Still Not Time To Be A Contrarian

U.S. equities are trying to catch a bid, but we are not yet convinced that it will stick.



Earlier this week, we noted that looming Fed rate hikes, intensifying global deflationary pressures and therefore profit disappointments, as well as perceptions about Chinese stability were culminating to wreak havoc on risk asset prices. These forces have not abated enough for us to become more optimistic on the cyclical view for equity prices.
  • As highlighted in the next insights, expectations for a September rate hike have collapsed. A ‘delayed’ rate hike will be justified by policymakers by the worsening in financial conditions and “international events”. But that does not materially change the thinking at the FOMC, namely that policymakers are keen to move off the lower bound at the first opportunity, so long as domestic growth holds. With market expectations of rate hikes now already very low for September, it will be hard for the Fed to engineer a “positive surprise” for markets.
  • The fundamental problem facing the world economy is deficient final domestic demand. Price adjustments in commodity markets, especially oil, should eventually boost final demand, but the response this cycle has so far been muted and slow. A cloud is still hanging over the profit cycle.
  • It has become clear that investors are assigning a much higher risk premium to EM/China risk assets: yesterday’s cut in the Chinese reserve requirement ratio failed to even temporarily halt the slide in Chinese equity prices. The timeline for when/how/if Chinese policymakers deliver sufficient stimulus is unknown. In addition, there is no way to assess the magnitude of capital flows out of and into China. These uncertainties imply that further market turmoil lies ahead.

Same Macro Headwinds

New York Fed Governor Dudley’s comments yesterday underscored what we already know: that the Fed is unlikely to lift interest rates while markets panic. But ultimately, the same global macro headwinds, and poor final demand conditions persist.



Dudley’s soothing words, along with a late day surge in Chinese equity prices, has shifted investor sentiment in a positive direction for now. But we maintain that the dynamics of the global economy have not materially changed. The Fed backing off from September could give financial markets some breathing room, but unless the dollar weakens substantially, the poor U.S. profit picture is unchanged.

In addition, DM equity markets are no longer ignoring the risks from China and EM. As highlighted in the next Insights, our EM strategists believe the EM selloff has further to run, implying that a cautious DM approach is still warranted.