Monthly Roundup
January started off much as December had finished: strongly. But then markets seemed to run out of puff. Again the commentary revolved around reactions to Donald Trump, and certainly while the new President may have contributed to the invigoration of animal spirits in the US, as we argued last month we think there are stronger underlying reasons that were the catalyst for the markets’ rally; reasons that are contributing to them running out of puff too.
Equities markets actually bottomed on 4 November last year and jumped almost 3% in the three trading days before the US election, when everyone thought Clinton would win. Cast your mind back to the night of the election when all the commentary was that a Trump victory would see markets dive, indeed the US futures traded limit down. But then they kept rallying and when commentators looked around the major change that seemed to coincide with markets rallying was, of course, Trump’s election; an easy narrative to reach for, but probably not the best explanation and certainly not the only one.
Other underlying forces had been at work over the preceding 6-12 months, driven by aggressive policy accommodation. Those forces build more slowly, gaining momentum from things like the availability of credit and liquidity, or changes in exchange rates. Then they show up in things like manufacturing data, or unemployment levels, or capital expenditure, but because they move slowly they don’t get as much attention and can’t compete with the noise of something like the election of a headline-grabbing new President, so they tend to be all but overlooked.
There is an index that measures whether economic data comes in stronger or weaker than consensus forecasts – when it’s above zero the data is better than expected and vice versa. Last October the global economic surprise index began its strongest three month rally in four years to reach a six year high – see the chart below. As you can imagine, when data are surprisingly strong markets tend to react very positively, in fact, there’s a 70% correlation between global equities and the surprise index.
The global economic surprise index recently hit a six year high
Source: Deutsche Bank
It is entirely possible the surprise index may continue to rise, but as you can imagine, given it’s at a six year high you’d expect it will struggle to go a lot higher and may well drop back a bit. Also, quite a few measures of underlying activity are reaching similarly extreme levels of multi-year highs or lows, some definitely in response to Trumponomics or Chinese reflation, but when that happens almost invariably you’ll see a reversal.
Here are some examples:
US small business optimism is the highest since December 2004
Source: NFIB
US consumer confidence is at pre-GFC highs
Source: Haver Analytics, Deutsche Bank
Chinese iron ore stockpiles are at a record high
Source: JP Morgan
Net long positions in oil are close to all time highs
Source: Deutsche Bank
Net short positions in bonds (traders betting the price
will fall and yields will rise) are at all time highs
Source: Deutsche Bank
US mutual funds’ cash holdings are at extreme lows
The appetite for risk in European equity markets is also at extreme levels
Source: Deutsche Bank
The level of volatility on the S&P500 (the VIX)
is as low as it’s been over the past 10 years
Source: Yahoo Finance
It is entirely possible markets will continue to rally, but there are mounting indicators that suggest it’s time for a breather. If markets do sell off you’ll almost certainly hear commentators attributing it to Trump’s latest policy tweet, or a Central Bank missive, or European elections. Odds are though, there will be another underlying reason.
