22 February, 2016
Did the US stock market send a false signal again?
– More to gold prices than just US interest rates (see Chart of the Day)
– Euro-zone PMIs should point to slowing activity (09.00 GMT, Monday)
– US durable goods orders probably rebounded in January (Thursday)
Key Market Themes
Despite experiencing a set back towards the tail end of last week, the US stock market has made significant gains since hitting a trough on the 11th February. We expect it to make further headway this year as the news from China improves, and do not think that its prior 15% slide heralds an economic downturn. Admittedly, recessions have typically been preceded by corrections in equity prices. But corrections in equity prices have not always been succeeded by recessions. (See our forthcoming Global Markets Update.)
In 1966 the economist Paul Samuelson famously quipped that the stock market had predicted nine of the last five recessions. He could have made a similar quip fifty years later. After all, there have been ten occasions since 1966 when the S&P 500 has fallen by more than 20% – the usual definition of a bear market – but only six of these have occurred in and around recessions.
Granted, recessions have usually been preceded by, or at least coincided with, bear markets. Of the seven recessions since 1966, only one – which ran from January to July 1980 – coincided with a peak-to-trough decline in the S&P 500 of less than 20%.
However, recessions have usually coincided with large bear markets. For example, there have been six occasions since 1966 when the peak-to-trough decline in the S&P 500 has exceeded 25% and five of these declines have occurred in, and around, recessions. The three biggest declines (of nearly 50% or more) all coincided with economic downturns.
By contrast, small bear markets have not tended to be accompanied by recessions. For example, there have been four occasions since 1966 when the peak-to-trough decline in the S&P 500 has been between 20% and 25%. Only one of these coincided with a recession. These small bear markets have also often reflected developments overseas. For example, the last one in 2011 was a reaction to the Greek crisis.
These observations may be of some comfort to those concerned that the recent slump in the S&P 500 is the harbinger of another recession. After all, the peak-to-trough decline in the index was only about 15% – less than the 20-25% correction of a small bear market that has typically not been followed by an economic downturn. In addition, the main cause of the slump was developments overseas – namely concerns about China.
Granted, the S&P 500 could yet plunge to new lows. But it has already rebounded more than 5% from its trough and we think it is more likely to make further headway – our end-2016 forecast for the index is 2,100, compared to a current level of around 1,910. In the meantime, we continue to expect the US economy to grow at a fairly healthy clip, paving the way for the Fed to tighten monetary policy further. (John Higgins)
Chart of the Day (For chart itself please see attachment.)
The price of gold has been boosted this year by three related factors, all of which owe something to worries about the world economy and financial system. The first is a sharp decline in expectations for global interest rates, with Japan’s central bank the latest to join the negative rates club. This has all but eliminated the opportunity cost of holding gold. The second is the renewed weakness in the dollar against other major currencies, reflecting the relatively large decline in expectations for US rates. And the third factor is a revival of demand for safe-havens.
These factors can be summed up in the close relationship between the price of gold and the level of short-term US Treasury yields, shown in the Chart below. The flipside, of course, is that the unwinding of these moves could now trigger at least a temporary correction in the gold price.
Nonetheless, it would be wrong to conclude that the prospects for gold boil down to a view on the outlook for US interest rates or Treasury yields. After all, the long bull market in gold in the 2000s survived a much more aggressive tightening from the Fed than looks remotely likely now. (See our Precious Metals Update, “Can gold rally even if Treasury yields rebound?”, published on Friday.) This was partly because of strong demand from households and central banks in emerging economies, which we expect to pick up again regardless of exactly what happens to Treasury yields.
What’s more, the factors driving investor demand for gold elsewhere may not be the factors that matter most in a year’s time. In particular, demand for safe-havens could be replaced by demand for inflation hedges. In a scenario where the Fed is raising US interest rates in response to strengthening inflation pressures, it would make perfect sense for rising Treasury yields to be accompanied by higher gold prices. We therefore reiterate our end-2016 forecast of $1,250 per ounce and still see plenty of upside potential over the coming years. (Julian Jessop)
What to watch for this week: US
The economic data releases this week should act as a timely reminder that, in contrast to futures market expectations, the Fed is unlikely to leave interest rates at near-zero levels for another year. We forecast a 5.5% m/m rebound in durable goods orders (Wednesday) in January. Meanwhile, we think that personal spending (Friday) increased by 0.5% m/m last month, with the gain likely to have been even bigger in real terms. We also suspect that there was finally a more substantial increase in the core PCE deflator (Friday) measure of inflation in January. If we are right, the Fed will find it increasingly hard to ignore evidence that core inflation is accelerating. (Paul Ashworth)
Consumer prices were unchanged in January, but the pick-up in core CPI inflation to a three-and-a-half-year high of 2.2% in January, from 2.1%, illustrates that domestic price pressures arerising. (Data released on Friday.) Energy prices dropped 2.8% m/m, while medical care prices were up 0.5% m/m. (Steve Murphy)
No major data or events scheduled for this week.
