Market sentiment follows the dragon

A new month and quarter has begun with plenty of green across trading screens for global equities and credit.

Where China leads, the hope is that others follow. Two measures of manufacturing activity for China shifted into expansion mode during March, rising above a reading of 50, helping offset disappointing news elsewhere. That sent the CSI 300 index up nearly 3 per cent and leaves the benchmark in positive territory over the past 12 months. 

In contrast, Japan’s Tankan survey for the first quarter and outlook were weaker than expected, while over in Europe, manufacturing activity continued to contract, led by Germany, while core inflation in the eurozone plumbed to its lowest level for two years, falling to 0.8 per cent in the year to March. 

US retail sales data were disappointing as January’s revision higher was offset by a weaker than forecast figure for February, but the latest manufacturing data for March arrived above expectations, bouncing from a two-year nadir. Tellingly, the employment component was robust and that helped to push Treasury yields higher on Monday, ahead of the March employment report due on Friday. 

Jim O’Sullivan at HFE notes:

“The data are signalling moderate rather than dramatic net slowing in manufacturing. The index is down from 58.8, on average, in 2018, but it is still well above the zero-growth 50 mark.”

This is just the start of a big week for data. Relief that China shows nascent signs of momentum ticks the boxes for global risk appetite. These are the kind of days when you can see what really matters for broad market sentiment; in a word, it's China. 

At BlackRock, they are confident that China is back on track “after having been a drag on global growth since early 2018”.

The asset manager notes a pick-up in growth for China looms “as the credit impulse (the year-on-year change in credit growth) turns positive and fiscal stimulus gains traction”.

One note of caution about Chinese equities comes from Oliver Jones at Capital Economics, who highlights that expected earnings for the Shanghai market are “around 25 per cent higher than actual earnings over the previous year”, as analysts bank on a strong economic rebound.

As seen before, Chinese equities can rally hard and shrug aside disappointing earnings and Oliver makes two interesting points: the price/earnings ratio for the Shanghai Composite remains “far short of previous peaks” and the 2019 rebound has been accompanied by surging trading volumes.

He adds:

“Both were hallmarks of the 2014-15 bubble, when the two markets surged despite the fact that earnings hardly changed.”

The FT’s Hudson Lockett in Hong Kong highlights that the rush by foreign investors into Chinese stocks slowed last month.

As for global sovereign bond yields, it is clear that economic data needs to be far stronger and consistent before the market firmly selects reverse gear. A US 10-year yield heading back to 2.50 per cent remains corrective in tone for now and not a surprise as the benchmark sits well below the 2.75 per cent top of a month ago.

A more interesting tale is the German 10-year remains stuck below zero. After Monday's US manufacturing data arrived, the euro slipped towards the floor of $1.12 that has been in place since November. 

Brad Bechtel at Jefferies is watching this level and notes:

“Given the issues around Brexit, Italy, the dovish shift by ECB and the continual sluggishness in the data, one would expect we would be a lot lower by now but so far 1.1200 is holding strong.”

Beyond a data-heavy week, the latest corporate earnings season starts soon and here the extent and outlook for margin compression is the key story for equities in April. 

Quick Hits — What’s on the markets radar

US dollar appeal dims for central banks — The International Monetary Fund has released its Currency Composition of Official Foreign Exchange Reserves, or Cofer data, for the final quarter of 2018. In spite of broad US dollar strength for much of 2018, central banks were not part of that. 

Alan Ruskin at Deutsche Bank has dug into the reserve currency allocations for central banks and notes how the yen and renminbi “do appear to be slowly ‘chipping away’ at the USD’s market share of central bank currency reserves”.

Alan also detects, “despite a variety of political travails, the EUR and GBP have been able to maintain their share of official currency reserves in recent years”.

Another observation is the Australian dollar losing ground as a reserve currency, which comes as concerns have grown over its housing sector and the hit from a Chinese economy tilting more towards the consumer from classic infrastructure stimulus.

Alan adds that although “longer-term trends in currency allocations are distorted by the changes in China’s reporting, what is clear, is that the net combination of China reserves being included in allocated data, plus the overall trends in the last few years, have seen the USD’s share of allocated reserves persistently decline from a share as high as 66 per cent of allocated reserves back in Q1 2015 down to the current 61.69 per cent”.