(Bloomberg Opinion) -- Investors generally fall into one of two camps: those that take the long view and largely ignore the noise emanating from day-to-day fluctuations in asset prices, and those that live and die by those same gyrations. In that sense, Tuesday’s action in the global stock market might not seem remarkable with the MSCI All-Country World Index inching up a mere 0.20 percent, but to the so-called fast money, the move is extremely important.
The day’s gain left the index right around 500, a level that it has made a run at three times since mid-October but failed to break through in any meaningful way, falling back each time. So, will this time be different, with the benchmark not only holding at this level but rising to even greater heights in short order, or will it retreat again? Sadly, the odds are on the latter. The bull case for stocks is largely based on suddenly dovish central banks and lower bond yields. But central banks are dovish and bond yields are lower for good reason, which is that a preponderance of the data indicate a much slower global economy ahead that brings with it an earnings recession. A UBS AG model suggests world growth slowed to a 2.1 percent annualized pace at the end of 2018, which the firm says would be the weakest since 2008-2009. China car sales dropped in January, and data last week showed U.S. retail sales posted their worst drop in nine years in December. In Europe, where the slowdown has been particularly notable, sentiment indicators continue to weaken, and the latest OECD leading indicator has also declined, according to Bloomberg News’s Fergal O’Brien. “Markets frequently change their mind, but even adjusting for that, the shift in ‘conventional wisdom’ in recent months has been nothing short of whiplash,” Morgan Stanley Chief Cross-Asset Strategist Andrew Sheets wrote in a research note Sunday.
Sheets and other strategists increasingly say that investors have taken on a Goldilocks-like view of the world, where inflationary pressures have receded, giving central banks wide latitude to pause almost indefinitely on monetary policy tightening. And while global growth is slowing, it’s not enough to be truly concerning. Also, U.S. political risks are close to resolution, with growing investor optimism that lasting solutions to funding the U.S. government and U.S.-China trade tensions are within reach. “We are skeptical that this story holds together,” Sheets added. So should markets.
BOND TRADERS PLAY THE LONG GAME
That’s certainly a lot of things that need to go right for stocks to continue rallying — or at least not fall back. But one thing that shouldn’t be ignored is a collapse in the so-called term premium on U.S. Treasury 10-year notes. The extra compensation investors need to own long-term bonds instead of continuously rolling over short-term debt has fallen to negative 0.7164 percentage point, not far from the record low of negative 0.8092 in July 2016. This is at odds with the rally in equities because it suggests bond traders are increasingly concerned that the current growth slowdown and resulting slowdown in inflation won’t just be a fleeting event. Just last week, the U.S. government said that the Consumer Price Index rose just 1.6 percent from a year earlier, the smallest increase since 2016. The naysayers may point to 2017, when the term premium collapsed from a positive 0.1169 percentage point to a negative 0.5531 percentage point and yet the S&P 500 Index managed to soar 19.4 percent. That’s true, but the surge in stocks was largely due to anticipation of a reduction in corporate tax rates and the massive deregulation movement under the Trump administration. In that sense, the bond market was already discounting those one-time items, knowing that such moves just pulled growth from future years and that there would ultimately be a payback. And there was some payback, as the S&P 500 dropped 6.24 percent in 2018.
CAREFUL WHAT YOU WISH FOR
The offshore yuan strengthened on Tuesday after Bloomberg News reported that the U.S. is asking China to keep the value of the currency stable as part of trade negotiations between the world’s two largest economies. The request is aimed at neutralizing any effort by Beijing to devalue its currency to counter American tariffs. That’s fine, but how will “stable” be defined? Yes, the Chinese government allowed its currency to drop to its weakest level since 2008 in late 2018, but based on historical volatility over 100-day periods going back to 2014, the yuan has been more stable than the Bloomberg Dollar Spot Index that measures the greenback against its chief peers. The other way to interpret “stable” is that the U.S. doesn’t want China to weaken the yuan for competitive purposes. Even though many currency strategists think the yuan would be much weaker if the China government hadn’t been managing its slide, what this really means is that the U.S. is, in fact, pursuing a weak dollar policy. That helps explain why the dollar had its biggest decline this month on Tuesday. If true, that has all sorts of implications, none of them really good for the U.S. outside of a short-term bump in exports perhaps. Foreign investors, who own about half of all U.S. government debt outstanding and help finance the budget deficit, would be less inclined to own dollar-denominated assets if they felt the U.S. was pressuring the greenback lower. That could cause borrowing costs for the government, companies and consumers to skyrocket.
