Opposing Market Signals

Global equities are near their cyclical highs, but several safe-haven assets are rallying.

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Three safe-haven assets have been undergoing a recovery since mid-December: gold, the Japanese yen and 10-year U.S. Treasuries. Gold has retraced all of its post-U.S. election decline. USD/JPY has given back about 62% of its rally following the election, while the10-year Treasury yield has retraced 50% of its advance. In relation to these trends, the equity market is the so-called “odd man out”.

BCA’s cyclical view of global risk assets remains bullish, but a variety of asset prices are indicating a subtle shift towards risk aversion. This could be due to geopolitical worries and/or a downgrading in growth expectations. Whatever the reason, a continuation of these trends could signal a broader retrenchment in global risk assets. We would view this as a long overdue technical setback from overbought levels. Any such correction would represent a buying opportunity on a 9-12 month cyclical investment horizon.

A Warning Sign For EM Equities

A relapse in industrial metals versus lumber prices is a poor omen for EM equities.

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The ratio of industrial metals to U.S. lumber prices has had a reasonably good track record in gauging relative performance of EM versus U.S. share prices. Industrial metals prices are a proxy for economic growth in China/EM, while U.S. lumber prices are indicative of America’s business cycle. Industrial metals prices (the LMEX index) have lately underperformed U.S. lumber prices, pointing to renewed EM underperformance versus the S&P 500.

Heading For A Choppier Market

Equity markets have given up some of their recent gains. Below, we highlight the critical variables to gauge whether a correction will devolve into a sustained sell-off.

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Investor confidence can be measured through margin debt. While extremely elevated, there is no concrete sign that access to funds is being undermined by the modest backup in interest rates. When the cost of borrowing becomes too onerous, it will manifest in reduced margin debt and forced selling.

M&A activity is losing momentum. A peak in merger activity typically coincides with a rising cost of capital. If corporate sector capital availability becomes a pressing issue, then M&A activity will decline further, signaling that the corporate sector is facing growth headwinds.

Economic signals are mostly positive. Durable goods orders have tentatively perked back up, reinforcing that profits and confidence have improved after a soft patch.

Temporary employment continues to rise. When temp workers shrink, it is often an early warning sign that companies are entering retrenchment mode. If temporary employment falls at the same time as share prices, that would be a red flag.

The relative performance of consumer discretionary to consumer staples can provide a read on purchasing power or the marginal propensity to spend. This share price ratio does not suggest that any consumption concerns exist. If consumer staples begin to outperform, then it would warn of a more daunting economic outlook.

In all, these indicators suggest that any pullback will be corrective rather than a trend change.

ECB Versus Fed: A Major Mispricing?

The expected difference between ECB looseness and Fed tightness two years ahead stands near a 20-year extreme.

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We have shown there is no difference between economic growth, inflation, or inflation expectations in the euro area and the U.S. on an apples for apples comparison. And in sharp contrast to the U.S., the percentage of the euro area population in employment is at an all-time high.

ECB President Draghi points out that “the risks surrounding euro area growth relate predominantly to global factors”. If these global risks do materialize, it would prevent both the ECB and the Fed hiking rates through 2018. But if these global risks do not materialize, allowing the Fed to continue hiking through 2018, is it really conceivable that the ECB just sits pat? Our European strategists think not.