Back To The Drawing Board

With December in the books as the worst close to a year for US stocks since the Great Depression and January now representing the best start to a year in decades, markets have a kind of “back to the drawing board” feel to them.

December’s bearish hysteria has been (largely) offset by a Fed-induced risk surge, and now here we are once again trying to figure out what the rational response is to ongoing signs of slowing global growth, gridlock in DC and a still simmering trade dispute between the world’s two largest economies.

Friday’s jobs report and ISM manufacturing data stateside suggest that the US recession narrative was overblown, but the cycle has to turn at some point and a quick look around the world reveals an Italian economy already in a downturn, a teetering Germany and an extremely fragile situation in China, where evidence that stimulus is working its way through to the real economy is still lacking.

The situation in Washington seems largely hopeless. Trump delivered some of his most divisive rhetoric yet last week and rather than compel him to the listen to reason, Democrats’ refusal to fund his wall seems to have had the opposite effect.

On trade, it’s the same old story. Both sides are parroting the same ostensibly upbeat lines about issues that aren’t all that contentious while remaining at odds over structural sticking points. Meanwhile, the US continues to ratchet up the tension around the Huawei dispute. At some point, that will need to be addressed directly.

Price action in December and January had an irrational feel to it, and with the two months having effectively canceled each other out, market participants are now tasked with sorting through a familiar list of problems, with the only difference being the Fed is now inclined to be more protective of risk assets.

SocGen’s Andrew Lapthorne underscores some of these points in a note dated Friday.

He begins by noting that the MSCI World’s 7.7% jump last month is the best start to a year since 1987. He then marvels that “December 2018 saw 90% of MSCI World stocks fall, while January 2019 saw 88% of stocks go up, a 20-year record.”

(SocGen)

Obviously, you can conjure any number of visuals to illustrate the same snapback phenomenon. Below, for instance, is the % of NYSE stocks closing above their 200-DMA. December saw the third-lowest reading since the crisis, but it’s now bounced back sharply.

(Bloomberg)

After spreads blew out to their widest since 2016, IG and HY had their fourth- and third-best January performances in thirty years, respectively.

(Goldman)

And on, and on.

For the above-mentioned Lapthorne, this is meaningless, and indeed that’s the point. It’s a wash and now we’re right back to dealing with the same old issues. Here’s Lapthorne:

What does all this mean? Well, from a prediction point of view, very little. A lack of discrimination in stock movements or strong price reversals over one month does not imply anything for the following month. But what you can say that it is symptomatic of a confused market, with the kind of performance we saw in price reversals last month in the US (+7.1%) only ever seen during periods of macro turmoil.

Right. And that’s exactly what we’ve got right now: macro turmoil.

One thing that we would emphasize (for the umpteenth time) is that when the shutdown first began in December, we were closer to the beginning of the trade truce with China than the end and we were a long way away from talking about the debt ceiling.

A new shutdown starting on February 15 would come less than two weeks ahead of the expiration of the 90-day truce with Beijing and it would also raise serious concerns about the debt ceiling fight. As BofAML’s David Woo reminds you, Mnuchin can “buy a few months by resorting to emergency measures” after the March 1 deadline, but “sometime in the summer Trump will need the cooperation of the Democrats to avoid a default [and] the question is what the latter will ask for in exchange and whether Trump is prepared to pay the price.”