An unusual combination just before the US elections

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Recent macro indicators have generally been positive or even very positive globally. Arguably the most impressive has been the string of strengthening and better-than-expected business confidence indicators. Rarely do we get such consistency.

As far as I can see, Clinton is still likely to win enough of them to secure the presidency. But this election isn't over until all the votes are counted. Han de Jong Han de Jong Chief Economist

  • Good macro news
  • Decent earnings reports
  • Rising VIX
  • Weak equities
  • Rising bond yields
  • Falling oil prices
  • Trump narrowing in on Clinton

The most recent important variables here are the various Purchasing Managers Indices in China. The national manufacturing PMI rose to 51.2. That does not sound impressive, but it is, nevertheless, the highest level since 2014. The non-manufacturing series also rose as did the rival Caixin PMIs. What this tells us is that the targeted stimulus provided by policymakers is working in China. Stronger Chinese growth is positive for the world economy and, particularly, for the rest of Asia which is reflected in various economic variables released in the region during the last couple of weeks.

20161107-China national PMI

Apart from these business confidence gauges a small number of other encouraging indices was released during the week. US car sales beat expectations in October rising to one of the highest monthly levels ever. Personal spending was also stronger than expected in September. The 161,000 increase in payrolls, plus the 44,000 upward revision to the last couple of months was modest and roughly in line with expectations, but positive.

The corporate news flow has also been positive. The US Q3 earnings season has developed favourably. Higher energy prices have supported earnings in the sector and, for example, US banks have surprised positively. It looks like S&P500 earnings may be up year-on-year for the first time Q2 2015.

Macro news beating expectations and earnings doing alright typically leads to a rising stock market. But not this time. European and US equities have lost some 5% in recent weeks. Why?

Trump, interest rates and oil

I think the failure by the stock market to respond positively to good macro and corporate news is caused by three factors. In no particular order, one reason is the US elections. Two weeks ago the race looked lost for Donald Trump. But then came the FBI director James Comey's letter to Congress about Hillary Clinton's emails and that has changed the momentum completely. As a result, Trump has narrowed Clinton's lead in the opinion polls. Some polls have Trump ahead. Clinton appears unable to stop and reverse that trend. What matters, however, is not the popular vote, but what happens in seriously contested states. As far as I can see, Clinton is still likely to win enough of them to secure the presidency. But this election isn't over until all the votes are counted.

The question arises what would happen on financial markets if Trump were to win. For a start, Trump is considered volatile and unpredictable. He cannot be serious about many of his election promises, but we will not know what policy initiatives he will take until he is in the White House, should he get elected. Financial markets do not like this sort of uncertainty. Many commentators are saying that markets are positioned for a Clinton win and will thus react strongly and negatively to a Trump win. I am not so sure. It may have been true a short while ago that markets were fully positioned for a Clinton win, but the sell-off in equities surely indicates that many investors have positioned themselves along the sidelines. I would therefore be inclined to say that we could see a significant relief rally in the case of a Clinton win and perhaps not such a particularly negative reaction if Trump gets elected.

Another reason for markets to feel unsure is what has happened to bond markets. Yields on 10 year US Treasuries have risen from 1.35% in July to around 1.80% now. 10 year Bund yields have risen from a low of -0.18% to around +0.15% now. We have seen periods of rising bond yields before during the last couple of years. 10 year Treasury yields rose from 1.60% in May 2013 to 3.0% by the end of that year during the tapering tantrum only to fall again to 1.60% early 2015. Within half a year, yields rose to 2.5% but fell again to below 1.4% in July this year. The big question during all these phases of rising yields is whether this is the big turn: has the 30 year bond market rally finally ended and if so, are we in for an extended bear market in bonds? What is making some people wondering very hard about this question is their view that inflation may be picking up and the perception that central banks are starting to reverse.

The US Federal Reserve is expected to raise rates in December. While I do not think a December hike is a done deal, I do think one is likely. And rumours about the ECB starting tapering its asset purchases at some stage appeared out of nowhere a couple of weeks ago. While it is very unlikely that the ECB would consider tapering any time soon, it probably focused investors' mind on the simple fact that QE will not last forever. On balance, we are still struggling to believe that bond yields will now rise on a sustained basis. We are less convinced than many others that inflation will rise materially soon (though a modest uptick is likely) and we think the ECB will remain very accommodative for a long time yet.

The softness of oil prices since mid-October is perhaps the third source of concern for equity markets. If sustained, this will put downward pressure again on energy companies' earnings and it casts doubt over the underlying strength of the global economy. The near-term outlook for oil looks very uncertain indeed. However, we would like to focus on the slightly longer term when we expect the market to rebalance. In the course of 2017 we expect the supply surplus to disappear altogether and to turn into a small demand surplus. This, we believe, will support a further recovery of the price.

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