Global Equities: The Rally Is Broadening

Recent global equity market strength has been driven by U.S. large caps, but is becoming more widespread.

Global equities are up 12% since their June low, boosted by sharp declines in crude oil prices and bond yields. The benchmark is near its May high, and market health is improving. BCA’s breadth measure for 36 major country markets (i.e. how broad spread is the trend) has rebounded sharply in recent weeks, indicating that there is increasing participation in the equity rally. This reflects growing optimism that the U.S. economy will enjoy a soft landing and that inflationary pressures will diminish.

Still, although breadth is improving, more growth sensitive markets, industries and stocks are lagging as global economic growth moderates. However, only a handful of equity industry benchmarks have surpassed their May highs; the implication is that gains are broad- based, but not yet robust. This reinforces the view that while stocks should move higher, selectivity is increasingly important as global growth decelerates. This reflects the maturity of the bull market. Bottom line: With the global economy decelerating, further gains in global equity markets will be more narrowly based than during the past year.

Inflation - Global Growth Slowdown Should Temper Inflation Risks

Upward pressure on core inflation in the advanced economies should fade as global growth decelerates.

BCA’s measure of resource utilisation in the major economies is now above the peak in 2000, reflecting strong growth in industrial production and historically low unemployment rates. In the past, resource utilisation has correlated closely with the annual change in the G7 core inflation rate; not surprisingly, core inflationary pressures have been building. But the latter is concentrated in the U.S., where growth is already slowing. In fact, some leading inflation indicators in the U.S. have already rolled over. Modest capacity pressures are emerging in Japan, but there is as yet no sign they are pushing up core consumer prices. Core inflation is also stable in the euro area, reflecting lingering spare economic capacity. Bottom line: core inflation should soon peak as global growth moderates, enabling central banks to tread cautiously.

FOMC Minutes Retain a Hawkish Bias  

The minutes from September’s Fed meeting were another reminder that the Fed has no intention of cutting rates, at least in the short term. The Fed admitted that the drop in oil prices and emerging housing slowdown made September’s decision to stand pat a little easier. But most Fed officials were still more concerned about the inflation outlook, nonetheless. That should already have been obvious from the Fed’s decision to keep its tightening bias in place and Richmond Fed President Jeffrey Lacker’s preference for another rate hike.

But markets had begun to price in a rate cut early next year regardless. Overall, the minutes support the view that elevated core inflation will prevent the Fed from starting to cut rates until the second quarter of next year. After that expect to see rates fall rapidly to 4.0% by the end of next year as the Fed is forced into a rear-guard action to boost economic growth. 

RICS + BCC + 2 New MPC members => 5% rates in the UK

Two key surveys – the monthly Royal Institute of Chartered Surveyors (RICS) and the quarterly British Chambers (BCC) survey – both point to above trend growth into next year. The RICS house prices balance reached its highest level in over two years in September while the BCC total orders balance touched a ten-year high in Q3.

The appearance of new MPC members Tim Besley and Andrew Sentance in front of the Treasury Select Committee suggests that neither are champing at the bit to join David Blanchflower on the dovish side of the interest rate debate. Accordingly, at the margin, their testimonies will do little to alter expectations that the MPC will hike interest rates at November’s meeting. But it is worth remembering that MPC members tend to be very guarded during their first testimony to the Treasury Select Committee and it would be wrong to read too much into these sessions. Bottom line: Interest rates should – and probably will – rise to 5% in November.

And finally……….

A wealthy old lady decides to go on a photo safari in Africa, taking her
faithful aged poodle along for the company.
One day the poodle starts chasing butterflies and before long, he
discovers that he's lost. Wandering about, he notices a hungry-looking
leopard heading rapidly in his direction.

 The old poodle thinks, "Oh, oh! I'm in deep doo-doo now!"
Noticing some bones on the ground close by, he immediately settles down
to chew on the bones with his back to the approaching cat. Just as the
leopard is about to leap, the old poodle exclaims loudly, "Boy, that was
one delicious leopard! I wonder if there are any more around here?"

 Hearing this, the young leopard halts his attack in mid-strike.
A look of terror comes over him and he slinks away into the trees.
"Whew!" says the leopard, "That was close! That old poodle nearly had
me!"

 Meanwhile, a monkey who had been watching the whole scene from a
nearby tree, figures he can put this knowledge to good use and trade it
for protection from the leopard. The old poodle sees the monkey heading
after the leopard, and figures that something must be up. The monkey
soon catches up with the leopard, spills the beans, and strikes a deal
for himself with the leopard.

 The young leopard is furious at being made a fool of and says,
"Here, monkey, hop on my back and see what's going to happen to that
conniving canine!"

 Now, the old poodle sees the leopard coming with the monkey on
his back and thinks, "What am I going to do now?" But instead of
running, the dog sits down with his back to his attackers, pretending he
hasn't seen them yet. Just when they get close enough to hear, the old
poodle says, "Where's that darn monkey? I sent him off an hour ago to
bring me another leopard!"

 Moral of the story...
 Don't mess with old farts. Age and treachery will always
overcome youth and skill. 

HAVE A GREAT WEEKEND!

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.