Today's Challenge: Markets vs. Economics

Today's Challenge: Markets vs. Economics

Last week's markets left investors looking to economics for clues; Italy faced up to the EU; China's trade surplus ballooned

"There has very definitively been a change of gear over the past 10 days"
UK Chancellor of the Exchequer Philip Hammond, on the negotiations over Brexit

Today’s challenge: Markets vs. economics This past week was difficult for bulls, with most headline asset classes turning in negative returns – even after Friday’s action.

The S&P 500 closed below its psychologically-important 200-day moving average on Thursday the 11th and traded just below it for much of Friday.  At its intra-day low on October 11th, the overall drop from the market’s 2018 high on September 21 came to (7.83%), not quite qualifying as a full-blown correction – but the NASDAQ Composite made the grade, falling (10.6%) from its high on August 30 to its intra-day low on October 11.

U.S. broad-based fixed-income indexes also retreated slightly for the week, and the Treasury yield curve flattened as safe-haven demand weighed on yields from 10-years and longer. The yield on the 10-year Treasury spent much of Friday in the range of 3.14% - 3.18%, down notably from its 2018 high of 3.259% on October 9.

Unusually for this steep of a pullback, no single piece of economic or market news seemed to drive the rout. To be sure, there was plenty of negative sentiment to go around – from saber-rattling on tariffs to potential shortages of crude oil; nervousness about the current earnings season; the International Monetary Fund (IMF) reducing its forecast for global growth; and Federal Reserve officials speechifying about the possibility of hiking rates to slightly above “neutral” in future meetings of the FOMC.

But by week’s end, the markets’ moves were described by many observers as a “technical” pullback as much as anything else, with some valuation-sensitive active fundamental investors using the pullback to buy favored assets at favorable prices.

Italy: Agreement to disagree The official version of Italy’s budget was ratified by Italy’s coalition government, with its draft 2.4% deficit still in place, defying the European Union’s warnings about exceeding its guidelines – but increasing political goodwill for the Eurosceptic parties in Italy’s ruling coalition. This sets the stage for continued confrontation, which is unlikely to calm Italy’s equity or bond markets, where 10-year spreads to benchmark German rates remain near 2018 highs, at about 3.08%.

U.S. – China trade: Volume matters September’s trade with China set new records, with a $34.1 billion surplus for China, bringing the year-to-date figure to $225.8 billion, according to official figures from China.  The year-ago figure for the same period was $196 billion. The increase came from a 14.5% increase in exports to the U.S., as well as a decline in the goods that China bought from the U.S. Ironically, the increase in the surplus comes in part from a booming U.S. economy, which is increasing the demand for goods from China.  It’s yet unclear how much of the increase in exports from China is due to inventory boosts in advance of the imposition of the next round of tariffs from both countries.

In related news, the IMF announced, via an interview with Markus Rodlauer, Deputy Director of the IMF’s Asia and Pacific Department that the renminbi (yuan) is “not out of line,,, [and] broadly in line with the fundamentals”, and went on to say that the People’s Bank of China (PBoC), the country’s central bank, was allowing the exchange rate to respond to “market pressures”. This assessment could have a positive influence on the upcoming semi-annual assessment of the state of the world’s currencies by the U.S. Treasury Department.

 


All data Source: Bloomberg, as of Oct 12, 2018, 2:20 PM ET.

Definitions:

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

The NASDAQ Composite Index is a market-capitalization-weighted index that is designed to represent the performance of NASDAQ securities and includes over 3,000 stocks.

 

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