Eco­nomic ex­pec­ta­tions are mar­ket test

The Denver Post - - BUSINESS - By Sid Verma and Luke Kawa

In­vestors who were bet­ting on U.S. re­fla­tion but are now wor­ried about Pres­i­dent Don­ald Trump’s abil­ity to push through his progrowth agenda may be in for an un­wanted eco­nomic sur­prise.

A grow­ing cho­rus of strate­gists are warn­ing that the jolts of eco­nomic growth that have helped power stocks over the past six months may no longer serve as a tail­wind for risk­tak­ing, while head­line global in­fla­tion looks close to peak­ing.

A lack of pos­i­tive eco­nomic sur­prises and wan­ing price in­creases may com­bine to test the mar­ket’s faith in the re­fla­tion trade at a time when the Trump ad­min­is­tra­tion’s fail­ure to push through health care re­form has al­ready sown doubts.

“I think mar­kets are go­ing to be caught in a vi­cious cir­cle: a failed per­cep­tion of pro-growth U.S. poli­cies — thanks to pol­i­tics — com­bined with a slow­down in pos­i­tive data at a time when econ­o­mists’ ex­pec­ta­tions prob­a­bly couldn’t be higher,” said Ju­lian Brig­den, man­ag­ing part­ner at Macro In­tel­li­gence 2 Part­ners, an in­de­pen­dent re­search firm.

“Mar­kets are ob­sessed with speed and ac­cel­er­a­tion in growth — they are, very often, less in­ter­ested in ab­so­lute lev­els,” added Brig­den, who cor­rectly pre­dicted the global stock mar­ket rout in 2015.

For ex­am­ple, the vari­abil­ity in eco­nomic sur­prise in­dexes, which tend to be mean-re­vert­ing, is driven far more by the volatil­ity of an­a­lysts’ ex­pec­ta­tions than sharp changes in the qual­ity of data. As such, overex­u­ber­ance on the evo­lu­tion of data flow glob­ally could jeop­ar­dize the per­for­mance of eq­ui­ties in the near term, he said, as the MSCI ACWI In­dex has loosely tracked eco­nomic sur­prises since the start of 2016.

Surg­ing global con­fi­dence — a key source of the im­prove­ment in these sur­prise in­dexes that have sown the seeds for a pickup in real ac­tiv­ity — may take time to bloom, warned a Cit­i­group Inc. team led by chief econ­o­mist Willem Buiter. Sen­ti­ment mea­sures are “prob­a­bly some­what over­stat­ing growth im­pulses, no­tably for busi­ness in­vest­ment which may take time to ramp up,” he said.

Mar­kets are braced for a cor­rec­tion as man­u­fac­tur­ing and in­fla­tion prints in the com­ing months fail to meet lofty ex­pec­ta­tions, said Martin En­lund, chief cur­rency strate­gist at Nordea Mar­kets in Stock­holm.

“Mar­kets have al­ready re­acted to the string of pos­i­tive sur­prises — soft data — we have seen, at a time when con­sumer and pro­ducer prices are peak­ing,” he said.

Re­cov­er­ing en­ergy prices have been the prin­ci­pal driver of ris­ing head­line in­fla­tion this year, helping to boost bond prices, stocks and in­fla­tion ex­pec­ta­tions along the way. But that ef­fect is set to dis­ap­pear by May fol­low­ing the re­bound seen in 2016.

Af­ter back-to-back years of fall­ing prof­its in the U.S., the bar for earn­ings growth has been raised to lofty heights — thanks in part to the re­cov­ery in oil. This an­tic­i­pated im­prove­ment in year-ahead in­come is a trend that pre­dates the Trump pres­i­dency.

Ex­pected earn­ings for S&P 500 com­pa­nies over the next four quar­ters bot­tomed out in March 2016, shortly af­ter oil prices reached a trough. A pro­longed bout of weak­ness in crude may, there­fore, tem­per bullish ex­pec­ta­tions for en­ergy stocks.

To be sure, pos­i­tive wage data in the U.S., euro area, and even Ja­pan, com­bined with broad-based pro­ducer price in­fla­tion in the U.S. may all boost core in­fla­tion in the com­ing months, ab­sent sec­ond-round ef­fects from com­mod­ity price in­fla­tion. What’s more, a syn­chro­nized uptick in global growth — meaning the world will be less de­pen­dent on the U.S. to power out­put — is fore­cast this year.

But in­vestors bet­ting on growth-sen­si­tive as­sets to out­per­form may have be­come too op­ti­mistic on the prospects of global out­put and price pres­sures, warn some strate­gists.

“The ini­tial as­sess­ment by in­vestors seemed to be that the U.S. pol­icy mix would pro­vide a near-term boost for U.S. growth and in turn sup­port risk as­sets,” said Sreekala Kochugovin­dan, as­set-al­lo­ca­tion strate­gist at Bar­clays. “Three months on, it seems that in­vestors have pared back some of the ini­tial bullish sen­ti­ment to­ward U.S. growth and eq­ui­ties as pol­icy ex­pec­ta­tions, both mon­e­tary and fis­cal, have been steadily re­vised.”

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