On Friday, we spent quite a bit of time discussing the extent to which August has proven that “bad news is good news” has its limits in terms of being a viable trading philosophy.
To a point, worsening economic data and trade frictions can be bullish for risk assets if the market believes central banks will respond by doubling down on accommodation and keeping the liquidity spigots open. That allows bonds and risk to rally simultaneously, and creates the conditions for the “everything” rally that, with the exception of May, defined the first half of 2019.
But, if negative growth expectations and geopolitical uncertainty become too acute (i.e., if the proximate cause of central banks’ dovish lean gets too pronounced), risk assets may come to “believe” that no amount of monetary intervention will be sufficient to head off a downturn. At that juncture, bad news is just bad news. Stocks and other risk assets will tend to fall with bond yields.
And so, the cross-asset picture looks quite different if we compare the first half of 2019 to May and August, months characterized by risk-off sentiment tied to trade concerns and growth jitters.
Of course, things turned around dramatically for risk assets in June following an abysmal showing in May.
If you recall, the reason US equities were able to stage such a dramatic bounce following the May selloff was that Trump’s threat to impose across-the-board tariffs on Mexico was seen as effectively cementing the case for a preemptive rate cut from the Fed. The short-end began aggressively pricing in easing and that, in turn, helped stocks surge. (Trump subsequently called off the Mexico tariffs, but not before the Fed was pigeonholed by market pricing.)
So, why not this time? Why can’t risk assets shake off the latest trade escalation and attendant growth concerns to rally on the promise of more accommodation from the Fed and the FOMC’s global counterparts?
According to Credit Suisse, there are four main reasons why a “risk-market-positive scenario [is] imaginable some weeks down the road [but] unlikely in the very near term”, where “near term” means “the next couple of weeks”.
The first reason is simply that the June bounce illustrated above came after May’s drawdown. Similarly, the early 2019 rally in stocks came after steep losses in Q4. “This time around the S&P sold off cumulatively by about 6% since it peaked on 26 July, and the news on the US-China standoff is arguably worse now than it was back in May”, the bank writes, in an emerging market strategy note out this week. For the bank’s EM FX team, the market would need to see “a decline… that is bigger than May’s to set the stage for a rebound”.
The second reason a quick surge isn’t likely is that Trump’s recent actions suggest the US president still views tariff escalations as an effective way of securing leverage. “Our base case view is that Trump will eventually adopt a more conciliatory tone, but we find it far from certain that he will, and we suspect that he will do so only in response to an equity market drop that is substantially more severe than the one that has played out in the past week”, Credit Suisse cautions.
The administration did attempt some damage control throughout the week, dispatching Larry Kudlow and Peter Navarro to the networks in order to defend the president’s policies, but Trump’s remarks didn’t suggest he’s in a conciliatory mood. Indeed, the decision to label China a currency manipulator came just hours after the worst day of the year on Wall Street, which suggests the White House was willing to risk more turmoil.
Credit Suisse goes on to offer two additional reasons why a near-term bounce isn’t likely. “China’s negotiators seem to have lost patience with (and trust in) the US administration and seem very reluctant to make the next conciliatory move”, the bank adds, before noting that “pricing in the US rates market is more aggressive now than it was in May [and] we find it hard to see how US Treasuries can rally much further unless the whole investor community becomes convinced that the risk of an imminent US recession risk is very high in which case risk markets presumably ought to be weak”.
That last point is important. The upshot is that a further rates rally would suggest the market sees an outright downturn as all but inevitable. At that juncture, risk assets (including equities), should trade lower as yields drop. Bad news would just be plain old bad.
Of course, thanks in no small part to a series of yuan fixes which together suggested the PBoC wanted to avoid further turmoil (at least for a couple of sessions), stocks managed to rebound last week and posted only minor losses.
But, as noted on Sunday morning in “Black Swans Crash Summer Dog Days For War-Weary Markets“, it seems like just a matter of time before the next shoe drops.
As Credit Suisse puts it, “risk markets, despite [a] rebound, are likely to sell off further before they stabilize and/or rebound in a convincing and lasting fashion”.