Don't ignore the signs!

Wednesday, 6th March 2019 11:20 - by Shant

Sticking with last week's theme of the wave of optimism over a US-Sino trade deal, the signs are once again pointing to the widening view that much of this bonhomie between the 2 major superpowers have been largely priced into the markets.  Chinese data continues to highlight the slowdown in growth and output and as we noted last week, the underlying factor behind global growth over the last few decades has been underpinned and also carried by the demand out of China for its infrastructure spending.  As China enters its next stage of economic growth through innovation and technology, we have to assume that there will at least be a lull in demand, and a new trade agreement with the US is not going to change that.  

Looking to the US, Tuesday's release of the ISM non-manufacturing PMIs offered scope for optimism, though this seems to have had little impact on the US indices with the benchmark S&P 500 holding off the key 2820 level this week.  Although there is no wholesale push lower, with the US economy in relatively healthy shape for now, one would have expected this to be the time to make hay (while the sun is shining so to speak).   As we saw in Asia today, cheaper money seems to be the overriding factor in determining stock market valuations, with Australia's ASX rising despite the miss on GDP for Q4, which led to calls for the RBA to cut rates.  This was off the back of local banks looking for a 25-50pt cut by the end of this year.  With wholesale funding costs lower due to the pullback in US Treasury yields, the dovish shift is clearly spreading through to domestic banks.  Based on this dynamic alone, financials look set to resume a period of underperformance as margins will only get squeezed again. 

Chinese equities have also been in fine fettle this year, and no doubt this is also linked with the stimulus measures offered up by the PBoC.  We see little other reason to become so bullish on stocks, in a region where the PMIs are all pointing to some degree of contraction.  Again, China is in a slowdown and stocks are moving completely against the growth backdrop.  The Shanghai Comp started the year in the mid-2400's and has since pierced the 3100 mark, with optimism of a trade deal with the US also playing a major part in this meteoric rise. 

As a result of this new found optimism in 2019, we have seen the traditional safe havens turning south once again.  Gold has dropped right back from the highs in the mid-1300's, testing below 1300 though finding some support in the 1275-80 as the daily charts will show.  We see this as an opportunity to hedge portfolios despite a resurgence in the US Dollar, which is another factor which undermines the global growth outlook based on Dollar denominated debt in the emerging markets.  

Currencies such as the Australian Dollar also serve as a bellwether to global growth and coupled with domestic issues, China's woes have been instrumental in its downfall in recent times.  Other emerging market currencies are also showing little positivity in the current climate, which should also serve as a warning on the broader landscape. 

The Baltic Dry index has also suffered heavily this year but has also been ignored.  From highs of 1800 seen midway through 2018, we have hit a 600 low in recent weeks, and the recovery has been anything but meek, to say the least.  

So, while central banks are turning dovish again, it may seem easy to assume we can get back to familiar ways.  In a unified stance, (central bank) governors around the world are warning against a softer economy worldwide, and weakness in the major exporting regions, such as Europe is a testament to this weakening backdrop.  

Optimism is one thing, substance and value are another.