Whilst emerging markets pushed higher last week, the US struggled to do much of anything and Europe gave back some recent gains. We reiterate our call for a passing of the growth baton away from the US towards the rest of the world.
Europe, the sick man of global markets, is on a tear with stronger data, reduced political risk and some of the best performing equity indices in the world. Meanwhile, this week commodity markets posted sharp falls as the glow of the first round French Presidential election result gave way to demand-side concerns based on weaker Chinese and US data. This included oil touching a 5-month low and the worst 2-day decline in base metals since 2015.
We think the world may remain “out of sync” for a while. For example:
As we’ve talked about since the beginning of the year, there is currently strong momentum behind global growth. However, the “balance of power” is shifting from North America to the rest of the world. For example, economic surprise indices, measuring incoming data against expectations, are firmly in positive territory everywhere except the US. For now, this comes alongside moderating inflation (in particular the oil price failing to join the rally) and as such provides a “perfect calm” for equities.
If this continues, the next stage will surely be a step up in policy tightening from central banks. However, last week the ECB maintained a dovish tone (we anticipate a change post the second round of the French elections in June) as did the Riksbank in Sweden and the BOJ in Japan. This week we have a FED meeting where, despite the weak Q1 GDP print (more below), we expect the committee to leave a June rate hike on the table.
On Friday GDP data for the US in Q1 will be released. We expect this to show a “passing of the baton”, as US growth moderates (to around 1% annualised) but Europe and Emerging Markets continue to improve. Some asset re-allocation has started, but we expect this to continue.
The oil price sunk below USD 50 per barrel again (both WTI and Brent more than 7% lower for the week) on evidence that US production and inventory growth is offsetting OPEC’s attempts to reduce supply.
After battles with the courts and with Senate, it’s started to look like President Trump will struggle to generate any real change domestically. Last week suggests that the US President might switch his attention to geopolitics:
Markets responded to Trump’s new effort at exerting his influence with apprehension rather than panic. The VIX index (measuring implied variance) jumped to the highest level since November (north of 16%). However, realised volatility remained very low at around 5% for the week. Similarly, risk aversion prompted a rally in bonds, with the US 10-year yield at a 2.23% 5-month low, but the S&P 500 lost only 1.13%.
The first round of the French Presidential election is on Sunday.
In a President Trump world, equity markets apparently don’t do big moves; realised volatility on the S&P 500 has come in below 7% since the 8th November election. Therefore, despite equities sitting only 1.7% below their all-time high, the last month has perhaps represented the modern-day version of “risk-off” for the US. This week:
Certainly, US growth for Q1 2017 will have slowed materially from the 2.1% annualised pace in Q4 2016 (consensus is closer to 1%). Moreover, expectations for Trump reform and fiscal stimulus are now almost all priced out.
However, on a global basis the tone is more optimistic. Inflows towards European equities over the last fortnight were the best in over a year, whilst there were also meaningful positive flows into European bond and EM bonds and equities. This helped continue the out-performance of emerging market equities.
Going forward, PMIs suggest the global manufacturing recovery is likely to consolidate after a block-buster rebound. However, the overall growth momentum should remain positive.
We’ve been talking for a while about a growing divergence between impressive “soft” economic data (surveys estimating sentiment) and more sluggish “hard” releases quantifying activity, particularly in the US. As examples, NIFB small business sentiment sits near 43-year highs and last week US consumer confidence hit a 17-year peak. However, US economic growth for Q1 is on course to register no more than a 1.5% annualised expansion. This week the dynamic gained broader attention as a report from Morgan Stanley suggested the performance gap has never been so wide.
Nonetheless, the balance proved “just right” for markets – sentiment supporting equities and more muted real data keeping interest rates in check. On low volumes, bonds, equities and commodities all moved higher. This included oil posting its best week of the year as Kuwait’s oil minister gave his support to a time extension for OPEC supply restrictions.
Three weeks ago, we suggested the global economy was entering a significant new phase in which aggregate monetary policy would start to tighten. We saw this as a consequence of an impressive, and broad based, pickup in growth. In particular, the manufacturing sector emerging from a multi-year slump (in no small part because of commodity price stabilisation) and both consumer and business sentiment significantly improving (confirmed by this week’s Eurozone PMI). The question for investors was then whether this would derail the raging bull market for equities.
From a tactical perspective, the last fortnight has thrown up two more potential skid risks. First, the oil price falling back below USD 50 per barrel on the back of rising inventories. Second, increasing concern that the “Trump trade” may end up a damp squib.
Many have feared the start of a proper US hiking cycle – suggesting it would prompt a huge USD appreciation and aggressive outflows from risk assets.
For now, a strong global backdrop, stable or declining real rates (headline inflation is close to 2%) and a 10-year yield that is anchored to 2.5% are helping a quite different, positive market outcome.
Over the past 6 months equity markets have benefited from the tailwinds of a strong rebound in the global economy and continued monetary stimulus. This week’s events confirm that the second order consequences of a better macro picture are building. In particular, the monetary impulse may be turning negative:
This leaves Brazil as the only major central bank still in a credible rate cutting cycle. The Bank of England also meets this week.
Of course the outlook is not set in stone. After US crude inventories rose by 8.2 million barrels (9th consecutive weekly gain), oil saw its biggest one-day drop in 13 months and touched a 3-month low. The recent surge in headline inflation could therefore reverse. There is also political risk. This week sees Dutch elections, which are expected to pass without major event.
In India, Prime Minister Narendra Modi claimed a landslide state election victory in Uttar Pradesh, steamrollering the opposition and generating a wave of support that already makes a victory in the 2019 general election look a very likely outcome. Indian markets are expected to perform strongly on Tuesday (closed for holiday today).
