David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.
The S&P 500 had its best start to the year since 1987, through to Jan. 26. Then it embarked on an unprecedented 10-per-cent slide in just nine sessions. It then magically bounced off its 200-day moving average and then, last week, the index staged its biggest one-week advance since 2013, (up 4.3 per cent).
The Dow is coming off six straight winning sessions as of last Friday, a streak we last saw in November. Half the correction is over and now, the blue-chips are up a grand total of 1 per cent for the year.
From deeply oversold to deeply overbought. And all we are really left with is a lot of volatility, which is enough to turn anyone off – although active fund managers are celebrating the return to a two-way traded market. In all of 2017, we saw but eight sessions when the S&P 500 moved at least 1 per cent in either direction; and here we are in 2018, not even two months old and we have already seen 10 such days.
That said, not everyone is buying into it. Both equity-based exchange-traded funds (ETFs) and mutual funds have seen US$30-billion of net outflow the past two weeks. Fund managers in the most recent Bank of America Merrill Lynch survey have taken their overweight in equities down to 43 per cent from 55 per cent, the sharpest such move in two years.
And if one thing rings true, it is that volumes have not confirmed the rally in prices, as trading since Feb. 9 has been 22 per cent lower than it was when the market was sinking the week before.
The equity market revival is merely a case of buying the fact after selling the rumour. The inflation concerns that rattled the stock market earlier gave way to reality last week with both the core consumer price index (CPI) and producer price index (PPI) data coming in above expectations. The various U.S. Federal Reserve measures of inflation dispersion picked up dramatically last month. The futures market is now fully pricing in a rate hike for March and building in expectations for June, too. Both Fed chairman Jerome Powell and New York Fed president William Dudley indicated that the developments in the equity market were not going to dissuade them from their gradual tightening path.
If U.S. President Donald Trump accepts the Commerce Department's recommendations and takes tough action on aluminum and steel imports, a trade war and spiking goods inflation (which already is going to make the Fed's job that much tougher) are not the sort of developments that should otherwise cause an expansion in the market multiple. Quite the opposite, in fact. And no wonder gold has advanced 28 per cent over the past year – something that receives scant attention.
Meanwhile, for all the talk of how great the economy is doing, we saw declines in January industrial output, real wages, retail sales and aggregate hours worked. The Citigroup economic surprise index is flirting with four-month lows. My own count shows that so far this month, 60 per cent of the U.S. economic data have come in shy of consensus views, double the 30 per cent that have beaten expectations. Yet, this narrative of how great the economy is doing has been extremely difficult to dent.
In fact, you may like to know that absent the paper wealth effect on spending from what the stock market did to consumer outlays last year, the impact the 10-per-cent decline in the dollar had on net exports and the debt binge in the household and business sector, real GDP growth would have been 0.7 per cent last year. This means that 70 per cent of the 2.3-per-cent growth in 2017 was completely artificial and inorganic. Maybe fiscal stimulus fills the void this year (although the dollar keeps on slip sliding away), but that again is temporary. The message is that 2017 really was a year of "low quality" economic growth, aided and abetted by wealth effects, dollar depreciation and borrowed money. Remember – the true hallmark of the past year was a complete lack of productivity growth, yet again, and all the "dereg" in the world and the wave of "animal spirits" did little to change that condition. As for the howling about "supply side" features in the fiscal plan, I have to tell you that rising budget deficits have a historic inverse correlation to productivity growth.
This may well be one reason the once-mighty greenback has continued to falter, even with bond yield spreads vis-à-vis Europe and Japan widening sharply in recent weeks and months. The yield on the 10-year T-note now commands a 215-basis-point premium over comparable German bunds, compared with 175 basis points last summer. From a flow-of-funds standpoint, China has been reducing its exposure to U.S. Treasuries, contributing both to the upward pressure on yields and downward pressure on the greenback. Maybe this is how China intends to retaliate against the overt move towards U.S. trade protectionism.
There's another matter, and it is the high-yield bond market, where yields hit 6.44 per cent last week – the highest since December, 2016. Investors are clearly de-risking as they pulled US$10.89-billion out of high yield bond funds in the week ending last Wednesday – the second-largest net outflow on record. Investors also withdrew US$3.2-billion from emerging market (EM) debt and equity funds last week, a rarity to say the least. In a nutshell, the technical bounce in the U.S. equity market is obscuring the de-risking beneath the surface.
David Rosenberg