Rather than MAGA perhaps it is time for the MEGA Trade — Make Europe Great Again. On Tuesday, the Trump Trade has had its first bona fide bad day with a 1.14 per cent fall for the S&P 500. That was unremarkable in itself, but after a period of calm stretching back to last October, in which the S&P managed to avoid any daily falls of as much as 1 per cent, it seemed rather a big deal.
Combine that with a fall in Treasury yields, now down more than 15 basis points in a week since they appeared on the cusp of breaking out upwards, and a fall in the dollar index to the bottom of its range, and markets had a decisive “reflation-off” day. Meanwhile, amazingly, European stocks overtook the US; the FTSE-Eurofirst 300 has now performed slightly better than the S&P 500, in common currency terms, since the US election.
As the US stock market is still up by a double-digit percentage since the election, it would be absurd to declare the Trump trade over. It is also hard to attribute Tuesday’s sell-off to the president’s current political difficulties. He certainly has some, and if he were to fail to get some workable compromise on healthcare through Congress then some the optimism on growth that has underpinned this rally would have to be cut back.
As it is, politics in Europe may be more important. Overblown negativity is in imminent danger of turning into overblown positivity.
The FTSE-Eurofirst 300 started its sharp rally against the S&P last Thursday, when traders arrived at work to news of a setback for the populist Geert Wilders in the Dutch election, and of what was regarded as a surprisingly dovish statement by the Federal Reserve. The euro was already recovering on the back of a surprisingly hawkish stance from the European Central Bank.
The odds on Emmanuel Macron winning the French presidency have increased slightly since Monday night’s presidential debate. But Europe’s political risks are significant and should plainly command a discount. Beyond France’s election, there is the continuing Greek debt crisis, and the uncertainty that Brexit will produce.
Rather than politicians, the most important market drivers continue to be central bankers. With the ECB setting itself up to be more hawkish, while the Fed has been more lenient, the gap between US and German bond yields has tightened considerably, relieving the upward pressure on the dollar. Add the UK inflation data, which increased the chance of monetary tightening there, and lifted the pound, along with last week’s tightening by the People’s Bank of China, and suddenly the US does not seem so out of step.
These shifts also call one of the assumptions of the reflation into question. The hope was that central banks would stay lower for longer, allowing more growth before applying the brakes; that looks to have diminished now.
The other critical factor this week is the oil price, which has now dropped clearly below its 200-day moving average for the first time since April last year. This has little or nothing to do with broader global demand and growth.
Speculators were heavily positioned “long” in oil as last week started, making a bet that the price would continue to rise. Further, the news on Saudi oil production, and on the scale of US inventories, showed that bullish hopes for oil prices had been overdone.
But even if oil’s fall was a function of the specific fundamentals of the oil market, and of traders’ positioning, rather than a retreat from a global reflation trade, the impact on energy stocks suggests that investors are unnerved. Relative to the rest of the US market, the energy sector is almost back to its lows from early last year, when the oil price was also at lows.
Cheaper oil also reduces short-term inflation expectations, and at the margin reduces the chance of a US rate rise, and it raises the chance of further pressure on high-yield bonds, heavily exposed to the US shale sector. That, again, would reduce pressure for a rise and impinge on growth.
None of this adds up to more than a reassessment of the Trump trade, as the US market is still up by a double-digit percentage since the election, but the internal pattern of returns suggest doubts about growth.
Growth has now outperformed value since the election, according to the Russell indices. That suggests that investors believe growth to be scarce; therefore they will pay more for it. Meanwhile large companies have almost overhauled small-caps, while the performance of financials, which benefit the most from higher rates compared to real estate, the sector which is arguably harmed the most, suggests a reassessment of the path of interest rates.
Thus far, none of this need be alarming. The rally had been looking overdone, and the streak of days without a one per cent fall was the eighth longest since S&P started keeping records almost 90 years ago.
A weaker dollar, stronger emerging markets, and a less frothy US stock market are all in a way healthy. Compared to the (justified) angst of late November and early December last year that the strong dollar and the new US protectionist agenda would force emerging markets into crisis, the position now is healthier for everyone — including the US.