Red flag still flying for global stock bulls

Summary

Some restraint is now showing in global stock market relief though even a qualified trade war truce is still a red flag for bulls.

Gap day

major European stock indices opened with a ‘gap higher’. Such gaps are almost always filled, when euphoria passes. With some markets bounding almost two standard deviations, in other words to edge of their recent range, reversion seems probable even for ‘technical’ reasons alone. There are plenty of fundamental reasons to question the underpinnings of this rally too, or at least how long these may hold. Sure enough, some indices have their halved earlier advances. But last week’s hint that Fed tightening could soon follow an easier cadence, capping dollar strength, continues to lift weight from currencies, bonds and markets where borrowing costs were getting troublesome. At the same time, the global economy’s place in the cycle—after the crest but way above the trough—should also mean the instinct to reprice risk outlasts the session. Given the glaring underperformance of Chinese shares this year and Europe’s often eye-catching sensitivity to that region they could both have an edge if typical end-of-year bargain hunting takes hold

Figure 1. – normalised stock index chart: MSCI Asia-Pacific excl. Japan; STOXX Europe 600; S&P 500; Shanghai Shenzhen 300: year to date

Source: Refinitiv/City Index

European mining stocks extend gains

It’s one reason why the sea of green remains a transatlantic one and for the ease with which the 10-year Treasury yield was sent scurrying after an early attempt on 3.05%. It was down a little short of a basis point from that top just now, having earlier returned almost all of its run higher in Asian trading. Also helping: 1. a more favourable set of circumstantial indications on the chances of an effective output cut when OPEC meets, starting on Thursday. 2. The spate of PMI prints due from all corners this week have mostly behaved so far. Friday buyers of shares in European banks, car makers and mining and metal industries look vindicated most. These sub-indices have surged to the front looking to correct deep underperformance. So far, they barely touch 15%-20% 2018 declines, including Friday’s anticipatory bounce. On Monday, STOXX’s Basic Resource gauge is among the few to extend gains in the second half of the session. In this context, a 2.8% jump by Europe’s technology sector reflects a more measured assessment of the reprieve that may have been won in Buenos Aires.

Signs of extended truce will be key

The least equivocal plus of the deal is Washington’s new willingness to offer Beijing time. But it is just as obvious that this inclination may not last. In fact, in some ways, it’s too late. The mid-term incentive has passed. The Trump administration can certainly avoid worrying about Republican farming states till at least March. And that stretch of some 90 days is nowhere near enough to talk over all contentious issues. The tight schedule suggests an extension is all but inevitable. But it’s not guaranteed. The chances of China and the U.S. agreeing to an even longer ‘ceasefire’ for negotiations thereby becomes one the most important points for investors to watch at the start of 2019.

What could possibly go wrong

Before then, hawks, led by the most competent one, Trade Representative Robert Lighthizer, can re-state their case to a President who often changes his mind, sometimes apparently reacting to perceived slights. If hawks prevail again, it’s worth noting that the 10% tariffs on $200bn in Chinese goods that automatically ratchet up to 25% won’t be all. Saturday’s agreement was loose enough for Washington to also impose tariffs on $267bn in further trade threatened in the autumn. For China, whose state news barely mentions the 90-day timeline, the accord ends just before the annual National People’s Congress. Since discussions will almost inevitably not be concluded by then, it might be bad timing for further compromise.

Fed’s Powell back in view

In the meantime, the return of Federal Reserve chair Jerome Powell to the TV cameras this week will be the next event that moves investors to the edge of their seats. His testimony on Wednesday to the congressional Joint Economic Committee will be his first opportunity to fine tune – or just outright tune – comments last week that triggered a big reassessment of rate expectations. Since the market seized on the notion of how close rates are to ‘neutral’ compared to October, the committee could request a working definition of what ‘neutral’ means right now. Depending on that, further reassessment of rate expectations, and hence risk, may be required. Powell’s counterpart, Mark Carney faces a similar hearing on behalf of the BoE earlier that day. Short-lived headline risk for the punch-drunk pound is likelier than in Powell’s hearing. The governor has been less of a stranger to the TV screens than the Fed chair and has hashed out most iterations of the Bank’s stance quite thoroughly already.