After a shaky start, we may finally have some respite from last month’s volatility. Everyone will be watching for a US-China trade deal and a conclusion to the Brexit negotiations. November will have no shortage of excitement in financial markets.
More Talking About Trade Talks
We have long argued that Asian markets have already factored into their prices a failure in the trade talks between the US and China. When the Trump Administration announced a 10% levy instead of 25%, the magnitude of rallies in these markets took most people off-guard. Chinese markets were near breaking points, and most investors had already given up on a bounce materializing at these levels.
Friday’s reaction to resumed negotiations is another example of the extreme bearishness that permeates equity allocations in Asia. Any hint of a trade deal creates buying frenzies on high volumes in markets across Asia. The Shanghai Shenzhen CSI 300 Index closed up 3.56% on the day at 3,290, and the Hong Kong Hang Seng Index closed up 4.21% at 26,486 after the US and China started talking trade again.
We see these bouts of panic buying as evidence that investors are mostly underweight Asian equities. We believe there so much pent-up demand that a successful conclusion of the trade negotiations will create a spectacular rally in Asian equities. The positioning only has to return to neutral to trigger than next bullish wave in Chinese equities.
Tuning in to the Bond Market
There is a little corner of the bond market that has its investors smiling of late. Yield-chasers utilizing structured products called steepeners have found themselves on the winning side at a time when most fixed-income investors are taking a hit from rising interest rates. Steepeners are basically a bet that the yields on the long-end of the Treasury curve will rise more than the short-end.
The bond market is further validating our expectations of higher official policy rates. Central banks around the world have no choice but to follow the Fed’s tighter monetary policy to stem foreign capital outflows. Countries with large dollar liabilities are especially vulnerable because the impact of capital outflows on foreign exchange rates makes the liability position worse in local-currency terms.
We continue to see more hikes in the Fed Funds Rate, and we continue to see this filtering down to structure premiums across the board. When the bond and equity markets are singing different tunes, we trust the bond markets.
Evidence of Strong US Expansion
Despite the media’s attention on disappointments from the old darlings like Apple, most US companies have reported earnings that exceeded analysts’ expectations. US jobs data came in strong, further strengthening our argument that the expansion is not over yet. On the aggregate, average earnings beat expectations by a wide margin, and that only increases the probability that the Fed will raise the Fed Funds Rate again in December. When equity investors began questioning the expansion’s longevity in October, we wrote the following:
The selloff in bonds was the bond market’s blessing that the expansion is nowhere near its end. It steepened the yield curve at a time when bond bulls were doubting the longevity of the equity bull market. They were buying the long-end for many reasons: the unusually long economic expansion, the Fed raising short-term rates, and the looming trade war. Now, none of these factors matter as much as the evidence of the continuing strength of the US economy.
As investors in steepeners have been suspecting, the slowdown isn’t happening anytime soon. Rising wages are the first step to a wage-inflation spiral. This is why we have been right on our higher interest rate forecasts, and it is why we expect another Fed rate hike in December. Until we see evidence to the contrary, we consider any US equity weakness as a buying opportunity. A retest of the S&P 500’s recent lows between 2600 and 2640 is not an unusual trading pattern before we make another run to higher levels.
The Week Ahead
Everyone will be listening to what Xi Jinping has to say at this week’s Shanghai Import Expo. We expect nothing less than proclamations of China’s openness and commitment to global trade. The relevant data from China this week will be China’s Caixin services PMI and Nikkei’s Hong Kong PMI figures. Also worth watching is this week’s release of Chinese Official Foreign Reserve Assets, which can be an early indicator of noteworthy intervention in the foreign exchange markets.
The FOMC meets on Thursday, but no change in the Fed Funds Rate is expected. The Fed has been signaling a December hike, and that continues to be the key date for the next interest rate hike. UK Quarterly GDP growth is expected to come in at 1.5% vs. the previous 1.2%. With oil prices turning lower, no surprises are expected out of the US and Eurozone PPI figures. PMI figures out of the US and Europe should give some comfort to jittery investors after the dismal equity market performance in October.
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