Submitted by Nicholas Colas of DataTrek Research
Optimism that the US and China will come to a “good” (growth-enabling) trade deal is virtually invisible across every capital market save US equities. Strange, but the data is clear enough on that point. Fed Funds Futures don’t believe such a deal is coming; nor does the Treasury yield curve. In the end, however, President Trump knows a strong 2020 US economy helps his reelection chances. And markets (equity markets, at least) know that he knows that.
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“Prices lead fundamentals” is as close to a guiding principal as we have at DataTrek. Capital markets aren’t perfect indicators of the future, but ignoring their signals is a sure path to getting run over. We are reminded of Churchill’s quip about democracy: “the worst form of government, except for all those other forms that have been tried from time to time”. Market prices are horrible predictors, except for “all the other forms” one might use.
Make no mistake: US equity prices don’t feel great as we make the sprint to the end of Q1 2019. For example:
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The S&P 500 tried to get through 2800 earlier this month, but failed and now sits at 2743.
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While we are not technicians by training or predilection, it is easy enough to see that the S&P topped out at 2800 no less than 3 other times in the recent past: October 16/17, November 7/8, and December 3 (falling short by 9 points, but close enough). Failing a 4th time earlier this month is a bad sign.
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Last week’s 2.2% decline was the first real pullback of 2019, stoking our fears that much of 2019’s rally was just reversion to the mean after late 2018’s tax loss selling.
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One year returns for the S&P 500 are basically zero (0.15%), which is better than EAFE non-US developed economy or Emerging Market equities (-9.9%/-14.5%) but still disappointing given last year’s +20% earnings growth and largely complacent rate environment.
When you cast an eye to near-future fundamentals and other market indicators, that uninspiring price action looks pretty well synced up with reality:
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Not to be a broken record on the topic, but analysts’ earnings estimates continue to decline for 2019, heavily focused on the first half. Q1 estimates now forecast a 3.4% decline to last year and Q2 numbers will likely be negative in another week or two. FactSet is showing analysts’ consensus of just 0.2% growth there.
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The latest FactSet Earnings Insight report out on Friday (link below) shows the source of the worst weakness in corporate earnings: S&P 500 companies with +50% of their revenues from non-US sources. Analysts who follow these firms expect to see 11.4% declines in earnings for Q1 2019 versus that 3.4% mean decline from the prior point. Credit a stronger dollar and softer international markets.
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Over the last month Fed Funds Futures have zeroed in on their default scenario: the US central bank will be forced to hold off on raising rates through at least January 2020 because of weak US and global growth. Odds that the Fed will have to cut rates by then are now 25%, the same as flipping heads twice in a row. Entirely possible, in other words.
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The difference between 2 and 10 year Treasuries has remained eerily quiet since December, banging around between 11 and 21 basis points. You know the drill here. Declining numbers (especially below 50 basis points) are the countdown clock to recession; rising numbers signal future economic growth. We haven’t seen this indicator hover just above zero so long since 1999, which is obviously not a positive sign.
“Ah, but once the US and China sign a trade deal global growth will reaccelerate, 2020 will be better, and all will be forgiven” is the strongest bull case at the moment. And that’s fair enough, as far as it goes. The hard thing about that logic is that it is only really visible in US equities. A stronger dollar is hurting Emerging Markets and the European economy is doing worse than anticipated, so any optimism about a “Trade Deal Rebound” is clouded by these other factors. And that rosy trade deal scenario is entirely missing from both bond and Fed Funds Futures markets, as noted above.
In the end, the US equity market’s optimism comes down to one point: President Trump would like to be re-elected and he knows a strong US economy would be immensely helpful to achieve that goal. US-China trade is the only lever at his disposal substantial enough to move the needle now that the House is in Democratic hands. Further, time is running short to assure that a resolution will filter through to the real economy and boost American labor markets/consumer confidence into Election Day 2020.
Source: FactSet
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