Consumer prices increased 0.2% m/m (s.a.) in January, as a sharp 0.6% m/m jump in food prices offset a 0.8% m/m decline in transportation prices. (Data released on Friday.) Added to some unfavourable base effects, that was enough to push the annual rate of headline inflation up to 2.0%, from 1.6%. The strength of inflation, despite the domestic economy’s woefully poor performance, is due to the collapse in the Canadian dollar. Excluding food and energy, core prices increased a seasonally adjusted 0.2% m/m in January and 2.0% over the past 12 months. Meanwhile, retail sales fell by 2.2% m/m in December, more than reversing the 1.7% m/m gain in November. (Paul Ashworth)
This coming week, the focus will undoubtedly be on the outcome of negotiations on Britain’s position in the EU. Meanwhile, euro-zone survey data are likely to show a deterioration in business and consumer confidence (Friday) as well as a slowdown in activity (09.00 GMT, Monday) in February, boding ill for Q1 GDP growth. In Ireland, opinion polls suggest that Friday’s general election will result in another coalition. (Jessica Hinds)
February’s decline in the EC measure of euro-zone consumer confidence probably reflected the declines in equity prices and increased concerns about the state of the global economy. (Data released on Friday.) The fall, from -6.3 to -8.8, was the fourth decline in six months and left the index at its lowest level since December 2014. On the basis of past form, confidence is now consistent with annual household spending growth slowing from 1.7% in Q3 to about 1.0%. (Jack Allen)
Monday’s CBI Industrial Trends Survey (11.00 GMT) is unlikely to bring any good news about the near-term prospects for the manufacturing sector. Meanwhile on Thursday, we expect to see GDP narrowly escape a downward revision. (Ruth Miller)
The Chancellor will have welcomed the better news on the public finances in January, ahead of the Budget next month. (Data released on Friday.) The surplus on the headline PSNB ex measure of borrowing of £11.2bn was larger than the £10.2bn in January 2015. That said, this left the cumulative total borrowing for the fiscal year so far at £66.5bn, just £7bn less than the OBR’s forecast of £73.5bn for the fiscal year as a whole.
Meanwhile, the recovery in spending on the high street is still looking strong. Retail sales volumes rose by 2.3% m/m in January, which left the annual growth rate at 5.2%. (Data released on Friday.) The breakdown showed that this was largely due to non-food store sales. (Paul Hollingsworth)
We expect the BoJ’s favourite inflation gauge (Thursday), which excludes fresh food and energy, to have slowed from 1.3% y/y in December to 1.2% y/y in January. Meanwhile, the monthly business surveys may reveal some strains from the recent market turmoil. We expect a slight drop in the flash estimate of the manufacturing PMI (02.00 GMT, Monday) from 52.3 in January to 52.0 in February, and a decline from 47.2 to 47.0 in the index of small business confidence (Wednesday). (Marcel Thieliant)
Australia & New Zealand
The big event this week will be the release of Australia’s private capital expenditure survey (Thursday) for Q4 2015. We estimate that real capital expenditure fell by a further 3.0% q/q at the end of last year and that the first estimate of capital expenditure in 2016/17 will be below the first estimate for 2015/16 of $103bn. Elsewhere, we think that the seasonally-adjusted trade deficit in New Zealand (Friday, local time) probably narrowed from $252m in December to $225m in January. (Kate Hickie)
There are no scheduled data releases of note from mainland China this week. However, Hong Kong GDP data (Wednesday) are likely to show that GDP growth slowed from 0.9% q/q in Q3 to 0.5% in Q4. (Chang Liu)
Other Emerging Markets
We expect final GDP data in Mexico (Tuesday) to confirm that the economy grew by 2.5% y/y in Q4 2015, down slightly from 2.6% y/y in Q3. Looking ahead, a fiscal squeeze, announced in response to the latest fall in oil prices, and tighter monetary policy, look set to weigh on growth this year. (Edward Glossop)
We think the Turkish central bank will continue to look through the deteriorating inflation outlook and keep its policy interest rate unchanged at 7.5% (Tuesday). The National Bank of Hungary’s MPC is due to meet on the same day and we expect the policy rate to be left on hold at 1.35%. Weak prospects for inflation there mean that the Council’s accompanying statement is likely to remain dovish. (William Jackson)
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