Relief rally or something more?

Tuesday, 4th December 2018 13:59 - by Shant

Over the weekend, the market only had eyes for the Trump-Xi meeting at G20, hoping for some positive dialogue which could allay fears that global trade (and growth thereon) could be spared the detrimental effects of protectionist policy which ultimately ends up hurting business and the consumer. 

Thankfully, any escalation in tariffs looks to have been shelved for now, as talks are set to resume with a view to resolving some of the issues which have prompted president Trump to undertake the measures that he has.   Somewhat expectedly, global stocks have rallied, the US indices gapping higher over the weekend and starting the week on a very strong note.  Touching on 2800, the S&P opened 15pts shy of the highs which have held firm from mid to late Oct, and this is the immediate test for those with the conviction to suggest that the late-year correction is another fresh buying opportunity.  

So far, the signals are that the supportive factors are running out or fading away at the very least.  As is a constant in my series of blogs, it is a case of monitoring the developments in US metrics, were both equities and yields are coming off in tandem, suggesting that there is indeed some movement into fixed income.  The question at this stage is now whether this gathers momentum and we effectively move into a bear market for stocks.  Earlier in the year, the highs in equities were gifted with fiscal stimulus by the Trump administration and as anticipated, this is now starting to fade.  As the Fed chairman reiterated last week, data dependency is what will shape monetary policy from here, and this is a double-edged sword for equity-focused money managers going forward. 

This ultimately points to the substance of stock market valuations.  We now have to evaluate just how much is baked into price based on the level of quantitative expansion over the last 8-9 years, given the fact that hikes or no hikes, the Fed is now steadily reducing its balance sheet.  Naturally, if the Fed does indeed soften their rate path for 2019, as I expect them to, we should see this proving supportive to some degree.  Whether this will have been tinged by any political influence is neither here nor there for investors to worry about as a key concern, so we will echo the words of the Fed chair in so much as it is very much the fact that the data counts - now more so than ever. 

At the end of the week, we get the latest employment report for Nov.  The latest survey reports suggest that headline job growth should continue at a familiar pace, with around another 190-200k added to payrolls,  In itself, this underpins the economy to some degree, but if consumption is to remain strong, then we have to see some material feed through into wages.  At 3.1% average earnings on an annualised basis, the numbers are by no means anything to worry about.  However, in the current climate where protectionist policies are likely to exports inputs into GDP diminish, domestic demand is ever more important to growth and for this, we need to see increased disposable incomes.  Factoring in some of the news that student and auto loans are suffering higher default rates adds to the concerns over domestic consumption and is added reason to believe that the Fed may pause sooner than expected.  Outstanding US student loans are close to $1.5trln and highlight the fact that debt crises are truly global and not confined to developing markets.  Higher wages will offset some of these concerns. 

Finally, we look at the level of the Dollar, and as we have seen for the best part of 2018, the greenback has been on a relentless path higher, with the market focusing on the Chinese Yuan rate and its proximity to the 7.0000 mark.  From a trade perspective, manufacturers and exporters will be relieved to see some moderation here due to the events over the weekend, but the basket remains elevated against the rest its majors, maybe not in historical terms, but certainly at a time when it is not in tune with current accounts.  The Trump administration has cooled its verbal intervention, though it is worth noting that the DXY (US Dollar Index) has risen to new highs since.  If we see a little more moderation across the board as we expect over the coming months, the relief in US stocks may extend a little more over the near term, though only as a temporary factor - much like the excitement over the G20 developments over the weekend. 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.