Quarterly Outlook
Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?
John J. Hardy
Global Head of Macro Strategy
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The six key topics on equity investors' minds
Peter Garnry
Chief Investment Strategist
Summary: Equities plunged into late December 2018 and rebounded sharply in the first quarter of this year. Since then, however, the path has grown more muddled, volatility has risen and markets have become more nervous. What are the key areas of focus for investors looking to allocate from here?
The market panic in Q4 '18 contained some elements of epic proportions, but the months that followed did as well. Global equities rose 16% in local currency from their bottom in late December to the end of February with only very few setbacks. In March, the dance has become more erratic with fresh evidence that the economy is still weakening and market participants are nervous. There are six key topics equity investors are talking about this week. Here are our views on each.
Global trade recovers in January
Despite the growing trade dispute between the US and China, global trade continued to grow throughout most of 2018 until November and December when it fell 4% in the biggest decline since 2008. CPB has just released January’s numbers (excluding the US due to the government shutdown), and they indicate firm rebound. Regardless of January’s rebound, global trade is still fragile and seven days ago, FedEx’s CEO warned that more weakness is coming.
The key to changing the narrative on global trade is a US-China deal, which according to many sources is getting closer. However, we still see a high probability for only a "soft version" that leaves many of the nasty details on the table, including forced technology transfers and intellectual property theft.
Global trade recovers in January
Despite the growing trade dispute between the US and China, global trade continued to grow throughout most of 2018 until November and December when it fell 4% in the biggest decline since 2008. CPB has just released January’s numbers (excluding the US due to the government shutdown), and they indicate firm rebound. Regardless of January’s rebound, global trade is still fragile and seven days ago, FedEx’s CEO warned that more weakness is coming.
The key to changing the narrative on global trade is a US-China deal, which according to many sources is getting closer. However, we still see a high probability for only a "soft version" that leaves many of the nasty details on the table, including forced technology transfers and intellectual property theft.
Yield curve inversion
The recent yield curve inversion (very short end versus 10-year) has received a lot of attention in financial markets as it has previously had a stellar record as a recession forecasting indicator. While it has been a good indicator and should have a high weight in investors’ decision-making, we should also recognise that the economy is very dynamic and recessions can play out differently.
All we know is that yield curve inversion indicates nervous investors and that things are clearly not well, which is likely one of reasons for the FOMC’s big pivot on monetary policy. The yield curve inversion is important and should be watched carefully.
Based on history, the timing between the yield curve inversion and a recession is fluid which makes decision-making difficult. Thus we recommend investors put a high weight on the yield curve inversion and watch other key indicators. As we highlighted in our monthly equity update back in February, global leading indicators from OECD are still not supportive for global equities, so we still recommend investors to be defensive on equities.
The recent yield curve inversion (very short end versus 10-year) has received a lot of attention in financial markets as it has previously had a stellar record as a recession forecasting indicator. While it has been a good indicator and should have a high weight in investors’ decision-making, we should also recognise that the economy is very dynamic and recessions can play out differently.
All we know is that yield curve inversion indicates nervous investors and that things are clearly not well, which is likely one of reasons for the FOMC’s big pivot on monetary policy. The yield curve inversion is important and should be watched carefully.
Based on history, the timing between the yield curve inversion and a recession is fluid which makes decision-making difficult. Thus we recommend investors put a high weight on the yield curve inversion and watch other key indicators. As we highlighted in our monthly equity update back in February, global leading indicators from OECD are still not supportive for global equities, so we still recommend investors to be defensive on equities.
Is Powell replaying Greenspan’s 1998 panic?
The Federal Open Market Committee's decision to make its biggest pivot on monetary policy in recent times has increased the likelihood that this is a replay of 1998. Back then, then-Fed chair Alan Greenspan panicked when Russia defaulted and LTCM was bailed out, taking the effective Fed Funds Rate down by 88 basis point. The run-up was a 27% decline in the NASDAQ Composite Index. The Fed put stopped the bleeding and the global economy continued to expand together with aggressive valuation expansion in US technology stocks.
In Q4, US equities were down 20% before the Fed panicked with high-duration equities such as high.valuation technology stocks leading the declines. As in 1998, the Fed’s put reignited a rally erasing the preceding decline. Is the Fed now hostage to financial markets due to the deep financialisation of today’s economy? Maybe, but the Fed is not able to see things the market is not seeing. As we have argued before, the Fed should pay more attention to financial markets in a late-cycle economy. But by easing here, the Fed is risking a financial bubble in high-duration assets (technology stocks, real estate, private equity, venture capital, art, wine et cetera). On the flipside, it means that we could see one final ramp up in global equities before the party ends.
