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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Doves on Parade

My main job on these pages is to  distil the market Narrative™ for my readers, and recent events have made this week’s missive a layup. The debate on whether to fire, and how to arm, the fiscal bazooka has continued, and now monetary policymakers have joined the party. For a while, it seemed as if the world’s biggest central banks were sleepwalking into coordinated tightening, or in the case of the PBoC, failing altogether in the attempt to counter a sustained cyclical slowdown. To the extent that the Q4 chaos in equities was investors’ vote on this strategy, they should consider their message received. In Japan, signs of wage growth briefly alerted markets to the prospect that the JGB market would be un-frozen by further loosening of the yield-curve-control. But the truth is that Kuroda-san is stuck. With global headline inflation pressures now easing, manufacturing and exports struggling, and the looming consumption tax, the BOJ isn’t going anywhere fast; zero rates and (modest) balance sheet expansion will continue as far as the eye can see.  In Frankfurt, the ECB recently downgraded its assessment of the economy—the convoluted shift from “broadly balanced” to “downside” risks—and expectations are building that the TLTROs will be extended, or even renewed and expanded.

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Head fake?

It’s been a choppy start to the year, but last week’s price action added to the evidence that the bulls have regained control, at least temporarily. The MSCI World and HYG US equity are now about 8% and 5% higher, respectively, from their lows in December, and treasury yields are up across the board. The rebound has been broad-based, but European and EM equity indices have shown particularly promising signs, consistent with the fact that they have, after all, been much cheaper than their U.S. counterparts through the Q4 chaos.   These headlines are good news, but at this point, I am not willing to treat them as evidence of anything but a reflexsive rebound in the wake of a horrific Q4. Short-term indicators suggest that a lot of fear already has been priced-out. The put/call ratio on Spoos it peaked at 2.7 SDs above its mean on December 27th, but has since plunged to -1.0 SDs. Normally, this would be a sign of complacency, at least in the very short run, but the put/call ratio looks more balanced on Eurostoxx 50, indicating that the picture for global equities as a whole is more neutral.  Other indicators also suggest that the market can run a further. My first chart shows that that the crash in the U.S. stock-to-bond return ratio at the end of 2018 was similar to the plunge during the EZ sovereign debt panic in 2012, and well in excess of the Chinese devaluation scare in 2015/16.

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The Fiscal Bazooka

Markets remain undecided on whether to treat the signs of intensifying global economic weakness in Q4 and a looming slowdown in earnings growth as the kitchen sink—a signal that the worst is over—or evidence that conditions are worse than anticipated. As such, I thought that I’d discuss the other macro story du jour: The likelihood of a grand global experiment in coordinated fiscal stimulus to take over from our tapped-out monetary policymakers. Laughable you say; perhaps, in the short run, but the signs are clear enough if you care to look. Fiscal discipline has become unfashionable, even to the point that it is deemed outright irresponsible for individual economies to pursue such a strategy from the point of view of global economic growth. These days, economies who show fiscal restraint with large external surpluses—the savers who finance the borrowing of others—are “leaches” on global aggregate demand. If they do not change their ways on their own, they should be coerced. The flirt with the idea of a big fiscal push diverges in intensity across the major economic regions, but I identify three common denominators.

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