A record-breaking week for equities, but can it last?
The S&P 500 finished last week well above the 3,000 level, as the index powered further into record breaking territory. Even though US corporate earnings are, on aggregate, in negative territory for the third quarter and are expected to remain so for the rest of the year, equity traders are in buoyant mood about the future. There are a couple of reasons why: fiscal largesse and a synchronised round of central bank liquidity.
Central bank liquidity party fuels markets
The Fed, the ECB and the BOJ have all cut rates and re-started liquidity programmes this year, and, unsurprisingly, their key stock markets are all higher. Although the Bank of England has been talking dovish of late and is very fond of pointing out the weaknesses and risks to the UK economy, it hasn’t pulled the trigger and made any changes to monetary policy in recent months. This is one reason why we believe that central banks in particular are driving stock markets right now: the UK’s FTSE 100 has failed to retrace steps back to the August high above 7,700; while the Dax is at a near record high, along with the US index. The technical indicators for these two indices suggest that both have decent buy signals, while the technical picture remains bleak for the FTSE 100.
When will the economic data matter?
Industrials and financials are driving stocks higher in the US, which tend to be pro-cyclical sectors and suggest that equity traders are looking ahead to a brighter economic future. However, to play devil’s advocate, will central bank largesse be enough to fuel an economic rebound? For example, the Dax has surged to record highs at the same time as the economic data remains sketchy, Germany barely avoided a recession last quarter. This week’s early previews of the private sector PMI reports for November in Europe and the US, released at the end of the week, will be watched closely to see how well the battered global manufacturing sector is faring. Also, worth noting is the US Philly Fed survey for November released on Thursday. This survey has been trending lower since peaking in July, and analysts are expecting a slight pick-up for November compared to October. The Philly Fed is considered a leading indicator for the US industrial sector, if it fails to pick up as expected then surely the US stock market should decline, or at least the industrial sector that has done so well recently? One would think so in normal times, however, these are not normal times. Thus, if we get a weak Philly Fed reading on Thursday and the S&P 500 continues to rise then that should be taken as a clear signal that the US central bank is fuelling this rally in US stocks, and the best advise that we can give to our clients is “don’t fight the Fed”.
What to watch for in the Fed minutes
We might get more insight into the “Hawkish cut” from the Federal Reserve last month with the release of the minutes from that meeting on Wednesday evening. While we don’t expect the minutes to give us too much new information, there was a Powell press conference at the October Fed meeting, any sign that the Fed will continue to react (read cut rates) if the economy deteriorates or there is a global slump could be seen as a green light to fuel another leg higher in the S&P 500 rally. Could we close the year above 3,250 in the S&P 500? We believe that it is a possibility at this stage. Of course, if the monetary policy doesn’t help either corporate profit growth or the economic data to improve then stocks will be on shaky ground; however, that is 2020’s problem, for now the market is focussed on a Santa rally that has come early.
Bloomberg vs. Trump, good for markets
We must also point out that politics is also playing a role in the upbeat tone of some financial markets. For example, the fact that the Democrats are now running “market friendly” candidates in their race to unseat President Trump in next year’s election. The market is likely to cheer the entrance of Michael Bloomberg into the race, and a Bloomberg vs. Trump Presidential race is probably the best political scenario for US stock markets. At the same time, politics is also a big risk for US stock markets. If Elizabeth Warren wins in Iowa in February, and if her campaign gains momentum from there then we could see US equity traders’ cash in and flee risky assets until the political picture becomes clearer. Also worth noting, President Trump’s tone towards China and a trade deal deteriorated last week, thus we could see some bouts of stock market volatility in the short term if the long-awaited US/China trade deal fails to materialise and if the President continues to use negative language when talking about trade with China in his tweets.
Boris gives the pound a boost
Elsewhere, GBP/USD closed the week back above £1.29, buoyed by the latest polling data that gives Boris Johnson a comfortable lead over Labour’s Jeremy Corbyn. There is also some analysis doing the rounds that shows how Corbyn’s path to number ten is unlikely as he has the lowest approval rating of any party leader since pollster Ipsos Mori started measuring approval ratings in the late 1970’s. The latest polls put the Conservatives at 45%, with Labour stuck at 28%, this would give Johnson a majority to, in his words “get Brexit done”. This is the most pound-friendly outcome in our view, as the resilience of sterling in the face of economic malaise suggests. We believe that if the polling continues in this direction, and if the Conservatives don’t blow this lead in the coming weeks, then GBP/USD may re-test £1.30 in the next week or so.
Labour’s policy pledges – pie in the sky
Politics are also weighing on the UK stock market. After Labour announced it would nationalise part of BT if it wins next month’s election in order to bring full fibre broadband to all by 2030, BT’s stock price fell some 3.7%. However, it quickly clawed back gains to close 1.2% lower on Thursday. The financial market was clear, it sees the chance of a Labour government as slim and their radical proposals as unlikely to see the light of day. While we would love to say that economics and fundamentals will move UK markets next week, we continue to think that politics will do the talking, so keep yourself informed of the latest polling data, particularly if you plan on trading the pound in the coming weeks.