Sentiment spike drives stock gains, fundamentals still precarious

There’s a relief rally afoot in global stock markets. Risk appetite has tangibly improved, with price action hinting that the latest bout of trade-war induced volatility is over, for now.

Source: Bloomberg

Relief floods the stock-market

There’s a relief rally afoot in global stock markets. Risk appetite has tangibly improved, with price action hinting that the latest bout of trade-war induced volatility is over, for now. The catalysts for the bolstered sentiment in the market are, more-or-less, twofold. The first: the classic case of central banks to the rescue. Ill-conceived or not, but the RBNZ’s highly aggressive 50-basis-point cut on Wednesday seems to have lifted confidence that other global central bankers will be more aggressive in their monetary policy support. The second: successive days of a stronger than expected Yuan fixes has ameliorated concerns that the US-China trade-war will not devolve into an all-out currency war.

Equity indices across the globe rally

Naïve or not, the combination of those two prevailing narratives has led to tangible bullishness in the market in the past 24-hours. The world equity index map is drenched in green, as investors apparently look to buy-up good stocks on the (relatively) cheap. Asian stocks lead the charge yesterday, with the ASX 200 adding 0.75%, and the likes of the CSI300 adding 1.32%. European equities powerfully followed suit, with the FTSE gaining 1.21% and the DAX rallying 1.68%. And as the centre of the financial universe, Wall Street has topped-off the day’s strong activity, with the benchmark S&P 500 climbing 1.88%.

Fear index suggests we are almost out of the woods

Based on gauges of fear in the market, as fallible as they may be, the market is coming close to being out of the woods, in the short-term. To be clear: the fundamentals haven’t shifted an iota. The global growth outlook is hardly any better than what it was at the start of the week. However, sentiment – the overriding, irrational driver of short-term price-action in financial markets – is improving to the point where further gains to risk assets look strongly-possible. Case in point: the VIX plunged last night. It sits around the 17 level now. Readings below 16 generally reflects a market optimistic enough to buy into risk-assets, and push the overall stock market higher.

The fundamentals are probably not better

There’s probably a catch to this, and this where long-term fundamentals come into play. Though stocks are recovering their losses this week at-the-moment, global government bonds haven’t quite retraced their gains. The implications for this ought to be considered crucial to the bigger picture. The general hit an escalating trade-war will have to the earnings outlook remains the same; all that is happening in the market presently is that risk free-rates are happening to be falling at a greater-rate than diminishing expectations for company profits are. That implies that earnings growth, ultimately the true driver of market price, is still in a weakening trend, portending a softer outlook for global equities moving into the future.

Bonds, gold and FX speaking the truth

Government bonds, currency markets, and commodity markets are providing a more accurate gauge on reality, still. The underlying trends in these markets haven’t changed a great deal in the last 24-48 hours, irrespective of what sentiment juicing news has been delivered to the stock-market. The pool of negative yielding government bonds is still swelling, with 10 Year German Bunds yielding below -0.5%, and 10 Year Japanese Government Bonds still yielding sub -0.2%. Gold prices remain elevated above the $US1500 mark, which hasn’t happened since the cheap(er)-money days of US quantitative easing. And the Japanese Yen hasn’t departed from its upward trend, dipping into the 105 handle again overnight.

Rate cuts are coming

The common thread behind of all of those markets is basically one thing: the expectation of some extraordinarily aggressive monetary policy easing from global central bankers. Again, the RBNZ seems to have set an expected precedent on Wednesday: policymakers are going to cut, and cut hard, to get ahead of the forecast economic slowdown. Interest rate curves are demonstration this fact wherever one may look. According to market-pricing, the Fed is a (crudely) 30% chance of cutting rates by 50 basis-points at its September meeting, the ECB will cut rates in September then December, and our own RBA will certainly be cutting by October and likely once again after that, in December.

RBA to headline calendar, ASX to join the party

As it applies to the RBA, market participants will be given the opportunity to test this thesis, somewhat, today. The central bank’s quarterly policy statement is released, and is expected to show a downgraded set of economic growth projections. It feeds into the view that the RBA is setting up for more interest rate cuts, as the global economy accelerates towards the end of this business cycle. Nevertheless, for the ASX 200, what the RBA has to say will be of secondary concern. There’s a wave of relief rushing through markets today, and the ASX ought to catch this today. SPI Futures are suggesting a 31-point jump at the open this morning.


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