US economy, Brexit, and the global slowdown during an equities rally

Equities continued their rally today, both in the US and globally. While the US rally was impeded by bad news for Boeing, the S&P 500 did eke out a gain on the back of a rally in tech. Cisco, for example, is up 29% since it bottomed on Christmas Eve, hitting 6 52-week highs in the process. And this is notable given the absence of positive economic data.

To my eyes, it looks like we are looking at overbought conditions, not just on a technical basis, but also on a sentiment basis as well. Shares are looking downright frothy. So let’s look at the economic catalysts here.

Emerging Markets

I want to start with EM because a lot of the price action there is due to the twin positive sentiment cues surrounding China and the Fed.

On China, the thinking is two-fold – first, that the US-China trade spat will not end badly, and second, that the Chinese government will provide enough stimulus to prevent a hard landing. If you look at the MSCI Emerging Markets Index, China has about a third of the weight there. So, China has outsized importance for investors.

Moreover, China has a broader impact on other economies via trade, especially in Asia. I know Morgan Stanley is pointing to copper prices having risen over 10% to nine-month highs as a sign that we are on the mend in EM. They see EM up 8% in 2019.

Finally, there’s the Fed, which is making incredibly dovish noises. So, the Fed and the dollar are now a tailwind for EM instead of a headwind.  But, given the following credit backdrop noted by Reuters, it may not be enough:

Non-performing loans have shot up to a global high of close to 10 percent of gross credit exposures in India, and they are expected to edge up this year in China, Mexico, Indonesia, Russia, Turkey and Argentina, say analysts.

A gloomy outlook on the final two issued by Standard & Poor’s undercuts the assumption that fallout from currency crises last year in both countries was already priced in.

Turkey, which is now in a recession, is seen as an outlier. Analysts have seen this coming for some time and see the country’s problems as idiosyncratic with no chance of contagion. And Argentina is seen as an outlier as well.

I don’t have a strong view on any of this. But, I would say that EM is particularly vulnerable to three things: China, the US dollar and commodity prices. If any of these falters, the Goldilocks scenario will come unstuck.

The US economy

And while I have my eye on Europe as a weak link in the developed world, the US and the dollar are probably more important here. And the data continue to show weakness. I have mentioned the jobless claims. And while I think the last non-farm payrolls figure was a lot better than the headline +20,000 print, I am concerned that job growth will weaken going forward.

What concerns me even more is that the retail sales figures continue to look weak despite average hourly earnings up some 3.4% in the last year. The December print was revised down to a -1.6%, the opposite revision of what I would have expected. And the January number came in at a paltry 0.2%. Yes, this is a noisy data series. But, the downtick coincides with what I see as weakening job figures. Goldman is now expecting 0.5% growth in Q1, down from a previous 0.9% estimate.

I think this is stall speed. I mentioned that 2% is no longer really stalling in a low growth world. But 1% or below certainly is because any exogenous shock can take us into contraction and recession. And, despite all of this, plus the prospect of falling S&P 500 earnings, the market continues to rally.

Global outlook

Global growth is at its weakest since the great financial crisis, according to Bloomberg Economics’ new GDP tracker: Growth in the first quarter is running at just 2.1 percent, sharply down from around 4 percent in mid 2018.

That’s Bloomberg’s analysis from just yesterday. Have we bottomed? There are no signs of it in my view. The EM credit numbers show an acceleration in credit distress. And I see EM as leading the way on global growth. Without EM – and China – growing robustly, we have not bottomed.

So I expect this rally in shares to fade. Bond markets are sending distress signals, with yields in the EU, the US and Japan remaining low or retreating further. The same is true everywhere in the developed world, which makes the rally in equities look misplaced.

The one place where risks have potentially diminished is the UK. I have been predicting an extension of the timetable for some time now. And that looks to be imminent. The real question now is not about downside scenarios for the UK and Europe due to Brexit, it is more about how long Brexit is delayed and what the political fallout is as a result. So, I am more bullish about the UK because downside scenarios are less likely.

Note that Theresa May lost a second vote on her EU exit deal by 149 votes. Frankly, she should resign. But, tomorrow, we get a vote on whether to prevent a no-deal Brexit. And then we get a vote on whether to extend Article 50 on Thursday.

For me, the rally in shares looks vulnerable. But there are no short-term catalysts for real carnage here. All of the major central banks are now dovish, oil prices have stabilized, and Brexit won’t push Europe over the edge. For now, we’ll muddle through until we get a read on whether we’re seeing re-acceleration in global growth or continued slowing into 2019.