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Stock Bulls Have Come to a Fork in the Road

Robert Burgess
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Stock Bulls Have Come to a Fork in the Road

(Bloomberg Opinion) -- The S&P 500 Index set a record high on Tuesday, completing an unusually swift rebound from the gut-wrenching decline in the fourth quarter. Global stocks are not far behind. Naturally, the question everyone wants answered is where do we go from here. The answer depends on whether markets begin to take heed of what Morgan Stanley describes as the growing number of “glass half empty” signs cropping up around the global economy or if investors sitting on a surprisingly large amount of cash decide they can no longer afford to sit idly by and miss out on a potential “melt up.”

“There’s too much money in cash,” Bob Michele, the chief investment officer of JPMorgan Asset Management, told Bloomberg TV on Tuesday. “It’s been going into cash the last three years waiting for the Fed to finish hiking rates. They were supposed to finish hiking at the end of this year, not last year. That money has yet to come back into the market.” He’s right. At a recent reading of 71.3, State Street’s monthly index of investor confidence is holding around its all-time low. To put that number in context, the index only got as low as about 82 during the financial crisis and was above 100 — the level at which investors are neither increasing nor decreasing their long-term allocations to risky assets — as recently as last summer. The measure has authority because unlike survey-based gauges, it’s based on actual trades and covers 15 percent of the world’s tradeable assets. Money-fund assets stood at $3.04 trillion as of Wednesday, up from $2.88 trillion at the end of October, according to the Investment Company Institute. The buildup in money-fund assets between October and March was the most since the period spanning the last three months of 2008 and January 2009. Then again, it’s not surprising that so many investors are so wary, even with unemployment low, inflation under control and the Fed in an accommodating mood.

For starters, it was just two weeks ago that the International Monetary Fund cut its global economic growth outlook to the lowest since the financial crisis in 2009, when output shrank. Although the 3.3 percent estimate for 2019 is not that out of line with the level of output since the global economy began to recover, the IMF noted that the downside risk to that estimate had grown. And this week has provided examples, with many prior tailwinds for the market suddenly turning into headwinds. The price of oil has surged with the Trump administration deciding not to renew waivers that let countries buy Iranian oil without facing U.S. sanctions. China is pulling away from stimulating its economy further despite the worst labor market in six years. South Korea, a well-known early warning system for global conditions, is suffering a big drop in exports. “The glass has turned half-empty,” the Morgan Stanley strategists wrote in a research note.

ARE BONDS BUYING THE GOOD NEWS SCENARIO?Perhaps the best indicator that investors are ready to embrace risky assets is the U.S. Treasury market. At the Treasury Department’s auction on Tuesday of $40 billion in two-year notes, investors submitted bids for 2.51 times the amount offered. That so-called bid-to-cover ratio was below the average of 2.65 times over the past 12 months despite yields moving up from less than 2.20 percent in March to 2.36 percent now. In other words, investors see less need for ultra-safe securities, leading to a “mediocre” auction, as Bleakley Financial Group’s chief investment officer, Peter Boockvar, put it in a note to clients. Then there’s the yield curve, which has started to steepen again after briefly inverting in March for maturities between three months and 10 years. While that part of the curve is still incredibly flat at 15 basis points, it’s no longer flagging a recession. Also, the gap between two- and 10-year yields has widened for four consecutive weeks, to 21 basis points in the longest streak since November 2016 and a sure sign that confidence in the economy is picking up, according to LPL Research. That gap could reach 25 basis points or more through the end of the year, the firm predicts. “We’ve been encouraged by the recent recovery in long-term yields as global data have improved,” LPL Chief Investment Strategist John Lynch wrote in a research note. “As the year progresses, sound economic fundamentals should eventually prevail over global uncertainty.”

THE DOLLAR IS BREAKING OUTHigher yields in the U.S. seem to be boosting the greenback, with the Bloomberg Dollar Spot Index rising on Tuesday to its highest level since early March. Treasuries due in one to three years yield about 2.42 percentage points more on average than government debt outside the U.S., up from 2.32 percentage points, according to ICE Bank of America bond indexes. There’s plenty to like about a strong dollar. For one, it makes dollar-denominated assets more appealing to global investors, which is a big plus for the Treasury Department as it ramps up borrowing to record levels to pay for a budget deficit forecast to exceed $1 trillion. It’s also a sign that the U.S. economy is in better shape than most anywhere else in the developed world. While the Fed has signaled that it doesn’t intend to hike this year, it’s seen as less dovish than many other global central banks, and there is a risk that current market bets for easing are dialed back, according to Bloomberg News’s Susanne Barton. On the other hand, a strong dollar has the potential to make U.S. exports less competitive. That could act as a drag on U.S. growth as well as corporate earnings. S&P Global Ratings figures that 30 percent of the revenue of S&P 500 companies comes from outside the U.S. Jodie Gunzberg, managing director and head of U.S. equities at S&P Dow Jones Indices, calculated that the S&P 500 rises 3.7 times more from a falling dollar than a rising one.

