The Stock Melt-Up Explained in Three Easy Pieces
(Bloomberg Opinion) -- The global rebound in equities from December’s gut-wrenching sell-off has many calling it a “melt-up,” defined as a sharp and unexpected gain driven by a stampede of investors who don’t want to miss out rather than any fundamental improvements. Including Wednesday’s gains, the MSCI All-Country World Index has rallied 9.13 percent since Christmas. That’s better than the gauge’s 7.28 percent surge in the first four weeks of 2018, a performance many compared to a bubble that was ready to pop — which it did, tumbling 9 percent over the following two weeks.
Although the latest moves come with most economists downgrading their outlook for global economic growth and corporate earnings, it’s not as if the move has been built on smoke and mirrors. Medley Global Macro Managing Director Ben Emons has zeroed in on three plausible reasons for sentiment quickly shifting for the better. First is the rally in China’s yuan, which has reduced the risk of a capital flight from the country that would throw global markets into turmoil. The yuan has appreciated on speculation authorities will continue ramping up their stimulus efforts to keep the local economy from slowing much further — as it did this week. “A stable-to-stronger yuan is positive for global market sentiment,” Emons wrote in a research note. Second, the bond market is paring back the odds of a Federal Reserve interest-rate cut by 2020, showing pessimism over the economy had gone too far. “A lower rate cut probability reduces expectations of a recession in the U.S.,” Emons added. Third, inflation is moderating globally, which takes the pressure off central banks from becoming too hawkish. Inflation rates are back to being lower than the targets set by either the Fed, European Central Bank or Bank of Japan. “These three reasons operate as an ‘elixir’ because they take away the fear of a global recession while at the same also avoid a global overheating,” Emons wrote.
“With interest rates going to stay fairly low as long as inflation stays low — that’s the big surprise, low inflation everywhere — you’ve got to be bullish on stocks,” Decision Economics head and co-founder Allen Sinai said in an interview with Bloomberg Television in Tokyo. “The equity bull market will be back. It never left.”
Stocks are also getting help from the bond market, where a rally has pushed yields down from 2.27 percent on average globally a couple of months ago to 2.02 percent this week, as measured by the Bloomberg Barclays Global Aggregate Total Return Index. That makes the dividends offered on stocks a more attractive option relative to the interest paid on bonds. On top of that, the amount of bonds globally with negative yields has jumped back above $8 trillion from less than $6 trillion in October. Both developments can be traced directly to the turn in rhetoric from central bankers, who just a few months ago were wringing their hands over whether or not they had fallen behind the curve in not being too hawkish. Perhaps the best example of this switch is Esther George, president of the Federal Reserve Bank of Kansas City. She had been one of the most hawkish members of the Fed’s policy group until she urged her peers on Tuesday to be patient and pause before considering additional rate increases. “A pause in the normalization process would give us time to assess if the economy is responding as expected with a slowing of growth to a pace that is sustainable,’’ George said in a speech. It’s no wonder that the $51 trillion Bloomberg Barclays gauge of global investment-grade obligations has already recovered half its index losses posted between last year’s record high in January and the low in November.
With bond yields heading lower, it’s not so surprising that investors are returning to stock funds. Investors added an estimated $6.9 billion to equity mutual funds in the week ended Jan. 9 after eight weeks of pulling money from them, according to data from Investment Company Institute. BlackRock Inc., the world’s largest asset manager, has seen customers putting money to work this month, Chief Executive Officer Larry Fink said in a CNBC interview Wednesday. The bulls say there is plenty of dry powder in the form of cash sitting on the sidelines. Assets in money market funds surged by $155.5 billion in the fourth quarter to $3.04 trillion. That’s the biggest increase since December 2008, when huge losses in equities, credit and other markets following Lehman Brothers’ bankruptcy sent investors fleeing to cash. Money fund assets continued to grow this year, rising to $3.07 trillion as of Jan. 9. The decision these investors must make is whether it’s worth the risk to jump back into equities now or keep the money in safe, relatively attractive cash amid all the uncertainties on the horizon. The rally in stocks has pushed the average dividend yield for members of the S&P 500 Index down to within 0.75 percentage point of rates on 12-month certificates of deposit as measured by Bankrate.com. In December, the gap was about 1 percentage point.
