The risk rally’s back on and most of the credit’s going to easing of concern around Hurricane Irma and North Korea. There’s likely more to it than that.
Consider the latest price data from China. They indicated a surge in inflation that suggests global growth is on the march and should prolong the rebound in commodities. At the same time, loose financial conditions -- from persistently low interest rates to record equity prices and a weak dollar -- have created a feedback loop that’s intensified the hunt for yield.
European equities marched toward their longest winning streak in five months Tuesday after both the S&P 500 Index and MSCI’s World Index posted record highs a day earlier.
“We have solid global growth and some of the easiest financial conditions in history,” Andrew Sheets, Morgan Stanley’s chief cross-asset strategist, wrote in a client note. “Hooray.”
China’s producer prices surged 6.3 percent in August from a year earlier, ahead of expectations by a margin comfortable enough to drive speculation that the world’s second-largest economy may spark momentum across developed and emerging markets alike.
“The China reflation 2.0 story remains alive and may become a more dominant factor as the storms pass and North Korean tensions (hopefully) ease,” notes Ben Emons, chief economist at Intellectus Partners LLC.
It’s already sent emerging-market currencies and commodity prices rallying over the past month, and commodity demand from China will likely spur producer-price gains in developed markets, Emons said.
An uptick in China’s producer prices often spurs better-than-expected economic data in Europe and the U.S., potentially adding fresh impetus to the global rally.
“China reflationary impact has been one of the keys ensuring globally co-ordinated recovery through 2016/17,” Macquarie Group Ltd.’s Viktor Shvets and Chetan Seth note.
The surge in commodities -- copper and oil are up roughly 20 percent since their second-quarter lows, and iron ore has surged even more -- also confirms that the outlook for global stocks has solid foundations, according to JPMorgan Chase & Co strategists.
“The renewed strength in commodities is reinforcing the case for healthy third-quarter results,” strategists led by Mislav Matejka wrote in a note. The bulk of bullish earning projections for the second-half of the year come from the energy and materials sector, they said. If commodity prices hold at current levels, sales growth of companies in the U.S. and Europe could rise to about 5 percent year-on-year in the current quarter.
“We should also see some mean-reversion into value and resource stocks as global bond yields increase and geopolitical risk subsides,” adds Dennis Debusschere, head of portfolio strategy at Evercore ISI.
The signs of accelerating global growth come as liquidity conditions have loosened thanks to the dollar’s retreat, lower Treasury yields and the relative resilience of credit and equity markets.
Investors in the $14.1 trillion Treasuries market aren’t getting compensation for time risk, forcing money managers to pour more cash into risky assets. The extra compensation to own 10-year U.S. Treasuries instead of shorter-maturity obligations, for example, a spread known as the term premium, has fallen to October lows.
Loose liquidity conditions are giving ammunition to credit bulls from the U.S. to emerging markets, with Tajikistan the latest frontier issuer to join the junk-bond party. Citigroup Inc. strategists on Monday said investors should boost their exposure to investment-grade corporate debt by selling bond insurance, citing dovish projections for the U.S. interest-rate cycle.
“It becomes ‘the greater fool’ game with investors counting on the U.S. yields falling and thus search for yield becoming ever more frantic,” conclude Macquarie’s Shvets and Seth.
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