PALLADIUM’S CAVEAT EMPTOR MOMENT
The commodities market has also staged a rebound this year, but nothing on the order of stocks. That suggests the almost 6 percent rally in the Bloomberg Commodity Index has more to do with a recovery from oversold levels than any positive referendum on the global economic outlook. The index is still down for the past three-, six- and 12-month periods. But the commodities market is so diverse that it’s impossible to paint every corner with the same brush. Consider palladium, which seems to dance to its own tune regardless of what’s happening in the broader market. Spot palladium climbed as much as 2.3 percent on Tuesday to an all-time high of $1,491.14 an ounce, extending its gain for this year to 18 percent and 76 percent from its low last year in mid-August. The rally has been driven by investors’ bets on tight supplies of the metal used to curb emissions in gasoline vehicles, according to Bloomberg News’s Ranjeetha Pakiam and Marvin G. Perez. Carmakers are scrambling to obtain the metal to meet more stringent emissions controls, particularly in China. Tight supplies have spurred a robust borrowing market for the metal, prompting investors to pull palladium from exchange-traded funds and offer them for lease. Some analysts are questioning the durability of the rally. Car sales in China continued to decline in January after their first full-year slump in more than two decades. Plus, markets in Europe and North America are shrinking as the increasing availability of ride-hailing and car-sharing services makes it less necessary to own a vehicle.
CRYPTOFANATICS HAVE SOMETHING TO CHEER
Promoters of Bitcoin and other cryptocurrencies hail them as a haven and alternative to traditional currencies being debased by central banks facing an uncertain economic outlook. And although the Bloomberg Crypto Index surged more than 17 percent on Tuesday for its biggest gain since September in the wake of the UBS report showing the global economy is the worst it’s been since the financial crisis, that’s not why cryptocurrencies are in demand. A more realistic explanation for the move is the recent news that JPMorgan Chase has developed a prototype digital coin that it plans to use to speed up payments between corporate customers. What has the cryptofanatics so excited is JPMorgan’s seeming turnaround. Chief Executive Officer Jamie Dimon famously called Bitcoin a “fraud” in 2017, though he’s repeatedly said he sees many ways the bank could use blockchain technology, according to Bloomberg News’s Michelle F. Davis and Alastair Marsh. No one is saying that cryptocurrencies are anywhere near ready to take over for the dollar, euro or yen, but they continue to make (very slow) progress in infiltrating the global financial system such that institutional investors should consider dipping their toes into the $120 billion market, according to Cambridge Associates, a consultant for pensions and endowments. “Though these investments entail a high degree of risk, some may very well upend the digital world,” analysts at the firm wrote in a research note Monday. Most large institutions have steered clear of the 10-year-old industry because it’s largely unregulated and cryptocurrencies have been used to finance illicit trade, according to Marsh.
TEA LEAVES
What were they really thinking? The Fed on Wednesday afternoon will release the minutes of its Jan. 29-30 Federal Open Market Committee meeting, when the central bank did a 180-degree turn away from the bias it expressed just last month toward higher borrowing costs, promising instead to be “patient” on any future interest-rate moves. The caveat is the minutes are heavily edited, so they’re not a word-for-word accounting of the discussion among policy makers. Even so, any sign that the Fed may not be as dovish as first believed could roil markets. As the top-ranked rates strategists at BMO Capital Markets noted in a Tuesday research report, this year’s 11 percent rally in the equities market “only managed to occur as yields failed to rise; said differently, further upside potential in risk assets is once again dependent on the stability of nominal benchmarks.”
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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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