THIS TIME, GOOD WEATHER IS THE TROUBLEGood weather is becoming the bane of commodities bulls. The Bloomberg Agriculture Subindex has dropped to its lowest since early 1970s as a streak of good weather around the world weighs on grain prices. Soggy conditions in the U.S. grain belt are beginning to ease, aiding corn and soy plantings, and large harvests loom in rival South American producers, according to Bloomberg News’s Megan Durisin and Michael Hirtzer. At the same time, forecasts are improving for wheat production in Russia, the world’s top shipper, as beneficial weather prevails in much of the region. “The path of least resistance remains lower for the grain and oilseed markets in the absence of a meaningful trade deal with China,” Arlan Suderman, chief commodities economist at INTL FCStone, wrote in a research note. Markets expect “ample moisture to result in big crops — both here and overseas.” July corn futures in Chicago reached a record low for the contract, falling as much as 1.2 percent to $3.5925 a bushel. July soybeans touched the lowest since September, and wheat was steady. A measure of the combined hedge fund net-short position across the three markets is at its biggest since January 2018. Though good weather isn’t to blame for the plunge in orange juice futures, which tumbled on Tuesday to the lowest since 2015. Consumers have been increasingly shunning the drink as health concerns about sugary beverages mount and as grocery stores carry shelves full of alternatives, Hirtzer noted. Meanwhile, production is set to rebound this year in Florida, the top U.S. citrus grower. “The U.S. consumer just refuses to drink O.J. for the most part — that’s just made this market terrible,” said Jack Scoville, vice president of Price Futures Group.

ARGENTINA IS DROPPING FASTIn what has so far been a good year for emerging markets, the notable exception is Argentina. Its peso has dropped 11.2 percent since the end of January, compared with a gain of 1.89 percent in the MSCI EM Currency Index. The slide comes after a 50.6 percent tumble in 2018 as Argentina’s economy fell into a recession and its deficits widened. That alone would be enough to put tremendous pressure on President Mauricio Macri, once seen as Argentina’s economic savior when he was elected in 2015, but now the nation’s bond market is suffering a deep dive. Prices have dropped below 75 cents on the dollar for its international bonds, pushing yields to an almost untenable average of just more than 11 percent, showing just how uneasy investors are despite an unprecedented $56 billion credit agreement with the International Monetary Fund and $76.7 billion of reserves at the central bank, according to Bloomberg News’s Daniel Cancel. Credit-default swaps are pricing in a 49 percent probability of nonpayment over the next five years, up from 22 percent a year ago. Investors demand an extra 8.58 percentage points in yield to own Argentina’s dollar bonds instead of U.S. Treasuries, the most since 2014. That just happens to be a year when the country was in default and before Macri, who is up for re-election in October, promised a return to economic normalcy. Macri’s approval rating has slipped below 30 percent for the first time since taking office, and a recession coupled with 54.7 percent inflation is making it hard for even some supporters to justify another four years in office, Cancel reports.

TEA LEAVESThe Bank of Canada will take center stage on Wednesday, with policy makers joining their colleagues worldwide in signaling a prolonged pause on interest rates. All 24 analysts surveyed by Bloomberg see policy makers leaving the benchmark overnight rate at 1.75 percent in a decision at 10 a.m. in Ottawa, according to Bloomberg News’s Theophilos Argitis. It would be the fourth consecutive meeting at which the central bank has refrained from raising interest rates after boosting them five times, to 1.75 percent from 0.5 percent, between mid-2017 and October. To be sure, Bank of Canada Governor Stephen Poloz has been reluctant to fully abandon the idea that the next move in rates will be higher, which makes this meeting a bit of a wild card for markets. That’s especially true with oil prices back on the rise, which should bolster Canada’s economy after a first-quarter slowdown. Bank of America is one firm betting on a dovish signal. Its strategists noted in a research note that the central bank will most likely revise its economic growth forecasts lower for at least this year, to 1.5 percent from 1.7 percent. “The BoC will be uncomfortably holding the rate at 1.75 percent as weak economic activity may call for lower rates, but on the other hand high household debt means the BoC cannot allow credit conditions to ease too much, in our view,” the Bank of America strategists noted.

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To contact the author of this story: Robert Burgess at bburgess@bloomberg.net

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.

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