The Federal Open Market Committee's decision to make its biggest pivot on monetary policy in recent times has increased the likelihood that this is a replay of 1998. Back then, then-Fed chair Alan Greenspan panicked when Russia defaulted and LTCM was bailed out, taking the effective Fed Funds Rate down by 88 basis point. The run-up was a 27% decline in the NASDAQ Composite Index. The Fed put stopped the bleeding and the global economy continued to expand together with aggressive valuation expansion in US technology stocks.
In Q4, US equities were down 20% before the Fed panicked with high-duration equities such as high.valuation technology stocks leading the declines. As in 1998, the Fed’s put reignited a rally erasing the preceding decline. Is the Fed now hostage to financial markets due to the deep financialisation of today’s economy? Maybe, but the Fed is not able to see things the market is not seeing. As we have argued before, the Fed should pay more attention to financial markets in a late-cycle economy. But by easing here, the Fed is risking a financial bubble in high-duration assets (technology stocks, real estate, private equity, venture capital, art, wine et cetera). On the flipside, it means that we could see one final ramp up in global equities before the party ends.
South Korea offers hope of green shoots
While global leading indicators measured by The Organisation for Economic Co-operation and Development are still falling as of January, there might be signs that the global economy is turning a corner. Leading indicators on South Korea turned higher in January, extending the small gains already observed in December (revised up from previously unchanged). I’s still too early to claim we are out of the woods, but if February also sees gains then the global economy may already be expanding again.
This would be clear evidence that Chinese stimulus is starting to work its way through the Asian region. Playing devil’s advocate, the leading South Korea equity index (KOSPI 200) has not managed to regain its February highs in March, so the weak price action in KOSPI 200 is obviously a cause for concern against the positive sign on leading indicators.
While global leading indicators measured by The Organisation for Economic Co-operation and Development are still falling as of January, there might be signs that the global economy is turning a corner. Leading indicators on South Korea turned higher in January, extending the small gains already observed in December (revised up from previously unchanged). I’s still too early to claim we are out of the woods, but if February also sees gains then the global economy may already be expanding again.
This would be clear evidence that Chinese stimulus is starting to work its way through the Asian region. Playing devil’s advocate, the leading South Korea equity index (KOSPI 200) has not managed to regain its February highs in March, so the weak price action in KOSPI 200 is obviously a cause for concern against the positive sign on leading indicators.
IPO market heats up with Lyft start trading on Friday
Lyft, Uber’s biggest competitor in the US and Canada, is finalising its IPO roadshow, aiming to raise $1.95 billion based on the mid-price at $65/share. The company will trade on SaxoTrader under the ticker code lyft:xnas and will start trading on Friday.
Lyft is not issuing a lot of shares so the free float will be quite limited at around 12.2% with some upside if the underwriters exercise their over-allotment option. In our initial analysis published March 4, we covered the industry, outlook and Lyft’s financials.
Lyft, Uber’s biggest competitor in the US and Canada, is finalising its IPO roadshow, aiming to raise $1.95 billion based on the mid-price at $65/share. The company will trade on SaxoTrader under the ticker code lyft:xnas and will start trading on Friday.
Lyft is not issuing a lot of shares so the free float will be quite limited at around 12.2% with some upside if the underwriters exercise their over-allotment option. In our initial analysis published March 4, we covered the industry, outlook and Lyft’s financials.
In our updated analysis published yesterday, we highlighted that the IPO valuation (at around $20bn on the enterprise value) is getting too expensive relative to where we are in the economic cycle, and there remains high uncertainty over future profitability. Lyft is not providing any meaningful metrics to gauge the spread in acquisition costs between a new customer and a new driver.
US small caps are sending out warning signals
On today’s Morning Call, we highlighted the Russell 2000 (US small-cap stocks) as an index to watch as it’s showing clear divergence with the S&P 500. US small caps are actually behaving more similarly to South Korean equities than to the S&P 500.
The price behaviour is not at odds with trend-following funds (CTAs) beginning to short this market segment. The Russell 2000 clearly offers a different narrative than the S&P 500, which continues to look strong following the FOMC's historic pivot on monetary policy. One joker in the deck for US small caps is that the US budget deficit continues to expand dramatically under the Trump Administration, which is a clear fiscal impulse into the domestic economy that should benefit smaller companies with domestic revenue exposure.
On today’s Morning Call, we highlighted the Russell 2000 (US small-cap stocks) as an index to watch as it’s showing clear divergence with the S&P 500. US small caps are actually behaving more similarly to South Korean equities than to the S&P 500.
The price behaviour is not at odds with trend-following funds (CTAs) beginning to short this market segment. The Russell 2000 clearly offers a different narrative than the S&P 500, which continues to look strong following the FOMC's historic pivot on monetary policy. One joker in the deck for US small caps is that the US budget deficit continues to expand dramatically under the Trump Administration, which is a clear fiscal impulse into the domestic economy that should benefit smaller companies with domestic revenue exposure.
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