Three things that will drive markets this week

The “hawkish” rate cut from the Federal Reserve along with a better than expected Non-Farm payrolls report set US stock markets on fire at the end of last week. The Nasdaq and the S&P 500 both reached fresh record highs, even though other key indicators of US economic growth remained mired in negative territory, including the important ISM manufacturing survey, which fell deeper into contraction territory last month. Combined with the unresolved US/China trade dispute, the UK general election and the prospect of another quarter of corporate earnings declines, the outlook for risky assets remains exceptionally unclear. To help you navigate these murky trading waters, we take a look at three events that could move markets this week. 

1, The US/China trade war 

This issue has rocked markets for most of the past two-years, but even though it remains unresolved, it hasn’t stopped the S&P 500 rising nearly 20% so far this year. In fairness, the most recent highs in US stocks have come at a time when the prospect of a trade deal seems close. Last week President Trump said that he would meet with his Chinese counterpart and they would make a deal that would cover 60% of the US/China trade deal at some point in the near future. However, so far, China has remained unwilling to boost imports of foreign goods, which suggests that Beijing could play hard ball with President Trump and the trade wrangle between the two superpowers is far from over. So, why are US stocks making record highs when there is still a huge amount of uncertainty around trade? We believe that three things are helping markets to remain optimistic about this outcome. Firstly, Chinese trade data is released on Friday and both exports and imports are expected to decline. If this is correct, then exports will have spent more than half of 2019 in contraction territory, which may put pressure on the Chinese to sign a trade deal with the US. Secondly, President Xi is expected to deliver a keynote speech at the Shanghai import expo this week, which is where he could announce a boost to foreign imports, which could also ameliorate his US counterparts into signing a mutually beneficial trade deal with China sooner rather than later. Lastly, Chinese pork production has come under threat from African swine fever, if this boosts imports of US hogs then the US may soften towards signing a trade deal with the Chinese. Traders are always looking to the future when they take a position on the stock market, thus, for now, optimism remains high that there is an end in sight to the highly destructive US/China trade war. 

2, The Bank of England 

The Bank of England is scheduled to announce its latest policy decision and release its updated Inflation Report this Thursday. Since the BOE is one of the last of the major central banks to hold out on loosening monetary policy, all eyes will be on whether Mark Carney and co. will follow the Fed and the ECB and loosen monetary policy.   This is the first BOE meeting since the EU and the UK agreed a Brexit deal in principal, although it still needs to be ratified by Parliament. Throw a general election into the mix and the outcome of Brexit remains unclear. However, the odds of a no deal Brexit have been slashed, and this is one reason why the chances of a rate cut at this meeting have fallen from more than 70% in September to less than 20% today. Although a rate cut is unlikely at this meeting, we believe that the latest Inflation Report could increase the chances of a New Year cut, that is unrelated to Brexit. We expect the BOE to downgrade both the UK’s growth and inflation forecast for the next two years and blame a global slowdown on its bleaker assessment. The MPC has arguably become more dovish in recent months, with two previous dissenters now toeing the party line. A dovish Inflation Report coupled with a sharp increase in expectations for a January rate cut could weigh on sterling.

Two factors could knock the pound off course this week, the other is the latest election opinion polls, where the Conservatives’ lead has shrunk, as the opposition parties form an alliance to try and stop Brexit.  The Conservatives are now at 39%, with Labour at 27%, the largest jump in the opinion polls for Labour for more than a year. The Conservatives launch their election campaign later this week, so we will have to see if that causes their lead to increase, however, we expect that this poll shock could trigger some uncertainty in the pond at the start of this week. At the start of trading on Sunday GBP/USD dropped back from the $1.2970 highs from Friday and is trading around $1.2940. $1.2850 is a key support area in the short term. Of course, on the upside, $1.30 is the level to beat, and so far, it has been an attractive selling ground for GBP. 

3, S&P 500 earnings update 

40% of the companies in the S&P 500 have now reported their Q3 earnings, and 80% have reported a positive Earnings-per-share surprise, while more than 60% have reported better than expected revenues, according to data provider Factset. The bar to positive earnings surprises was low, as the blended earnings decline so far is -3.7%, this is slightly better than the 4% decline that was expected, as seven sectors have beaten EPS estimates so far. Worryingly, 26 S&P 500 companies have issued negative EPS guidance for Q4 2019, with only 12 companies issuing positive guidance. Combined with the elevated Price-to-earnings ratio for the S&P 500, which currently stands at 17, above the 5-year ratio of 16.6, one has to wonder why the S&P 500 isn’t backing away from these record highs. We believe that the market is not focussed on the earnings data for Q3, and traders are willing to look through a US corporate earnings recession as long as the Fed remains accommodative and the US/China trade deal does get signed. For now, we believe that positive momentum may continue to propel the S&P 500 higher, possibly to 3,100 in the coming days and weeks. However, traders would be wise to remember that this is a rally built on shaky foundations.