Markets are still picking up the pieces from the rout in asset prices that dominated the final weeks of 2018. Such a process takes time and with a warning that not all the shards of broken glass are usually collected with the first sweep of the floor.
Ian Lyngen at BMO Capital Markets neatly sums up the current mood in markets:
“December was a moment in which the prices changed more than the facts; presently the facts are quickly catching up.”
That entails confining asset prices in a holding pattern for some time as markets await the extent of stimulus from China and whether a lengthy pause in policy tightening from the Federal Reserve ultimately boosts the US economy.
Tomorrow the European Central Bank steps forward with its assessment of the economic outlook. It won’t be pretty and see Quick Hits below for more on that.
In the meantime, the US inventory build late last year ahead of a looming trade deadline with China and the current government shutdown entails a softer start to 2019 for the economy and one that runs for a while.
Earlier today in New York, I sat down with Steve Blitz from TS Lombard. Steve thinks it will take time for the recent policy tightening by the Fed and last year’s slide in equities and credit to work through the financial system and the broader economy.
“We are not really out of the woods,” he says, adding that it’s important for investors to focus on leading indicators of activity, particularly that of credit and flows such as those through small bank lending.
Across the US, small banks, or those institutions outside the top 25, have been very important sources of business and consumer lending, notes Steve, who adds:
“Small-bank loans have increased from 55 per cent of large-bank loans when this cycle began to 75 per cent.”
And since the Fed funds rate rose above 2 per cent in September, Steve says there has been a slowdown in lending from small banks and this is a very important factor to watch in the coming months.
Focusing ahead rather than looking backwards typified global equity trading today. After a tough session for much of Asia and European, Wall Street made a bright start, buoyed by solid quarterly earnings reports and upbeat outlooks from IBM, Procter & Gamble and United Technologies.
That soon fizzled and reflects in part the pressure many see for earnings growth in the first half of 2019. BlackRock notes that there has been a sharp decline in the earnings revision ratio, which measures the number of analysts upgrades versus downgrades.
The asset manager says:
“We see some potential for more downgrades, although the ERR is nearing past trough levels outside of recessions.”
“Earnings per share of global stocks are expected to grow 6.6 per cent in 2019, versus 14.9 per cent in 2018, according to consensus estimates.”
On Wall Street the outlook for US corporate earnings growth during the first half of the year has in the words of Nicholas Colas at DataTrek “ground to a standstill”.
Factset now says that its analysts expect earnings growth of 1.9 per cent for the first quarter versus the same time a year ago, and for an expansion of 2.6 per cent year-over-year for the second quarter.
That doesn’t leave much wriggle room for a flat outcome and the risk of an earnings recession. Sure, this time last year earnings growth soared thanks to US tax reform, but a year later, companies also face the headwinds of rising wage costs and interest rates along with a firmer dollar.
“This shifts the narrative for US stocks to macro factors like US-China trade negotiations, long-term interest rates and Federal Reserve policy.”
The niggling issue for investors and markets is that we have plenty of road to travel before these macro factors become clearer and affirm a bullish or bearish outlook for equities and credit.
Quick Hits — What’s on the markets radar
The pound rally — We have a break-out in the pound as it finally motors above $1.30 on hopes of a delay in the UK leaving the EU on March 29. The latest rise in the pound is capped for now by its 200-day moving average at $1.3069. Breaking beyond this long-term measure of momentum — not seen since May 2018 — would trigger further gains in sterling. Not a bad outcome for those with half-term holidays coming up. But a firmer pound requires stronger evidence of resolution.
A delay in Brexit simply means kicking the can down the road and does not resolve the terms of the UK’s divorce from the EU and its costs. As some traders have duly noted today, enjoy the rally while it lasts and look to sell into it.
The ECB meeting — The call for tomorrow’s meeting by many is that the European Central Bank will say that the balance of risks for the eurozone economy has turned negative. Beyond that, expectations of policy shifts, such as new long-term lending to banks, are seen coming in March.
But that hasn’t stifled the chatter and indeed a hope in some quarters that the ECB tries to get ahead of slowing activity. What would help is mitigating the damage inflicted by negative overnight interest rates on banks. There is no sustainable broad equity market rally in Europe unless the banks can stabilise and prosper. During last month’s press conference, ECB president Mario Draghi mentioned the problem of structural profitability for the region’s banks.
One idea doing the rounds is a nod by Mr Draghi towards a “tiered reserve system” that mitigates the cost of negative overnight rates and the ensuing hit to bank margins that we have seen in recent years. Pulling that kind of rabbit from the hat would certainly fire-up bank share prices.
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