The bulls are back, thanks to better-than-expected market news. But there’s little support for their optimism

Expectations have so much influence over investors that a slower contraction than anticipated has boosted markets
They’ve gotten ahead of themselves: there’s little about global conditions to indicate the economy has hit bottom

Nicholas Spiro

Published: 3:00am, 15 Nov 2019

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In financial markets, expectations are crucial. Bad economic news can be treated as good news if the data comes in better than expected.

Last week, the publication of an index of global manufacturing activity, produced jointly by JPMorgan and IHS Markit, showed that output in October contracted for the sixth straight month as the trade war continued to take its toll on the world economy.

However, investors seized on the slower pace of contraction, with the index rising for the third consecutive month, suggesting that the manufacturing downturn may have bottomed out during the summer.

Even if the uptick proves to be a false dawn, most investors are now convinced that their fears of a global recession earlier this year were overdone.

The facts speak for themselves. Since October 8, the yield on the benchmark 10-year US Treasury bond has surged 37 basis points to 1.89 per cent, its highest level since early August. More tellingly, the global stock of negative-yielding government and corporate debt, which had ballooned to a record high of US$17 trillion in August, has plunged to US$12.5 trillion. Even Japan’s 10-year bond yield is threatening to turn positive.

Traders work on the floor of the New York Stock Exchange on Wednesday. Global stocks currently stand at a mere 1.5 per cent below their all-time high set in January 2018. Photo: AP

Global stocks, meanwhile, currently stand at a mere 1.5 per cent below their all-time high set in January 2018, while all three main US equity gauges have risen to record peaks in the last week.

However, the strongest indication of the degree of bullishness in markets came on Tuesday, when Bank of America Merrill Lynch published its latest fund manager survey, which revealed that investors have jettisoned bearish bets – cash holdings have sunk to their lowest level since 2013 – and significantly increased their allocations to stocks. The findings showed the biggest monthly rise in optimism about the outlook for global growth since the survey began in 1994.

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Michael Hartnett, one of the authors of the poll, summed it up when he noted that “the bulls are back”.

The question is: why are they back and, more importantly, should they be?

The resurgence of optimism stems from two factors: growing confidence that the worst of the global downturn has passed and expectations that a trade truce is finally at hand.

Both of these factors have been feeding off each other over the past several weeks, so much so that the “fear of missing out” – known in markets by its acronym “FOMO” – on a powerful rally has taken over as the main driver of sentiment. Never mind that the economic data, particularly in Europe, remains bleak, or that the prospect of a meaningful and durable easing of trade tensions is remote, investors’ belief that the outlook for the global economy has improved has created its own reality.

As JPMorgan rightly observed in a note published earlier this month, asset prices reflect market expectations of a turning point in growth. The issue is “whether markets [are] front-load[ing] the next business cycle to an extreme degree”.

Whether the bulls are jumping the gun will only become clear in the coming months, when the headwinds from the trade war will have either abated or intensified, and when the economic data will either validate or negate the recent improvement in sentiment.

Global economic gloom casts a dark shadow on Asian equity markets

To be sure, the fact that investors are no longer unduly pessimistic about growth is to be welcomed, particularly when it comes to America’s economy which, as I argued previously, is still in relatively good shape. The excessive gloom was a risk in itself as it threatened to become self-fulfilling, undermining consumer and business confidence further.

Still, the fact is the green shoots are barely visible, leaving asset prices in a race against time. If the data does not improve significantly by early next year – or if trade tensions flare up again, which is a distinct possibility – the mood will turn sour, and quite sharply if investors reposition their portfolios more aggressively in anticipation of stronger growth.

While markets are right to focus on forward-looking indicators, which signal a modest improvement in global manufacturing activity, the service industry – which had been outperforming the manufacturing sector over the past year – is now suffering a sharper slowdown, boding ill for employment and consumer sentiment.

The strongest evidence of this is in Germany, Europe’s largest economy, which some forecasts say has fallen into recession last quarter. The service sector barely grew last month, with companies’ expectations for future growth turning negative for the first time since 2012, survey data from IHS Markit revealed last week.

This is hardly a sign of a global economy that has hit bottom; on the contrary, the scope for further weakness is considerable.

Investors invariably tend to get ahead of themselves, especially when they realise their previous assumptions were misguided. Yet the current bullishness, while preferable to too much gloom, is unjustified. The green shoots need to sprout before the bulls can rejoice.

Nicholas Spiro is a partner at Lauressa Advisory

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