in oil, which went from being down as much as 2.33 percent to up as much as 5.22 percent to $47.78 a barrel, was the more important news. It turns out that before its agreement to cut oil supplies even started, OPEC’s production plunged by the most in almost two years last month. In a sign of the urgency felt by the cartel amid tumbling crude prices, leading member Saudi Arabia throttled back production, according to Bloomberg News’s Grant Smith, citing a survey of officials, analysts and ship-tracking data. Oil output from the Organization of the Petroleum Exporting Countries fell by 530,000 barrels a day to 32.6 million a day last month. That’s the sharpest pullback since January 2017, when the group first embarked on its strategy to clear the glut created by rising supplies of U.S. shale oil. A global coalition of oil producers known as OPEC+, which comprises both members of the group and other exporters including Russia, agreed on Dec. 7 to reduce output during the first six months of 2019. Crude prices failed to rally, however, and instead slumped to $42.36 on Dec. 24, the lowest in more than a year. “We’ve seen a couple of times where the market’s attempted to pick itself up and it seems the selling pressure always returns,” Gene McGillian, market research manager at Tradition Energy, told Bloomberg News. “Until we see more evidence that fundamentals in the market are not as weak as some think, I think we’re going to keep feeling that pressure.”
THE DOLLAR GETS DUMPED
For all of President Donald Trump’s boasting about the strong performance of the U.S. economy, the dollar has so far failed to benefit in one key area. On Monday, while most investors were out of the office and getting ready to usher in the new year, the International Monetary Fund released its quarterly report on global foreign-exchange reserves. The report showed that the dollar accounted for 61.9 percent of global reserves as of the end of the second quarter, its second consecutive decline and the lowest level since the end of 2013. The greenback’s share has shrunk every quarter but one since Trump took office, contracting from 65.4 percent at the end of 2016. What makes the declines alarming is that they came when the Bloomberg Dollar Spot Index was rising. In other words, the shrinkage was most likely due to foreign reserve managers selling the dollar rather than watching their dollar-denominated assets shrink in value because of a depreciating greenback. It’s almost impossible to know whether the declines are a referendum on the Trump administration and its policies, but diminishing demand for the U.S. currency comes at an awkward time with the U.S. ramping up borrowing to unprecedented levels as the federal budget deficit approaches $1 trillion. That could keep U.S. borrowing costs higher than they would be otherwise. Even with a 0.51 percent gain on Wednesday, the Bloomberg Dollar Spot Index is about where it was at the end of October, showing investors see rougher waters ahead for the U.S.
BOLSONARO BOOSTS BRAZIL
Wednesday was a good day for Brazilian investors as the nation’s real turned in the strongest performance among the 31 top currencies tracked by Bloomberg against the dollar, and its stock market bucked a global emerging-market sell-off. The real gained as much as 2.93 percent in its biggest rally since 2012, while the Ibovespa index of equities surged 3.56 percent to close at a record high. Some might say the Brazil real was due for a rebound after it depreciated some 15 percent last year, but the rally also reflects optimism under new President Jair Bolsonaro, a populist who brings with him big plans for reform and who was inaugurated on Tuesday while markets were closed. Nearly two months after his election victory, around 75 percent of Brazilians think Bolsonaro, 63, is on the right track, according to polls. Investors, though, are waiting for evidence that his market-friendly economic proposals can actually be carried out, particularly a planned pension overhaul that would cut spending and help balance the budget, according to Bloomberg News’s Mario Sergio Lima and Flavia Said. The risk is that Bolsonaro becomes another Andres Manuel Lopez Obrador, Mexico’s new populist president who initially charmed investors but has since made some market unfriendly moves. “We suspect like the case of AMLO in Mexico, investors will end up being disappointed,” the currency strategists at Brown Brothers Harriman wrote in a research note Wednesday.
Concerns that the global economy has entered a synchronized slowdown have been confirmed by various manufacturing reports. A global manufacturing index compiled by from JPMorgan Chase & Co. and IHS Markit fell in December to the lowest level since September 2016 as measures of orders and hiring weakened, according to Bloomberg News. Factory conditions in China are signaling contraction for the first time since mid-2017. That’s why Thursday’s Institute for Supply Management’s U.S. manufacturing index for December will be watched closely. The gauge is expected to dip to 57.5 from 59.3 in November, but that will still be well above the level of 50 that divides contraction from expansion. Nevertheless, it will be hard for the U.S. to buck the global trend and the economists at Renaissance Macro Research figure the reading will “be lucky if it hits 56.”
Markets Signal Rising Odds of a 2019 Recession: Komal Sri-Kumar
The U.S. Must Keep Leading Global Growth: Mohamed A. El-Erian
Five Doom Loops Investors Must Navigate in 2019: Satyajit Das
Yield Curve Is Telling the Fed to Hold on Rates: Noah Smith
Beijing Dithers as the Economy Declines: Christopher Balding
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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