Posts tagged central banks
Front-running Easy Money

In a nutshell, this is what my models are telling at the moment: the three-month stock-to-bond ratios in the U.S. and Europe have soared, indicating that equities should lose momentum in Q2 at the expense of a further decline in bond yields. That said, the three-month ratios currently are boosted by base effects from the plunge in equities at the end of last year. They’ll roll over almost no matter what happens next. Moreover, the six-month return ratios are still favourable for further outperformance of stocks relative to fixed income. Looking beyond relative returns, my equity valuation models indicate that the upside in U.S. and EM equities is now limited through Q2 and Q3, but they are teasing with the probability of outperformance in Europe. Finally, my fixed income models are emitting grave warnings for the long bond bulls, a message only counterbalanced by the fact that speculators remain net short across both 2y and 10y futures. This mixed message from my home-cooked asset allocation models is complemented by a mixed message from the economy. The majority of global growth indicators still warn of weaker momentum, but markets trade at the margin of these data, and the green shoots have been clear enough recently. Chinese money supply and PMIs showed tentative signs of a pick-up at the end of Q1, a boost reinforced by data last week revealing that total social financing jumped 10.7% y/y in March.

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Valuations to the Rescue?

Equities have wobbled a bit at the start of the month, but unless they lose the plot in coming weeks, it is fair to say that Q1 will be everything that Q4 wasn’t; decent and calm. Indeed, the finer details reveal an even more striking dichotomy with the calamity that culminated in the rout at the end of last year. Between June—when the PE multiple peaked at just under 21—and the low for the S&P 500 in the final weak of December, EPS rose by 13%, but the index fell by 10%. In other words, the multiple crashed, a story which was repeated across almost all key DM and EM indices. By contrast, the story so far in Q1 is the exact opposite. By my calculation, trailing EPS for the S&P 500 and MSCI World are down 0.5% and 2.1% year-to-date, respectively, but both indices have rallied smartly. This can only mean one thing; multiples have expanded, and they have indeed, by about 14% in both cases since the end of December. I am confident that the tug-of-war between multiple expansion and deteriorating earnings will determine the fate of many equity investors in 2019. 

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Finely Poised

Let’s spare a few moments of symphathy for the equity bears. The Q4 rout was supposed to have been an appetizer for a more sustained bear market, and by most accounts, the major narratives are still on their side. Excess liquidity indicators—chiefly real M1—and other leading macro-indicators look dire, and the hard data have predictably rolled over. They gave up the ghost in Europe a long time ago, and are now softening in the U.S. Even better for the bears, earnings growth is now slipping and sliding, a logical consequence of the sharp drop in the rate of growth in almost all main hard macroeconomic indicators and surveys. 

Despite such a perfect set-up from the macro data, the equity market has rallied strongly at the start of the year, and is showing few signs of rolling over mid-way through February. There is still hope for the bears. If you are just looking at the headline data, it is relatively easy to dismiss the rebound at the start of the year as a reflexive rebound from the horror show in the latter part of 2018, a bear market rally to suck in the naive bulls before the next deluge. The idea of a bear market rally is still alive, but equity bears also now have to contend with a revival of their greatest foe to date; the global central bank put. 

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A Great Story

We will probably spend a big part of Q4 deciphering the economic data through the murky looking-glass of U.S. hurricanes and Asian typhoons, so just to be clear. I am still not happy with the trajectory of global leading indicators. Narrow money growth has collapsed, and recent data suggest that the slowdown will worsen in Q3. M1 in China rose 3.9% year-over-year in August, the slowest pace since the middle of 2015, and the trend in the U.S. and Europe also is poor. In the U.S., M1 is growing just under four percent on the year, the weakest since 2008, and the EZ headline also has slowed, though it is robust overall. The crunch in narrow money chimes with central bank balance sheet data. My home-cooked broad index, which includes the SNB and Chinese FX reserves, is now falling on a six-month basis. These data don’t mean the same in all economies—M1 is not a good LEI in the U.S. for example—and the Chinese numbers will turn up soon to reflect recent efforts to ease financial conditions. That said, a slowdown in US dollar liquidity matters for non-US markets, and the Chinese M1 numbers lead by six-to-nine months. The overall story is clear: Global liquidity growth has slowed to a trickle, warning about risks of growth and asset prices.

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