Economic expectations are market test
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.”