Equity Monthly: Macro and equities divergence increased in October
Head of Equity Strategy
Summary: The disconnect between macro data and equity markets seems to be growing as equities are making new highs despite weaker macro data and earnings growth going negative in emerging markets and close to negative in developed markets. Equity investors are clearly discounting a soft patch in the economy before returning to trend growth. Our view remains that of being defensive.
October was a mercurial month with global equities rising 2.7% in USD terms despite clear evidence that the global economy continues to slow down. In fact, the global leading indicators from OECD have been declining for 20 straight months. The US chemical industry shows weakness to persist into Q2 2020, South Korea export data shows little signs of rebound in Asia and in particularly China, US employment is slowing down, and earnings growth has gone negative in emerging markets and close to negative in developed markets. The disconnect between what we observe in macro data and equity markets has many explanations but one of them is that equity investors are only discounting a soft patch for the economy before returning to trend growth. This is key assumption so any broad-based weakness in the US services sector and employment in general should in theory in set in motion a repricing of global equities.
This year’s 19% rally in global equities has been fueled entirely by expanding valuation multiples which to some degree can be justified as global interest rates have come down reflecting lower inflation and growth expectations. We observe a clear pattern of lower inflation rate translating into higher valuation multiple. This reflects lower hurdle rate for return on capital for companies but also substitution effects from bonds into dividend paying stocks, something we have talked a great deal about during October in our daily equity updates.
In our Q4 2019 Outlook: The Killer Dollar we also showed how the USD is a key driver of equity returns globally. Our findings suggest in the last three major USD cycles that stronger USD coincide with strong US equity returns compared to developed equities ex US and emerging markets. The stronger USD theme is also important to be watching as the USD is a constraint on financial conditions and global growth. For the time being we remain defensive on equities but will switch to overweight as soon as leading indicators are turning higher again and the USD is weakening.
Given the trajectory of macro data, the geopolitical uncertainty on the rise and a bumpy ride on the trade deal we still have the view that volatility could pick up in November and December although this seems like a contrarian view as equities are climbing higher. The VIX is back to levels around July before the August volatility kicked in. In our view equity volatility is fragile to news on the US-China trade deal and US jobs data out today.
Latest Market Insights
Quarterly Outlook Q3 2022: The Runaway Train
- Central banks' attempts to kill inflation is a paradigm shift, which could end in a deep recession.
Tangible assets and profitable growth are the winnersWith US equities officially in a bear market, the big question is where and when is the bottom in the current drawdown?
Understanding the lack of investment appetite among oil majorsThe everything rally seen in recent quarters has become more uneven, as its strength is driven by commodities in short supply.
The pressure is on as the wind leaves the sailsWith cryptocurrencies in sharp decline, are we entering a crypto winter or is the bear market a healthy clean-up of the crypto space?
Why the Fed can never catch up and what turns the US dollar lower?Many other central banks are set to eventually outpace the Fed in hiking rates, taking their real interest rates to levels higher than the Fed will achieve.
Bank of Japan: Swimming against the tideThe Japanese economy has gone from the age of deflation to rapidly rising prices in no time, leaving the Bank of Japan in a pickle.
Green transformation detour and bear market hibernationWith the impending risk of global econonomic derailment, we share the five things investors need to consider in this new half year.
Crisis redux for the eurozone?Whether there's going to be a recession in Europe or not, the path towards a stable economy will be agonizing.
Technical Outlook: Gold, Oil and a remarkable multi-decade perspective on EquitiesThe Nasdaq bubble pattern, USDJPY resistance, crude oil uptrend losing steam and the technical outlook for USD.
China: the train of new development paradigm left the station two years agoChina is transiting to a new development paradigm, as they are hit by deteriorating terms of trade, a slower global economy and an uncertain future while continuing attempts to contain the pandemic.