More evidence of animal spirits are being seen in emerging markets, where even those countries that have disappointed investors in recent months are borrowing with no problems. Russia netted its biggest bond sale in almost half a year on Wednesday as rebounding oil prices and a risk-on wave in global markets offset the lingering threat of sanctions at its first auction of 2019, according to Bloomberg News’s Áine Quinn. The Finance Ministry sold all 35.1 billion rubles ($528 million) of bonds offered after a three-week break over the holiday period. It didn’t need to tempt buyers with a premium for any of the three offerings, which included a placement of inflation-linked notes. On Wednesday, investors shrugged off a Senate bid to block the Treasury Department from lifting sanctions on companies linked to billionaire Oleg Deripaska. That contrasts with a string of canceled auctions in September when sanction concerns soared. Mexico is offering $2 billion of 10-year debt in the first global bond sale under new President Andres Manuel Lopez Obrado. Readers may recall that in October AMLO, as the president is known, roiled markets by ditching a $13 billion airport project for Mexico City backed by some of the nation’s wealthiest businessmen and international investors. But now all is forgiven. The peso is the world’s best-performing major currency since Nov. 26, and talk is that the bonds will price to yield about 185 basis points more than U.S. Treasuries, down from initial expectations of 190 basis points in a sign of strong demand.
COMMODITIES BULK UP
The market for raw materials seems to be buying into positive sentiment. The Bloomberg Commodity Index is up 4.59 percent in January, already making this the best month since April 2016. The industrial metals, agriculture and energy sectors are all showing gains. Much of the better performance in commodities is most likely tied to the growing sense that the U.S. and China both want to end the trade war quickly rather than let it linger and continue to add to the uncertainty. China said this week that exports fell 4.4 percent in December, the biggest drop since 2016 in dollar terms. Imports slumped 7.6 percent, also the worst reading since 2016 and hinting at softening demand at home, according to Bloomberg News. In the U.S., the economy is being hobbled by a government shutdown. Chinese Vice Premier Liu He is scheduled to travel to the U.S. for further talks around the end of this month. Negotiators from both sides expressed optimism after midlevel talks wrapped up in Beijing last week. The U.S. is shipping a third cargo of soybeans in a month from the Pacific Northwest to China, according to Bloomberg News’s Kevin Varley and Isis Almeida. Bulk carrier Haoyue left Louis Dreyfus Co.’s Pier 86 grain export elevator in Seattle on Jan. 14 and is headed to Qingdao, according to vessel tracking data. China agreed in early December to buy American supplies as part of a truce in the trade spat. China aims to buy at least 5 million tons, people familiar with the matter said this month.
Speaking of inflation, the second reading for euro-area consumer prices in December will be released on Thursday. The forecast is for the inflation rate to have risen 1.6 percent from a year earlier, the smallest advance since April and underscoring just how inflation in advanced economies is no threat despite pumping in trillions of dollars, euros, yen and pounds after the financial crisis. European Central Bank President Mario Draghi admitted as much on Tuesday, confirming that the ECB plans to keep interest rates at current levels and reinvest maturing debt back into the market for some time. “A significant amount of monetary-policy stimulus is still needed to support the further buildup of domestic price pressures and headline inflation developments over the medium term,” Draghi told members of the European Parliament in Strasbourg.
Traders Indulge in Some Wishful Brexit Thinking: Lionel Laurent
The Economy Can’t Shrug Off the Shutdown Forever: Noah Smith
Stimulus Worked in 2009. What About Next Time? Peter R. Orszag
China’s a Tough Rival, But Is It Really Cheating?: Stephen Roach
Virtuous Investing Is Finally Starting to Pay Off: Mark Gilbert
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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