The Stock Market Finally Acknowledges Reality

(Bloomberg) This year’s remarkable surge in global equities sparked optimism that the recovery from the fourth quarter’s steep 13 percent sell-off would be V-shaped. The action on Thursday suggests it’s more likely to look like a W. After surging 8.65 percent since the start of the year, stocks tumbled as much as 1.37 percent as investors could no longer make excuses for the deteriorating economic outlook.

That was on full display in Europe, where the European Commission made sweeping downward revisions to most of the region’s major economies. It now sees the 19-nation euro-area economy expanding by just 1.3 percent this year, down from the 1.9 percent projected in November. Italy’s economy has already met the technical definition of a recession. “Much of the euro area’s loss of growth momentum can be attributed to fading support from the external environment, including slower global trade growth and high uncertainty regarding trade policies,” the commission said. That’s not wrong. The JPMorgan Global Manufacturing PMI index fell to 50.7 for January, the lowest since 2016. The measure is a diffusion index, meaning readings above 50 denote expansion and those below 50 signal contraction.

“When you get these numbers coming out of Europe, it just reminds you, ‘Well, gee, that’s an issue and it’s symptomatic of all of this prevailing view that the global economy is slowing down,’’’ David Joy, chief market strategist at Ameriprise Financial, told Bloomberg News. As for “trade policies,” which is really code for the talks between the U.S. and China, the normally upbeat White House economic adviser Larry Kudlow expressed some unusual pessimism that surprised investors. He told Fox Business in an interview that there is a pretty sizable distance to go in U.S.-China trade talks, which sent stocks to their lows of the day.

Although it was positive sign that stocks bounced off their lows of the day, with the MSCI ending just 0.94 percent lower, the reality is that 2019 is going to be a tough year for the global economy. There are just too many things that would have to break just right for stocks to build on their best start to a year since 1987. That’s not to say equities can’t end the year higher, but as they say on Wall Street, past performance is no guarantee of future results.


For proof that the surge in global equities in January had little to do with growing confidence in the outlook and was more likely just a technical bounce from oversold levels, just take a look at the bond market. While stocks were rebounding, bond economists and strategists were steadily reducing their forecasts for how high yields on U.S. Treasuries — the world’s ultimate haven asset — will get. The latest monthly Bloomberg News survey of about 60 forecasters shows that the median estimate for 10-year yields at the end of 2019 is 3 percent. Although that’s above the current market rate of 2.65 percent, it’s far below the 3.50 percent that was forecast as recently as November. Much of this, of course, has to do with a more dovish Federal Reserve, which has signaled that it will stop raising interest rates for the time being.

But the reason the Fed pivoted from its hawkish stance was because of the worsening global outlook. Central banks around the world are sounding very concerned. On Thursday, the Bank of England said it expected the U.K. economy to grow at its slowest pace in a decade. Reserve Bank of Australia Governor Philip Lowe shifted to a neutral policy outlook this week as he acknowledged increased economic risks at home and abroad.


Oil has followed much of the same script as stocks. Prices plunged 44 percent between early October and late December as worsening demand met with abundant supplies. And like stocks, crude has bounced back, surging 18 percent in January. But also like stocks, the challenges facing oil bulls haven’t gone away. Futures tumbled as much as 4 percent, the most since Christmas Eve, on the poor euro zone economic forecasts and Kudlow’s disappointing remarks about the progress of trade talks.

“Clearly if we have an all-out trade war, with quite a bit of the market’s growth slated to come from China and other emerging markets, that ain’t bullish for oil,” Kyle Cooper, a Houston-based consultant at Ion Energy Group LLC, told Bloomberg News. While the Fed’s dovishness has provided support to riskier assets such as commodities and equities, it seems investors are just realizing such a boost is little more than a knee-jerk reaction that glosses over the fact that the reason the Fed is less inclined to raise interest rates is because the global economy is looking weaker by the day.


The Bloomberg Dollar Spot Index rose to its highest level in five weeks on Thursday, which is a bit of a head-scratcher to many market participants given that a central bank that goes from hawkish to dovish — like the Fed — is normally bad for a currency. But once again, when looked at in a global context, the move makes sense. That’s because the U.S. economy, although decelerating, is being viewed as the cleanest dirty shirt. And although U.S. bond yields have fallen, which is another negative for a currency, they are much lower in most developed economies.

Yields on U.S. government bonds are about 2 percentage points higher on average than elsewhere in the worldwide government bond market, according to the ICE Bank of America Merrill Lynch bond indexes. The spread has grown from virtually nothing five years ago, making the dollar a virtual no-brainer for investors looking to hide out in safe assets until the global economic outlook brightens. If the market begins to price back in a Fed rate hike later this year and 10-year Treasury yields move higher, “that would be the next leg for a dollar rally,” said Win Thin, Brown Brothers Harriman’s global head of currency strategy.


But the problem here is that many companies this earnings seasons have complained about the strong dollar denting their profits. If that’s true, then it stands to reason that a further appreciation in the greenback (some 50 percent of earnings for members of the S&P 500 come from outside the U.S.) will act as yet another drag on earnings in a year that’s not expected to see much of any gains. “The equity market is most closely correlated to the direction of earnings,” Tony Dwyer, Canaccord Genuity Group’s chief market strategist, wrote in a report on Tuesday. While analysts’ views of fourth-quarter 2018 earnings have improved since the start of the year, they’ve soured on 2019, according to Bloomberg Intelligence’s Gina Martin Adams and Wendy Soong.

For the first quarter, analysts expect S&P 500 companies to report earnings per share of $38.40, a decline of 4.2 percent since early January, because of a weakness in multinationals, while EPS targets for both the second and third quarters have also been lowered, according to Bloomberg News’s Sophie Caronello. That drops overall earnings expectations to $169 a share from $172 in 2019, and $186.80 a share from $190.20 in 2020.



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