Global markets were relatively quick to flip bets on modest global recovery, of which early signs appeared in September, following a year and a half slowdown for most of 2019. At the peak of the negative outlook, investors could only accept negative bond yields on bonds worth $17 trillion. But, the reality is that global economic signals give us only a mixed picture at best. The Citi Economic Surprise Index barely agrees with the optimism, as it fell to 0 points in early autumn and moved into positive territory by mid-November:
Source: Yardeni research
The lack of confidence in the economic outlook is partly confirmed by the stock market valuations. So, why do we have to dig deeper into the nature of the last leg of stock market rally? In the absence of fair economic signals, markets, by nature, should take cues from the monetary course of the Fed. And indeed, the weekly returns of the S&P 500 index have recently been correlating with changes in Fed’s balance sheet. On the chart below, you can see that weekly returns had the same sign as indicated by the Fed’s balance sheet in their “QE not QE” REPO market operations:
The divergence between index returns and credit spreads in early November also point to weak footing of the current rally, if we assume that the high correlation between two variables (88% in June-Oct) should hold:
The credit spread widens when capital moves from low quality bonds to investment-grade bonds and, this is usually reckoned as an indicator of rising concerns in the fixed income market. The S&P 500, apparently, ignored this anxiety.
The statistical relationship between the index and the price of copper was also interrupted in early November, which is also a red flag:
On the other hand, we have China PMIs in Mfg/services sectors, where expansion has been outlined for the first time in six months. The optimism about China was confirmed by a private sector survey from Caixin released on Monday which indicated expansion among small Chinese enterprises. German industry also experienced relief in October, data showed last week. And, this concurrent rebound in manufacturing between close trade allies cannot be simply regarded as a matter of chance.
At the weekend, South Korea’s foreign trade data showed that exports were down 14.3% year on year. For six consecutive months, exports have shown double-digit negative values. The export of the Asian state is a leading indicator of corporate profits of world companies, as well as an indicator of the state of world trade.
To recap: the inflection point can be somewhere around the corner and US stocks markets could ran ahead of themselves correctly, but more data is needed to confirm that. Betting on further stock market growth has no grounds at this moment.
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