E Markets: Reconvergence

Don’t expect the quality and success of any journey to stand on how it starts, this is a marathon not a sprint. Two clock paths that feed into a time series suffer clock reconvergence pessimism.

Perhaps in the new world of computer aided trading and thinking we all suffer from this bias. However, history is on the side of the optimists – there have only been 4 times since 1929 when the S&P500 fell in back-to-back years – and those were in recessions, the oil crisis and in wartime. The last time was 2000-2002. The history of trading markets over the last 40 years has been about convergence where global markets sprung up from the push for a global economy after the Pax Americana at the end of the cold war with the Soviet Union. The inclusion of China in the WTO in 2003 and the sprint of the emerging markets to catch up to the developing world brought 3 billion people out of poverty. The great recession gave pause to this movement and last year the Trump foreign policy and trade tariffs brought further doubts about how history plays out into 2019.

The first trading 3 days of 2019 proved more exciting than those of 2018 as the fear of a bear market requires more diligence than running with the bulls. We end the week with many rethinking their gloom with renewed talk of Goldilocks, where US growth is better, rates are not restrictive and global tensions ease. For those interested in history here is the January 7 Weekly Track from 2018 – outlooks and lookouts. For those looking for just how bad 2018 was, consider this chart from DB – the USD returns of all assets was the worst in history.

The rush to safe-havens in 2019 may be the logical consequence of 2018 but it surely is a risk for a reversal, as 2019 unfolds as the mirror image of 2018 – bears are in control, rallies are meant to be sold, good news is always countered by fear of policy mistakes.

There are three significant fears driving markets – 1) FOMC rate hikes, 2) China growth with or without US tariffs, 3) Global politics – whether it’s the US government shutdown or Brexit or rising populism in Europe or the key elections in the year ahead. The first week of the year brought hope that the first two drivers are going to be less scary – specifically because of Friday and the FOMC Chair Powell dovish comments – suggesting he would pause and if necessary ease or stop the QE unwind.

Also key was the China PBOC RRR cut of 1% where talk of officials pushing banks to lend to private enterprises drives hope for stabilization in the economy there. Finally the lessons of 2018 and fear about elections – with Macron and France being the poster child for relief. Many see the fear of politics as event risk specific rather than endemic to a new post convergence world. In fact, the bulls will argue that 2019 is about reconvergence, where value and growth plays in emerging markets lead to more global gains. The problems for emerging markets maybe about their own divergence as current accounts and currencies play out after 2018 pain from Brazil and South Africa to the more extreme stories of Argentina and Turkey. In between, India and Mexico look cheap.

The value of the USD has been linked to the expectations of its rate differentials into the next year with many expectations that this will narrow rather than widen driving up speculation for EM and EUR gains. Other factors are at play as well with growth, current account deficits, inflation and government stability all mattering and hurting the USD outlook. However, there are few alternatives to the USD with the EUR facing Brexit and budget and growth issues. This weekend, the German AfD threatens to put German exits to the EU at play. The deglobalization threats outside the US remain in play and will hinder the EUR.  The US dollar index is more in a range than a new trend. 

There are other things at play for 2019 beyond PPP, rate spreads, politics and trade. Those wrap around the flow of money - with the sentiment shifts from October to the present so dramatic its historic and stunning. Being able to reverse those into a meaningful new trend seems unlikely and unwise. The bears will remain in charge of the bigger equity pictures accordingly. The need for 1Q earnings to beat expectations, for 1Q growth to surprise to the upside and for central bankers to remain patient - all are key factors for trading all assets not just equities. 

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